The Welfare Economics of Market Power Roger Ware

The Welfare Economics of Market Power Roger Ware ECON 445

Consumer Surplus, Producer Surplus, Total Surplus • Consumer Surplus is the difference between the consumer's willingness to pay for another unit of output and the price actually paid. • Producer Surplus is the difference between what a producer receives (price) and marginal cost – the minimum required to ensure supply. • Total Surplus is just the sum of Consumer and Producer Surplus

Consumer Surplus and Producer Surplus

General Theorems on Economic Efficiency • Competitive markets lead to all prices being set equal to marginal cost • Competitive equilibria (in ALL markets) are Pareto optimal (first theorem of welfare economics). In partial equilibrium terms this is equivalent to maximizing total surplus.

Competitive Equilibria 2 • Departures from competitive markets can occur because of externalities and other market failures • They can also occur because of the exercise of market power, which is the focus of Competition Policy

Market Power • A firm has market power if it finds it profitable to raise price above marginal cost. • A firm with market power is often called a price maker (as opposed to a price taker in a competitive market) • The exercise of market power involves a loss of surplus to society, often called “deadweight loss”

Monopoly Pricing (review) P(Q) MR(Q) MC

Lerner Index of Monopoly

Measurement of Deadweight Loss

Example: Dead Weight Loss in the Superior Propane Merger