Week 1: Ch2-Welfare Economics

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.
• 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
Consumer Surplus and
Producer Surplus
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.
Competitive Equilibria 2
• Departures from competitive
markets can occur because of
externalities and other market
• They can also occur because of the
exercise of market power, which is
the focus of Competition Policy
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”
Monopoly Pricing (review)
Lerner Index of Monopoly
Measurement of Deadweight
Example: Dead Weight Loss in
the Superior Propane Merger