Лекции_Микроэкономика

be treated as an increase in MC. As this increase is the same at every level of output, the MC shifts up parallel, which implies that industry supply curve shifts up by the value of tax.

As a result consumers’ price goes up and quantity produced falls.

Conclusion: this policy results in DWL D G

Alternative approach to calculation of DWL: Total benefit is reduced by (D+G+I), while cost goes down only by I and as a result TS ( D G I ) I ( D G )

Q

Qt Q

Note that both producers and consumers are worse off due to the tax. Distribution of the tax burden b/w consumers and producers depends on relative slopes of demand and supply curves. Note that relationship b/w slopes implies the corresponding relationships of price elasticities.

61

A.Friedman ICEF-2012

Since in equilibrium QS QD Q , then demand at equilibrium is less/more price elastic (in

terms of absolute value) than supply if and only if demand (in terms of absolute value) is steeper/flatter:

Greater share of tax burden corresponds to market side with lower (in terms of absolute value) price elasticity

5.3 Monopoly

Fundamental assumptions of pure monopoly

Single firm is a price maker (affect price by changing its output level)

Buyers are price takers

Price discrimination is impossible (each consumer pays the same price)

Entry is blocked

Relationship between MR and inverse demand function:

Special case of linear demand function p Q A bQ . In this case MR curve is also linear and two times steeper than inverse market demand MR Q A bQ bQ A 2bQ .

p

where pd denotes price elasticity of demand.

Conclusion 1: monopolist produces only at (price) elastic part of market demand.

63

Resource-based monopoly power comes from the exclusive ownership of a natural resource essential in a particular production process.

Regulator can force the monopolist to sell off some portion of essential resource, which makes competition a feasible market alternative to monopoly.

Patent monopoly arises from government action to enable inventors and authors to gain the exclusive right to their respective discoveries and writings by means of patent or copyright.

Patents serve a potentially useful economic purpose by stimulating the invention and developments of new products. Eliminating patenting rights does not necessarily increase efficiency because the economic benefit to consumers of patented products might outweigh the economic cost of monopolistically exploited innovations. Regulation requires the optimal length of patent.

Monopoly by good management occurs when the monopolist can deter entry and finds it profitable to do so. In fact this type of monopoly results from oligopolistic strategic interactions between the established monopoly and a potential entrant.

In this case the monopolist will not produce the output that corresponds to equality of MR and MC. The firm would maximize the profit taking into account additional constraint that comes from the possibility of entry that results in oligopolistic competition. To deter entry firm may decide to produce output that exceeds the standard monopoly output.

Regulatory responses to monopoly 1) Average cost pricing

Objective: to limit monopoly to a fair, or normal, rate of return

65

Problem: even though average cost pricing (if successful) does eliminate monopoly profit, it does not induce the monopolist to produce the efficient level of output. Both overproduction

(a) and underproduction (b) relative to efficient output may take place.

p AC

p AC

Moreover average cost pricing do not provide incentive to minimize the costs of production as this policy allows monopoly to cover its cost but do not allow to make a profit.

Finally, knowing that the regulator is going to use AC information to set price, a rational firm would misreport its AC curve in order to get positive profit. As regulation is based on private information, monopoly will use this information to its own advantage and report AC that induce regulator to set monopoly price.

2) Rate of return regulation

Rate of return regulation is aimed at limiting the rate of return a regulated monopoly can earn on its invested capital. Suppose that monopolist produces output with 2 factors of production, capital owned by the firm and labour hired by the firm. The monopolist’s total return on its capital is given by the difference between total revenue and labour costs: TR Q wL Q . Rate of return regulation imposes the following constrained on the firm’s behaviour:

TR( K ,L ) wL K ,

where is the allowed rate of return on capital Regulatory agency will choose that is not

less than r as otherwise monopolist’s profit would be negative and he will be forced out of business:

K ,L TR( K ,L ) wL rK r K 0 if r .

