NOTE: The first 6 slides I showed are in the file from Nov. 8.

Social Consequences

Some consumer surplus goes instead to the firm (higher prices); some is lost as output decreases. The value of the lost consumer surplus is called the deadweight loss of monopoly. The market is NOT efficient. Some beneficial transactions do not occur. The monopolist produces too little. Additional units have a value to consuemrs (price they'd pay) greater than the marginal cost of producing them. The monopolist won't produce these units because it would gain less in revenues (MR) than the cost of producing them (MC).

Social consequences continued

Cost may be higher. Under competition, those who fail to keep costs to a minimum will operate at a loss because entry will drive the price down to minimum average cost of the efficient firms. A monopolist which fails to keep costs to a minimum will usually still earn an economic profit (although in the long run entry will be somewhat more likely). Additional resources will be used in rent-seeking -- in persuading the government to grant it a monopoly or to raise barriers to entry.

Smaller monopoly burden

The deadweight loss due to monopoly will be less If production on a larger scale reduces costs. If there are external costs associated with production. A smaller output and higher prices reduce the burden of pollution. There is no guarantee that the smaller monopoly output is the socailly optimal level. Fear of consumer or government backlash against monopoly practices can induce the firm to produce more and sell at a lower price. All entry barriers are eventually overcome.

Policy considerations
Monoplies created through mergers or other actions of the firm create a dead-weight and offer no offsetting advantages. The government tries to prevent the formation of such monopolies through anti-trust activities which prevent mergers or outlaw anti-competitive conduct.

Policy- franchises

The government which grants the franchise tries to reduce the dead-weight loss by requiring some level of service and regulating the price. The government granting the franchise often asks the firm to carry out other policies which promote the public interest and which the firm would not otherwise do. Example: requiring the garbage franchisee to offer curb-side recycling to reduce the external (garbage disposal) costs of consumption. Because the franchisee has reduced risk and greater profits, firms will use resources to acquire franchises or to persuade government to create a monopoly. Firms spend on lobbying, political campaigns, and elaborate presentations to win the franchise. The cost of these activities (known as rent-seeking) add to the burden on the economy.

Patent monopolies

If the new product or process is easily copied, then, without a patent, the innovator is unlikely to be able to earn enough revenues before others enter the market to recover the cost of research and development. Without the prospect of the patent, research and development will not take place. The new idea will not be developed and introduced to the market. The patent is worth granting because without it the consumer and producer surplus (social gains) available even under monopoly would be lost. If it's difficult to copy the new idea quickly, the innovator might be able to earn sufficient revenues to cover the costs even without a patent. Development will occur anyway. In that case, a patent reduces the surplus. The monopolist will not face competition and will restrict output for longer than would occur without a patent. There's no way to know ahead of time whether the innovation would have been developed in the absence of a patent or how many future inventions will fall in each category. Threfore, we grant patents to all new products and processes at the innovator's request.

Policy toward Natural monopoly
Natural monopolies are the result of the technology which creates the economies of scale and the size of the market, not government or company action. Any effort to break up the firm or enforce competition results in higher costs (in the short-run) and long-term failure. The government accepts the monopoly and tries to improve performance through regulation.

Rate regulation

Breaking up a natural monopoly into separate firms would raise costs and be unstable. To ensure that consuemrs benefit from economies of scale and to improve the efficiency of the market, the government (usually state) regulates natural monopolies. The regulatory agency sets the price the firm can charge after viewing the evidence and holding a series of rate hearings. For efficiency, the should evaluate MC and set p = MC. A natural monopoly receiving that price would have to subsidize to continue producing at that price. So the regulator sets p = AC; that is , they set price to cover expenses (accounting costs) plus a normal return on what stockholders have invested in plant and equipment anf financial assets.

Problems with Regulation
Firm increase spending on capital goods to increase its ratebase and profits. Regulators are/become friendly to the regulated firms. All requests are passed. Entry blocked to help established firms. Incentives to innovate and look for cost savings are blunted. Time for rate increase to be approved (regulatory lag) to some degree offsets other factors leading to higher prices.