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Price control by Commerce Commission Justified under Monopoly- but what happens?. Previously, neoclassical view: GE under perfect competition led to (a) Price = MC (b) Price = min. ATC and (c) markets all cleared.

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Price control by commerce commission justified under monopoly but what happens

Price control by Commerce Commission Justified under Monopoly- but what happens?

Previously, neoclassical view: GE under perfect competition led to (a) Price = MC

(b) Price = min. ATC and (c) markets all cleared.

And any state interference in free markets would lead to sub-optimal results unless there existed monopoly or externalities.

With monopoly, negative impacts on the economy: Price not = MC, Price > ATC

And failure of consumer efficiency; production efficiency; and allocative efficiency.

Can the State interfere to eliminate all the negative impacts?

Many countries have price regulation institutions “Prices and Incomes Board” or “Commerce Commission” etc which are legally empowered to regulate prices in the economy if it is thought that without the regulation, there are negative impacts in the economy.

Q1: what criterion should the state use to determine prices?

Q2: Is it possible for the State to eliminate all the negative consequences of monopoly?


Reminder impact of monopoly

Reminder: impact of monopoly

MC

$

A

E

H

ATC

Pm

Output Qm < than under perfect competition : govt “decree” that monopolist sell more?

Price Pm > MC : could govt decree that price be reduced to MC?

Price > ATC > min ATC. (super-profits are being made): decree that price be brought down to = min. ATC?

G

D

C

F

MR

O

q

Qm


Q what is the primary government objective in price control

Q: what is the primary government objective in price control?

MC

$

A

E

ATC

Pm

Logically: to achieve the “good results” of Perfect Competition.

Ensure economic efficiency? ie ensure that price charged = MC?

Ensure that there are no super-profits? Price charged is the minimum of the ATC?

Ensure that all markets must be cleared: no excess supply or demand at prevailing price

What about maximising consumer surplus?

Can all be satisfied together?

G

D

C

F

MR

O

q

Qm


Many points on the diagram where price ceiling could be set

* control?

Many points on the diagram: where price ceiling could be set

MC

$

A

E

ATC

Pm

*

*

Look at the position of the :

Where D curve is cut by MC, or by ATC

Or where MR curve cuts MC or ATC

Or where ATC is minimum.

G

*

D

*

C

*

F

MR

O

q

Qm


Profit maximising output for monopolist still determined by mr mc rule

Profit maximising output for monopolist still determined by MR = MC rule

MC

$

A

E

H

ATC

Pm

*

With a price ceiling, what does the “revised MR curve” MRp looks like?

Suppose objective is economic efficiency: want price to = MC: where on the graph?

Could be where MC cuts the Demand curve OR

Where original MR curve cuts the MC curve.

G

*

D

C

F

MR

O

q

Qm


Price ceiling gives maximum price that can be charged

Price ceiling gives maximum price that can be charged: MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc

eg if price ceiling is set at Pc (where MC curve cuts the Demand curve)

Up to the output at H, the monopolist can only charge price Pc

Which therefore becomes the MR up to that point H

G

D

C

F

MR

O

q

Qm


New mr curve is a kinked line

New MR curve is a kinked line MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc=MR

Thereafter, since a lower price can be charged, the MR curve drops to the usual dotted line.

To find profit-maximising output, equate the new MRc to the MC curve-

G

D

C

F

MRc

MR

O

q

Qm


Mrc intersects the mc curve at point h

MRc intersects the MC curve at point H MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc

Hence output under the price ceiling = Qc which is > Qm (ie output higher)

Equilibrium price = OPc which is < Pm (price is lower) i.e consumer surplus increased.

Price also = MC (hence economic efficiency: no dead-weight loss)

G

Cc

J

D

Cm

F

MRc

MR

O

q

Qc

Qm


But price and atc

But price and ATC? MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc

Pc still > ATC (Cc) ie super-profits exist.

Are super-profits greater or less than before? (note price lower, but sales higher).

MUST be lower. Why? Bonus mark. Logical deduction.

Previously the monopolist was free to charge price Pc himself- if he chose Pm rather than price Pc, then profits must be higher at price Pm.

G

Cc

J

D

Cm

F

MRc

MR

O

q

Qc

Qm


Are the markets cleared at price pc

Are the markets cleared at price Pc? MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc

i.e. is equilibrium output = demand at price Pc? Yes.

Is the price being charged = min. of ATC? No.

G

Cc

J

D

Cm

F

MRc

MR

O

q

Qc

Qm


In summary with the price ceiling at point h

In summary, with the price ceiling at point H MR = MC rule

$

MC

A

E

H

ATC

Pm

Pc

Quantity consumed has increased

Price has decreased (consumer surplus has increased)

Pc = MC hence economic efficiency, and no dead-weight loss now.

Demand = Supply

Super-profits have reduced (but not zero)

and Price not equal to min. of ATC.

G

Cc

J

D

Cm

F

MRc

MR

O

q

Qc

Qm


Suppose government tries to eliminate super profits

Suppose government tries to eliminate super-profits MR = MC rule

$

MC

A

E

ATC

Pm

J

K

Brings down the price ceiling further to correspond to the point K where the ATC intersects the demand curve: where firm, if it operates there, will make “normal” profits.

But will this eliminate super-profits?

The revised MR curve is as shown: where does it intersect the MC curve? At J

Output Qc is higher than under free monopoly, but less than under the previous price ceiling.

Pc

G

Cc

D

F

MRc

MR

O

q

Qc

Qm


Do we have economic efficiency is p mc

Do we have economic efficiency? Is P = MC? MR = MC rule

$

MC

A

E

ATC

Pm

J

K

Yes: Pc = MC at output Qc.

Pc

G

Cc

D

F

MRc

MR

O

q

Qc

Qm


Are the markets cleared supply demand

Are the markets cleared? Supply? Demand? MR = MC rule

$

MC

A

E

ATC

Pm

J

K

Supply = OQc = PcJ But demand = PcK i.e unsatisfied demand = JK

Result: black markets

Result: “Twinning”

Pc

G

Cc

D

F

MRc

MR

O

q

Qc

Qm


And oddly enough super profits have not been eliminated

And oddly enough: super-profits have not been eliminated MR = MC rule

$

MC

A

E

ATC

Pm

J

K

Super-profits = CcPcJL.

In tutorials examine where the price ceiling would have to be so that at profit maximising output level, super-profits will be eliminated. And explain other consequences.

Pc

G

L

Cc

D

F

MRc

MR

O

q

Qc

Qm


2 bonus marks the real world

2 Bonus marks: the real world MR = MC rule

How control petroleum prices?

What are the advantages and disadvantages associated with setting

Fixed Margins: dollar amounts

Percentage amounts?

Same for all items?

How control hardware merchants’ profiteering?

Fixed Margins: dollar amounts

Percentage amounts?

Same for all items?


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