Applications of Monopoly

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Lecture 14 Applications of Monopoly Theory
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Deadweight Loss of Monopoly

• The monopoly sets MRMC, despite the fact that P
  exceeds MC.
• This action generates a deadweight loss due to
  monopoly.
• Definition
• The deadweight loss of monopoly is the value of
  output minus cost between the monopoly output,
  where MRMC, and the output where PMC.

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Deadweight Loss of Monopoly

• Figure 17 illustrates deadweight loss. P24-Q
  again is inverse demand, MR24-2Q and MC2Q.
• Output under monopoly is Q m6, while output
  where PMC is Q c8. At Q m P18, MC12. The gray
  triangle is the deadweight loss. A tax increases
  this loss see figure 18.

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Chapter 10, Figure 17Deadweight Loss of Monopoly
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Chapter 10, Figure 18Taxation and the Deadweight
Loss of Monopoly
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Deadweight Loss of the Postal Service

• Figure 19 shows an estimate of the deadweight
  loss from the US Postal Services delivery of
  Third Class Mail.
• Private companies could have delivered this mail
  for 12.3 cents per piece.
• But the USPS charged 16.7 cents.
• Current delivery is 49.8 billion pieces.

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Deadweight Loss of the Postal Service

• The USPS estimates that the demand elasticity is
  0.63.
• Based on this information, delivery at P12.3
  cents would have been 60.4 billion pieces.
• The deadweight loss of the monopoly over third
  class mail is the blue area plus the gray, or
  2.46 billion dollars.

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Chapter 10, Figure 19Deadweight Loss of the U.S.
Postal Service
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Natural Monopoly

• Natural monopoly is brought about by increasing
  returns to scale.
• One leading cause of increasing returns is
  start-up costs. Figure 20 provides an example,
  where MCAC10 and start-up costs equal 60.
• Such a setting contributes to increasing
  returnsas shown by falling AC.

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Chapter 10, Figure 20Natural Monopoly
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Patent Monopoly

• Patent rights are another cause of monopoly. In
  the US the first firm to invent is awarded a
  monopoly on commercialization for a period of 17
  years after the award of the patent.
• Figure 21 shows a stylization of the monopoly on
  Tagamet (since contested by close substitutes
  like Zantac).

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Chapter 10, Figure 21Patent for the Drug Tagamet
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Regulation of Monopoly

• Figures 22 and 23 illustrate price regulation.
• Figure 22 shows that if there is sufficient
  knowledge and inclination, the government could
  set the competitive price and output.
• Figure 23 shows the case of a natural
  monopolyan electric utility.

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Regulation of Monopoly

• Here you can have the firm to charge PMC, in
  which case you must subsidize, because PMCltAC.
• Or you can have the firm charge a break-even
  price of PAC.
• But what all these solutions miss is that you
  can regulate simply by allowing cross-state
  competition!

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Regulation of Monopoly?

• This is exactly what is happening now.
  Ironically, regulators formerly prohibited
  cross-state electricity sales.
• This brings up the point that government has
  often been responsible for legal monopolies,
  like the post office, state-run liquor stores,
  and so on.

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Chapter 10, Figure 22Optimal Price Regulation
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Chapter 10, Figure 23Regulating an
Electric Utility