Chapter 3: Welfare Economics

1
Chapter 3 Welfare Economics

• General Analysis Overview
• Welfare under Monopoly
• Welfare under Monopsony
• Welfare under Middlemen

2
General Analysis Overview

• Welfare analysis is a systematic method of
  evaluating economic implications of alternative
  allocations. It answers the following
  questions
• 1. Is a given resource allocation efficient?
• 2. Who gains and who loses under various
  resource allocations? By how much?
• Welfare economics A methodological approach to
  assess resource allocations and establish
  criteria for government intervention.
• Partial analysis Evaluates outcomes in a subset
  of markets assuming efficiency in others.

3
Graphs of Demand and Supply
D demand curve
S supply curve Area under demand curve ABC0
gross Area under supply curve 0ELM cost
benefits from consumption.
of production. ABP consumer
surplusarea between PLM producer
surplusarea demand and price.
between price and supply
4
Efficient outcome
When there are no externalities, an efficient
outcome occurs where the sum of consumers and
producers surplus is maximized.
Area under demand gross benefits Area under
supply gross cost Social surplus gross
benefit cost.
5
Welfare under Monopoly

• A monopoly is the only seller in a market. The
  basic condition for a monopoly is
• Optimality occurs where
• MR(Q)-MC(Q)0, where MRmarginal revenue and
  MCmarginal cost

6
Monopoly
P
Qc, Pcunder competition Qm,Pmunder monopoly
C
A
Pm
Monopoly produces too little and charges too
much. Welfare loss under monopoly is
.
C
Pc
B
MR
D
Qc
Qm
Q
7
Linear Example of Monopoly-1
Inverse demand P(Q) a - bQ Revenue (a - bQ)Q
aQ-bQ2 Supply c dQ Competitive outcome is
where Demandsupply? a - bQ c dQ
8
Linear Example of Monopoly-2
Under monopoly, MRMC
9
Welfare under Monopsony

• A monopsony is the only buyer in a market.

P
MO
MC
Qc, Pcunder Competition Qmn,Pmnunder Monopsony
Pc
Pmn
D
Q
Qmn
Qc
10
Calculation of monopsony

• Maximization equation
• Area
• Optimality condition
• Price paid by monopsony

11
Summary of monopoly and monopsony

• Monopolist Underbuys and oversells.
• MonopsonistUnderbuys and underpays.

12
Welfare under Middlemen

• A middleman is the only buyer and seller of
  product.

MO
P
S
Qmmmiddlemen output Pmmsprice paid by
middlemen to supplier Pmmbprice paid to
middlemen by buyer
Pmmb
C
E
Pmms
MR
D
Q
Qmm
13
Profits under Middlemen

MO
P
S
Profits PmmbCEPmms
Pmmb
C
E
Pmms
MR
D
Q
Qmm