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The Welfare Economics of Market Power

The Welfare Economics of Market Power. Roger Ware ECON 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.

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The Welfare Economics of Market Power

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  1. The Welfare Economicsof Market Power Roger Ware ECON 445

  2. 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

  3. Consumer Surplus and Producer Surplus

  4. 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.

  5. 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

  6. 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”

  7. Monopoly Pricing (review) P(Q) MC MR(Q)

  8. Lerner Index of Monopoly

  9. Measurement of Deadweight Loss

  10. Example: Dead Weight Loss in the Superior Propane Merger

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