Welfare economics of monopoly and rent seeking

Monopolisation has resulted in a higher price being paid (Pm not Pc) and the quantity bought (Qm not Qc) has been reduced. Part of the consumer surplus triangle has been shifted to producers as excess profits but part of it is totally lost to society as shown by the reduction in output from Qc to Qm.

The monopolised industry may result in more efficient production techniques and lowered costs. The net welfare gain or loss to the total economy is the difference between the red and blue areas.

Tullock’s (1967) argument is that if a successful monopolist can extort the excess profits from his customers such as through a government licence giving them a monopoly, such a large prize is worth the investment of up to an equivalent amount of resources  equal to the capitalised value of the future monopoly profits.

Rational entrepreneurs should be willing to invest resources in attempts to form a monopoly until the marginal cost equals the properly discounted marginal return. Under certain assumptions (see Posner 1975) the competitive outlays to establish a monopoly will exactly equal the present value of the profit rectangle.

Rent_seeking - Rent_seeking Picture Slideshow

The Tullock rectangle may have to be added to the Harberger triangle when calculating the potential loss of welfare associated with monopoly.


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