Appendix

Graphs and Discussion Relating to

Rent Seeking

1. THE PURE MONOPOLY

Figure 1 shows a market in two possible situations under the simplifying assumption of constant cost per unit. The first is perfect competition. In this case, the competing firms would tend to bid the price down to p_c and sell the output of q_c per month. The combination of p_c and q_c is called the competitive equilibrium. If the competitive equilibrium is reached, the gain to consumers is the triangle adp_c per month.

Now suppose that a monopoly supplies the good at the same cost. It would charge a higher price p_m and produce the smaller quantity q_mper month. The gain to consumers would fall to the triangle abp_m per month. The monopolist would gain the rectangle p_mbcp_c per month. This is part of what the consumers lose. It is amount that is redistributed to the monopolist. Let us call this rectangle M. Consumers also lose the triangle bdc per month. bdc is the efficiency loss. It is a loss to consumers that no one receives. It represents the fact that resources that are more valuable in the monopolized industry are used somewhere else.

Figure 1

PURE MONOPOLY RENT SEEKING

Economists have traditionally represented the state of affairs described in by figure 1 by saying that the monopolist is in a position where he can earn monopoly rent. The monopoly rent is simply the gain to the monopolist, M. In this context, rent seeking refers to the actions involved in the struggle to attain the monopoly position.

2. THE IMPORT TARIFF

Suppose that the world price of some commodity, say a particular type of rice, is w, as shown in figure 2. Given the demand curve shown in the figure, if there was no tariff, the price in the domestic market would be established at w and the quantity bought and sold would be q_w. The amount produced at home would be q_h. The rest, q_w - q_h, would be supplied by foreign rice producers. The gain to consumers would be the triangle agw. The gain to domestic rice producers would be the triangle wdh.[The correct term for this is economic rent.]

Figure 2

RENT SEEKING BY IMPORT TARIFF

Suppose now that rice producers at home join together in a special interest group. They go on to persuade legislators to impose a tariff of trf per unit. Assume that the tariff is completely effective. In other words, there is no smuggling of non-tariffed goods. Then, under the usual economic assumptions, the price would rise to t and the quantity bought and sold would fall to q_t. A higher amount, q_r, would be produced and sold at home. The rest of the supply, q_t-q_r, would be supplied by foreign rice producers. The gain to consumers would fall to act, and the gain to domestic rice producers would rise to tbh. Unlike the previous example, tariff revenue of bcfe would be collected by the government from foreign producers.

The efficiency loss due to the tariff is more complicated than in the first example. To see why, consider the effects on consumers. Consumers of rice lose an amount equal to tcgw due to the higher price of rice. But part of this loss is a transfer. Two transfers occur. First domestic rice producers gain an amount of tbdw, or M. Second, an amount bcfe, or P, is collected in tariff revenue. This money can be used to reduce other taxes or to pay for other programs. The remainder, cgf + bed, is the efficiency loss.

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