Recap. What do we know about efficiency so far?

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Mercy Ferguson
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1 Recap What do we know about efficiency so far?

2 Key Efficiency Definitions Recap Allocative Efficiency Productive Efficiency Static Efficiency The optimum allocation of scarce resources that best accords with the consumers pattern of demand AR=MC When a firm operates at the minimum ATC, producing the maximum outputs per input into the production process Bottom of ATC Efficiency at a point in time includes allocative and productive efficiency Dynamic Efficiency Efficiency over time new products, techniques and processes which increase economic growth Dependent on R&D investment

outputs per input into the production process Bottom of ATC Efficiency at a point in time includes allocative and productive

3 Recap: Long run equilibrium in Perfect Competition and efficiency MC ATC D=AR=MR Output The diagram shows long run equilibrium in perfect competition AR=ATC so normal profits are being made Remember MC always crosses ATC at its lowest point The firm operates at Profit Max: MC=MR At this point AR=MC so the firm is also ALLOCATIVELY EFFICICENT The firm is operating at the bottom of its ATC curve so the firm is PRODUCTIVELY EFFICIENT Because both of these are achieved we say the firm is STATICALLY EFFICIENT

operates at Profit Max: MC=MR At this point AR=MC so the firm is also ALLOCATIVELY EFFICICENT The firm is operating at the

4 Perfect Competition and Dynamic Efficiency Dynamic Efficiency relies on R&D investment Does this happen in perfect competition? How do we explain this?

5 Monopoly and Efficiency

6 Efficiency based Arguments against Monopoly Allocative and Productive Efficiency

7 Monopoly and Allocative Efficiency The conventional textbook argument against market power is that monopolists can earn abnormal (supernormal) profits at the expense of efficiency and the welfare of consumers and society. Competitive Market s d Pure Monopoly PROFIT MAXIMISATION MR=MC MC ALLOCATIVE EFFICIENCY AR=MC MR AR=P=D The introduction of the MR curve reduced output and increases price. The firm no longer operates at the point of allocative efficiency Consumers are overcharged and under supplied Output Output

Competitive Market s d Pure Monopoly PROFIT MAXIMISATION MR=MC MC ALLOCATIVE EFFICIENCY AR=MC MR AR=P=D The introduction of the

8 Deadweight Loss of Welfare because of monopoly Pure Monopoly PROFIT MAXIMISATION MR=MC MC ALLOCATIVE EFFICIENCY AR=MC Which area represents the loss in consumer surplus? Which area represents the loss in producer surplus? MR Output AR=P=D Deadweight loss of welfare: Reduction in consumer and producer surplus when output is restricted to less than the optimum level

Which area represents the loss in producer surplus?

9 This diagram makes the assumption of constant long-run average and marginal costs under both competition and monopoly Before the MR curve is introduced the firm will operate at allocative efficiency (MC=AR) and consumer surplus will be maximised When the MR curve is introduced production moves back to Profit Maximising MC=MR and the orange area becomes a deadweight loss of welfare At MC=MR AR>AC so this means a supernormal profit is being made, represented by the green area The monopolist has turned consumer surplus into profit The new area of consumer surplus is shown in yellow greatly reduced

moves back to Profit Maximising MC=MR and the orange area becomes a deadweight loss of welfare At MC=MR AR>AC so this means a supernormal profit is

10 Monopoly and Productive Efficiency MC ATC Does a monopolist always operate at the bottom of the ATC curve? Why not? MR D=AR Is productive efficiency always achieved in monopoly then? But is it possible? Output

11 Monopoly and Static Efficiency Likely?

12 Efficiency based Arguments for Monopoly Dynamic Efficiency and Economies of Scale

13 Monopoly and Dynamic Efficiency Supernormal Profit MC ATC Can the supernormal profits be maintained? Why? Investment in R&D likely? Innovation likely? Dynamic efficiency likely? MR D=AR Output Based on the differing situation with Perfect Competition and Monopoly and DYNAMIC EFFICIENCY is monopoly always bad for the consumer and economic welfare?

14 Monopoly and Dynamic Efficiency As firms are able to earn abnormal profits in the long run there may be a faster rate of technological development that will reduce costs and produce better quality items for consumers. Monopoly power can be good for innovation. Despite the fact that the market leadership of firms like Microsoft and Sony is often criticised, their investments in research and development (R&D) can be beneficial to society because they expand the technological frontier and open new ways to prosperity. Many innovations are developed by firms with patents on the leading-edge technologies.

Despite the fact that the market leadership of firms like Microsoft and Sony is often criticised, their investments in research and development (R&D)

15 Monopoly and Economies of Scale Economies of scale sends MC down and thus supply up, this results in a lower price Given the new supply curve the monopolist does not achieve allocative efficiency, but in comparison to prior to the economies of scale there is still a fall in price and an increase in quantity

monopolist does not achieve allocative efficiency, but in comparison to

CHAPTER 12 MARKETS WITH MARKET POWER Microeconomics in Context (Goodwin, et al.), 2 nd Edition

CHAPTER 12 MARKETS WITH MARKET POWER Microeconomics in Context (Goodwin, et al.), 2 nd Edition Chapter Summary Now that you understand the model of a perfectly competitive market, this chapter complicates