The Welfare Economicsof Market Power

Roger WareECON 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) MCMR(Q)

Lerner Index of Monopoly

Measurement of Deadweight Loss

Example: Dead Weight Loss in the Superior Propane

Merger