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Chapter 15: Problem 2

Explain why market power leads to a deadweight loss. Is the total deadweight loss from market power for the economy large or small?

Short Answer

Expert verified
Market power leads to deadweight loss because it allows firms to set prices above marginal costs, thereby reducing the amount of trade that occurs and creating inefficiencies. Whether the total deadweight loss from market power is large or small for the economy is subjective and depends on several factors. In general, while it's present, one could argue it isn't typically large given the trade-offs involved.

Step by step solution

01

Understand Deadweight Loss

First, we need to understand deadweight loss. Deadweight loss represents inefficiencies in a market - situations where the allocation of goods and services is not optimal. In an ideal competitive market scenario, the price of a product is determined by the intersection of the supply and demand curve, which leads to economic efficiency. This is because the marginal cost (MC) equals the marginal benefit (MB), i.e., what consumers are willing to pay for the last unit is exactly equal to what it costs the producers to produce that last unit.
02

The Role of Market Power in Creating Deadweight Loss

When a firm holds substantial market power, such as a monopolistic firm, it can influence the price of the product or service, effectively breaking away from the ideal situation where price equals marginal cost (P=MC). Instead, the firm will increase the price (P) above the marginal cost (MC) to maximise their profit, leading to P>MC. In this situation, the quantity of goods produced and consumed is lower than the socially efficient level. This reduction of trade due to market power is what leads to the deadweight loss, as there will be consumers willing to pay more than the marginal cost of production who are nevertheless priced out of the market.
03

Assessing the Size of Deadweight Loss Due to Market Power

As for whether the deadweight loss from market power is large or small in an economy, this depends on several factors including the size and number of markets where firms have significant market power, the degree of their power, and the elasticities of supply and demand. Additionally, it's worth mentioning that while market power can lead to deadweight loss, it may also enable firms to invest in research and development. The act of balancing these facts may lead many to conclude that the overall deadweight loss from market power in the economy is present, but isn't generally large.

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Most popular questions from this chapter

Will a monopoly that maximizes profit also be maximizing revenue? Will it be maximizing output? Briefly explain.

Food service firms buy meat, vegetables, and other foods and resell them to restaurants, schools, and hospitals. US Foods and Sysco are by far the largest firms in the industry. In 2015 , these firms were attempting to merge to form a single firm. A news story quoted one restaurant owner as saying, "There was definite panic in the restaurant industry \(\ldots\) when the merger was announced. They know they're going to get squeezed." a. Analyze the effect on the food service market of US Foods and Sysco combining. Draw a graph to illustrate your answer. For simplicity, assume that the market was perfectly competitive before the firms combined and would be a monopoly afterward. Be sure your graph shows changes in the equilibrium price, the equilibrium quantity, consumer surplus, producer surplus, and deadweight loss. b. Why would restaurant owners believe they would be "squeezed" by this development? c. Ultimately, the merger did not occur because the Federal Trade Commission was successful in suing to stop it. The judge who decided the case wrote, "The proposed merger of the country's first and second largest broadline foodservice distributors is likely to cause the type of industry concentration that Congress sought to curb at the outset before it harmed competition." Briefly explain what the judge meant by "industry concentration" and what the results will be of a merger that harms competition.

What is the purpose of the antitrust laws? Who is in charge of enforcing these laws?

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