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Chapter 3: Welfare Economics

Chapter 3: Welfare Economics. General Analysis Overview Welfare under Monopoly Welfare under Monopsony Welfare under Middlemen . General Analysis Overview.

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Chapter 3: Welfare Economics

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  1. Chapter 3: Welfare Economics • General Analysis Overview • Welfare under Monopoly • Welfare under Monopsony • Welfare under Middlemen

  2. General Analysis Overview • Welfare analysis is a systematic method of evaluating economic implications of alternative allocations. It answers the following questions: 1. Is a given resource allocation efficient? 2. Who gains and who loses under various resource allocations? By how much? • Welfare economics: A methodological approach to assess resource allocations and establish criteria for government intervention. • Partial analysis: Evaluates outcomes in a subset of markets assuming efficiency in others.

  3. Graphs of Demand and Supply D = demand curve S = supply curve Area under demand curve ABC0 = gross Area under supply curve 0ELM =cost benefits from consumption. of production. ABP = consumer surplus=area between PLM =producer surplus=area demand and price. between price and supply

  4. Efficient outcome When there are no externalities, an efficient outcome occurs where the sum of consumers’ and producers’ surplus is maximized. Area under demand = gross benefits Area under supply = gross cost Social surplus = gross benefit – cost.

  5. Welfare under Monopoly • A monopoly is the only seller in a market. The basic condition for a monopoly is • Optimality occurs where: • MR(Q)-MC(Q)=0, where MR=marginal revenue and MC=marginal cost

  6. Monopoly P Qc, Pc=under competition Qm,Pm=under monopoly C A Pm Monopoly produces too little and charges too much. Welfare loss under monopoly is . C Pc B MR D Qm Qc Q

  7. Linear Example of Monopoly-1 Inverse demand= P(Q) =a - bQ Revenue = (a - bQ)Q = aQ-bQ2 Supply = c + dQ Competitive outcome is where Demand=supply a - bQ = c + dQ

  8. Linear Example of Monopoly-2 Under monopoly, MR=MC

  9. Welfare under Monopsony • A monopsony is the only buyer in a market. P MO MC Qc, Pc=under Competition Qmn,Pmn=under Monopsony Pc Pmn D Qmn Q Qc

  10. Calculation of monopsony • Maximization equation: • Area: • Optimality condition: • Price paid by monopsony:

  11. Summary of monopoly and monopsony • Monopolist: Underbuys and oversells. • Monopsonist:Underbuys and underpays.

  12. Welfare under Middlemen • A middleman is the only buyer and seller of product. MO P S Qmm=middlemen output Pmms=price paid by middlemen to supplier Pmmb=price paid to middlemen by buyer Pmmb C E Pmms MR D Q Qmm

  13. Profits under Middlemen MO P S Profits PmmbCEPmms Pmmb C E Pmms MR D Q Qmm

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