If r monopolist will chose the combination of inputs that is not cost minimizing: he has

an incentive to use too much capital and too little labour as with increase quantity of capital used monopolist can get higher profit.

3) Marginal cost pricing combined with lump sum subsidy (if necessary)

Regulator may set efficient price and if AC is above this level (it might be the case with natural monopoly due to diminishing AC) the policy could be combined with the lump-sum subsidy that allows to cover the gap.

66

Implementation problem is similar to the one discussed with respect to AC pricing: knowing that the regulator is going to use private information on MC to set price, a rational firm would misreport its MC and induce regulator to set monopoly price.

4) Per unit subsidy

As unregulated monopoly under-produces relative to efficient output, government can create an incentive for output expansion by offering per unit subsidy.

$

But problem with private information is not eliminated. The efficient subsidy rate is given by seff MC Qeff MR Qeff and Qeff is a solution of the equation p Qeff MC Qeff . Thus

we need information on private marginal cost to find efficient subsidy rate, which create an incentive for misreporting.

5) Efficient regulatory mechanism based on market demand only

The scheme proposed by Loeb and Magat (1979) does not require private information to attain efficient output. The idea is to give monopoly a subsidy, equal to the value of CS. In this case monopolist profit will be given by the sum of profit from sales (PS) and subsidy (CS). Thus profit maximization would be equivalent to the maximization of TS. By definition output that brings maximum TS is efficient. Thus monopolist will choose efficient level of

67

output. To implement this policy regulator needs information on demand curve (which is not related to monopolist), so we eliminate the problem of misreporting.

To implement this policy regulator needs to subsidize the profit can be taxed away without any efficiency loss by combining this subsidy with profit tax.

5.4 Monopolistic price discrimination

Price discrimination- selling different units at two or more different prices for reasons not associated with differences in costs.

Necessary conditions for profitable price discrimination:

the firm must be a price maker;

the firm must be able to identify which consumer is which (i.e. identify willingness to pay);

the firm must be able to prevent consumers from engaging in arbitrage (arbitrage is the process whereby customers whom the firm charges low prices make purchases that they then resell to customers who would otherwise have to pay high prices);

the transaction costs (the costs of meeting the second and third requirements) must be less than the benefits.

Perfect or first degree price discrimination - the practice of selling each unit of output at a price just equal to the buyer’s maximum willingness to pay for that unit.

Under first degree price discrimination monopolist leave consumers with zero CS as each unit is sold at price, equal to maximum willingness to pay. Thus monopolist gets TS and trying to maximize it, he will end up with efficient level of output.

Example. Suppose that the good is discrete, MC=const and there are two consumers with different demand functions.

Monopolist will sell 2 units to agent A at prices 14 and 8, which bring profit of 22-10=12 and 3 units to agent B at prices 12, 9 and 6, that brings profit of 27-18=9. Thus total profit is 21. He is not willing to produce the sixth unit as additional cost of 5 can’t be covered since the maximum willingness to pay for additional unit is only 4.

68

Let us compare TS under pure monopoly and under market segmentation.

The total output produced under market segmentation may rise, fall or stay the same as under pure monopoly.

But we should take into account that under market segmentation output is inefficiently allocated among consumers.

Conclusion 1. If price discrimination does not bring an increase in output, then

TS segm TS monopoly.

Conclusion 2. If price discrimination results in an increase in output, the change in TS is ambiguous: it may rise, fall or stay the same.

Special case of linear demand functions and constant MC.

Let us consider a special case of third-degree price discrimination, when demand curves are liner and marginal costs are constant.

Claim 1. If all markets are served under uniform price then discrimination lowers (total) welfare in comparison with pure monopoly.

c ai / bi . To find output under pure monopoly, we need to find aggregate demand, derive the corresponding marginal revenue function and the equate MR with MC.

We look only at the segment of market demand where sales are positive at all markets, thus

i

Now, let us find sales under market segmentation. As we know at each segment marginal