Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Firms produce where MR = MC (a labour-market buyer where MRP = MRC). A policy changes output only by changing one of these.
- Per-unit taxes and subsidies shift MC, so they change the price consumers pay, the net price firms keep, quantity, consumer and producer surplus, deadweight loss and government revenue or cost. The less elastic side bears more of a tax.
- Lump-sum taxes and subsidies change only fixed cost (and ATC). Price and output stay the same; profit changes.
- Price controls cut output in perfect competition but can raise it where firms have market power or a buyer has monopsony power.
- Natural monopoly regulation: fair return (P = ATC) or socially optimal (P = MC, plus a lump-sum subsidy).
- Antitrust policy aims to make markets more competitive.
- Intervention raises efficiency only when it fixes the incentive behind the market failure.
Key relationships
| Policy | Perfect competition | Monopoly (or monopolistic competition) |
|---|---|---|
| Per-unit tax | P up, Q down, DWL appears | P up, Q falls further, DWL grows |
| Per-unit subsidy | Q above efficient, DWL appears | Q rises towards efficient, DWL shrinks |
| Lump-sum tax or subsidy | no change in P or Q (short run) | no change in P or Q; profit changes |
| Binding price ceiling | shortage, Q down, DWL | ceiling where D meets MC → efficient Q; between MC at old Q and old P → Q up; below MC at old Q → Q down |
| Labour market | Binding minimum wage |
|---|---|
| Perfectly competitive | employment falls; surplus of labour |
| Monopsony | wage and employment both rise, up to the wage where supply meets MRP |
| Natural monopoly | Price rule | Profit | Deadweight loss |
|---|---|---|---|
| Unregulated | MR = MC | positive | largest |
| Fair return | P = ATC | zero | smaller |
| Socially optimal | P = MC | loss = lump-sum subsidy needed | zero |
Deadweight loss = ½ × (efficient Q − actual Q) × (price on demand − MC at actual Q), when MC and demand are straight lines.
Assumptions
- Firms maximise profit; price controls are enforced; curves are straight lines in calculations.
Mistakes to avoid
- Shifting MC for a lump-sum tax.
- Saying every price ceiling reduces output.
- Claiming a natural monopoly breaks even at P = MC.
- Paying the natural monopoly a per-unit subsidy instead of a lump-sum one.
- Forgetting that a per-unit tax on a monopoly makes its deadweight loss bigger.
- Drawing a collusion-and-policy graph: it is outside the course.
Quick self-check
- A monopoly pays a new $50 thousand annual licence fee. What happens to its price? (Nothing: a lump-sum fee leaves MR and MC unchanged; only profit falls.)
- A natural monopoly has MC = $5 and fixed cost $300 thousand. At P = MC it serves 60 thousand customers. What subsidy does it need? (ATC = 5 + 300 ÷ 60 = $10; loss = (10 − 5) × 60 = $300 thousand, a lump-sum subsidy.)
- Why can a minimum wage raise employment at a monopsony? (It makes MRC equal the minimum wage, so hiring one more worker no longer raises the wage of all the others.)
Next: practice questions.