Economics Online Tutor

Monopolies: Efficiency and
Price Discrimination

MONOPOLY AND EFFICIENCY


BECAUSE A MONOPOLIST SELLS A LOWER QUANTITY AT A HIGHER PRICE, ALL ELSE EQUAL, THAN A FIRM
IN PERFECT COMPETITION, THE MONOPOLY MARKET STRUCTURE IS CONSIDERED TO BE INEFFICIENT.

RECALL FROM THE DISCUSSION OF PERFECT COMPETITION, WHICH IS CONSIDERED TO BE THE MOST
EFFICIENT MARKET STRUCTURE, THAT EFFICIENCY IS DEFINED BY TOTAL SURPLUS.  TOTAL SURPLUS IS
MAXIMIZED UNDER PERFECT COMPETITION, AND INCLUDES THE ENTIRE AREA LEFT OF THE EQUILIBRIUM
POINT LYING BOTH BELOW THE DEMAND CURVE AND ABOVE THE SUPPLY CURVE.

CONSUMER SURPLUS IS THE PORTION OF TOTAL SURPLUS THAT LIES ABOVE THE MARKET PRICE.  
PRODUCER SURPLUS IS THE PORTION OF TOTAL SURPLUS THAT LIES BELOW THE MARKET PRICE.

FOR A MONOPOLIST, THE SAME GRAPH WOULD HAVE THE MARGINAL COST CURVE SUBSTITUTE FOR THE
SUPPLY CURVE.  THIS ALLOWS FOR COMPARISON OF SURPLUS BETWEEN THE TWO MARKET
STRUCTURES.

THE MONOPOLIST WOULD HAVE A HIGHER PRICE AND LOWER OUTPUT.  THE AREA OF TOTAL SURPLUS IS
LOWER UNDER A MONOPOLY THAN UNDER PERFECT COMPETITION BY THE AREA BORDERED BY THE
MONOPOLIST'S PRICE AND OUTPUT POINT, THE POINT WHERE THIS QUANTITY INTERSECTS THE
MARGINAL COST CURVE, AND THE PRICE AND OUTPUT POINT UNDER PERFECT COMPETITION.

THIS TRIANGULAR AREA REPRESENTS LOSS OF TOTAL EFFICIENCY, AND IS CALLED DEADWEIGHT LOSS.

ALSO, THE AREA OF THE REMAINING TOTAL SURPLUS UNDER MONOPOLY THAT LIES BETWEEN THE
MONOPOLIST'S PRICE AND THE PRICE UNDER PERFECT COMPETITION REPRESENTS SURPLUS THAT IS
TRANSFERRED FROM THE CONSUMER TO THE PRODUCER.

THE NET RESULT IS THAT A MONOPOLY MARKET STRUCTURE WILL HAVE A LOWER CONSUMER SURPLUS
(CONSUMERS ARE WORSE OFF), A HIGHER PRODUCER SURPLUS (SELLERS ARE BETTER OFF), AND A
LOWER TOTAL SURPLUS, RESULTING IN LESS EFFICIENCY.

MONOPOLY AND PRICE DISCRIMINATION


IN GENERAL, A FIRM CANNOT LOWER ITS PRICE ON SOME UNITS SOLD WITHOUT LOWERING ITS PRICE
ON ALL UNITS SOLD, EVEN THE UNITS THAT IT COULD SELL AT A HIGHER PRICE.  OTHERWISE, THE
CUSTOMERS THAT PAY THE LOWER PRICE WILL SIMPLY SELL THE PRODUCT TO THE CUSTOMERS WHO
WOULD BE CHARGED THE HIGHER PRICE.  THIS WOULD PREVENT THE FIRM FROM MAKING SALES AT
THE HIGHER PRICE.

UNDER CERTAIN CONDITIONS, THOUGH, A MONOPOLIST MAY BE ABLE TO CHARGE DIFFERENT PRICES
TO DIFFERENT CUSTOMERS BASED ON WILLINGNESS TO PAY.  IT COULD INCREASE REVENUE WITHOUT
INCREASING COST, AND THEREFORE INCREASE PROFIT BY DOING SO.

IF THE MONOPOLIST CAN IDENTIFY DIFFERENT CLASSES OF BUYERS, WITH DIFFERENT DEMAND
CURVES WITH DIFFERENT ELASTICITIES, AND AT THE SAME TIME PREVENT RESALES OF ITS PRODUCT, IT
CAN GAIN BY USING PRICE DISCRIMINATION.

EXAMPLES OF PRICE DISCRIMINATION IN THE REAL WORLD:

AIRLINES CHARGE HIGHER PRICES DURING THE TIMES AND DATES WHEN BUSINESS TRAVEL IS HIGHEST.  
BUSINESS CUSTOMERS HAVE A LOWER PRICE ELASTICITY OF DEMAND THAN OTHER CUSTOMERS.

RESTAURANTS, THEATERS, AND OTHER BUSINESSES OFTEN GIVE SENIOR CITIZEN DISCOUNTS TO A
CLASS OF CUSTOMERS THAT INCLUDES MANY PEOPLE ON A SMALLER BUDGET (THINK FIXED INCOME)
THAN THE GENERAL POPULATION.

IN-STATE TUITION, GROCERY COUPONS, AND LOWER PRICES FOR LARGER (BULK) PURCHASES ARE
OTHER FORMS OF PRICE DISCRIMINATION.