Evaluating the Gains and Losses from Government Policies—Consumer and Producer Surplus

We saw at the end of Chapter 2 that a government-imposed price ceil- ing causes the quantity of a good demanded to rise (at the lower price, consumers want to buy more) and the quantity supplied to fall (pro- ducers are not willing to supply as much at the lower price). The result is

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The Efficiency of a Competitive Market

To evaluate a market outcome, we often ask whether it achieves economic efficiency—the maximization of aggregate consumer and producer surplus. We just saw how price controls create a deadweight loss. The policy therefore imposes an efficiency cost on the economy: Taken together, producer and con- sumer surplus are reduced by the amount of the

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Minimum Prices

As we have seen, government policy sometimes seeks to raise prices above market-clearing levels, rather than lower them. Examples include the former regulation of the airlines by the Civil Aeronautics Board, the minimum wage law, and a variety of agricultural policies. (Most import quotas and tariffs also have this intent, as we will see

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Price Supports and Production Quotas

Besides imposing a minimum price, the government can increase the price of a good in other ways. Much of American agricultural policy is based on a system of price supports, whereby the government sets the market price of a good above the free-market level and buys up whatever output is needed to maintain that

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Import Quotas and Tariffs

Many countries use import quotas and tariffs to keep the domestic price of a product above world levels and thereby enable the domestic industry to enjoy higher profits than it would under free trade. As we will see, the cost to taxpay- ers from this protection can be high, with the loss to consumers

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The Impact of a Tax or Subsidy

What would happen to the price of widgets if the government imposed a $1 tax on every widget sold? Many people would answer that the price would increase by a dollar, with consumers now paying a dollar more per widget than they would have paid without the tax. But this answer is wrong. Or

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Introduction to Monopoly

As the sole producer of a product, a monopolist is in a unique position. If the monopolist decides to raise the price of the product, it need not worry about competitors who, by charging lower prices, would capture a larger share of the market at the monopolist’s expense. The monopolist is the market and

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Monopoly Power

Pure monopoly is rare. Markets in which several firms compete with one another are much more common. We say more about the forms that this competition can take in Chapters 12 and 13. But we should explain here why each firm in a market with several firms is likely to face a downward-sloping demand

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Sources of Monopoly Power

Why do some firms have considerable monopoly power while other firms have little or none? Remember that monopoly power is the ability to set price above marginal cost and that the amount by which price exceeds marginal cost depends inversely on the elasticity of demand facing the firm. As equation (10.4) shows, the less

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The Social Costs of Monopoly Power

In a competitive market, price equals marginal cost. Monopoly power, on the other hand, implies that price exceeds marginal cost. Because monopoly power results in higher prices and lower quantities produced, we would expect it to make consumers worse off and the firm better off. But suppose we value the welfare of consumers the

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Introduction to Monopsony

So far, our discussion of market power has focused entirely on the seller side of the market. Now we turn to the buyer side. We will see that if there are not too many buyers, they can also have market power and use it profitably to affect the price they pay for a product.

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Monopsony Power

Much more common than pure monopsony are markets with only a few firms competing among themselves as buyers, so that each firm has some monop- sony power. For example, the major U.S. automobile manufacturers compete with one another as buyers of tires. Because each of them accounts for a large share of the tire

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Limiting Market Power: The Antitrust Laws

We have seen that market power—whether wielded by sellers or buyers—harms potential purchasers who could have bought at competitive prices. In addition, market power reduces output, which leads to a deadweight loss. Excessive mar- ket power also raises problems of equity and fairness: If a firm has significant monopoly power, it will profit at

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Capturing Consumer Surplus

All the pricing strategies that we will examine have one thing in common: They are means of capturing consumer surplus and transferring it to the producer. You can see this more clearly in Figure 11.1. Suppose the firm sold all its output at a single price. To maximize profit, it would pick a price

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Price Discrimination

Price discrimination can take three broad forms, which we call first-, second-, and third-degree price discrimination. We will examine them in turn. 1. First–Degree Price Discrimination Ideally, a firm would like to charge a different price to each of its customers. If it could, it would charge each customer the maximum price that the

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Intertemporal Price Discrimination and Peak-Load Pricing

Two other closely related forms of price discrimination are important and widely practiced. The first of these is intertemporal price discrimination: sep- arating consumers with different demand functions into different groups by charging different prices at different points in time. The second is peak-load pricing: charging higher prices during peak periods when capacity constraints

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The Two-Part Tariff

The two-part tariff is related to price discrimination and provides another means of extracting consumer surplus. It requires consumers to pay a fee up front for the right to buy a product. Consumers then pay an additional fee for each unit of the product they wish to consume. The classic example of this strat-

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Bundling

You have probably seen the 1939 film Gone with the Wind. It is a classic that is nearly as popular now as it was then.13  Yet we would guess that you have not seen Getting Gertie’s Garter, a flop that the same company (MGM, a division of Loews) also distributed. And we would also

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Advertising

We have seen how firms can utilize their market power when making pricing decisions. Pricing is important for a firm, but most firms with market power have another important decision to make: how much to advertise. In this sec- tion, we will see how firms with market power can make profit-maximizing advertising decisions, and

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The Vertically Integrated Firm

Many firms are integrated—they consist of several divisions, each with its own managers. Some firms are horizontally integrated: There are several divisions that produce the same or closely related products. We saw an example of this when we discussed the multi-plant firm in Section 10.1. Some firms are verti- cally integrated: They have several

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