The Deadweight Loss Of Monopoly

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The Deadweight Loss of a Monopoly

To have a monopoly firm is often very beneficial for the monopolist, who can make a profit, but it is negative for society. In that point MC = D. The marginal cost is the cost of the last produced unit, and the demand is the consumers’ corresponding valuation of that unit. At point a, the cost of producing the last unit and the valuation of that unit are the same. To the left of that point, the consumers’ valuation is higher than the cost of producing additional units. Society therefore loses production of goods that cost less than what they are worth, according to the consumers’ valuation. Then the quantity that the monopolist produces cannot be efficient. The deadweight loss that arises corresponds to the dark grey triangle in the figure.
Let us look closer at the consequences. In Figure 11.2, we have drawn the supply curve, i.e. the MC curve. (Remember that the supply curve of a firm corresponds to the part of the MC curve that is above the average cost.) Furthermore, we have drawn the demand curve, D, and the marginal revenue curve, MR. Under perfect competition, equilibrium had been reached
at the price pC and the quantity QC, but in a monopoly market, equilibrium is reached at the price pM and the quantity QM. The producer surplus (PS) in a monopoly market corresponds to the area B + D, and the consumer surplus (CS) corresponds to the area A. The social surplus will therefore be A + B + D. If the market had been perfectly competitive instead, PS had been D + E while CS had been A + B + C and the social surplus A + B + C + D + E.
In other words, society, particularly the consumers, loses utility: The deadweight loss is C + E. The monopolist, on the other hand, will lose if competition is increased. Note that the monopoly is not efficient, It would have been possible to produce the quantity QC to the price pC and then compensate the firm by transferring the area B back from the consumers. The consumers would still get an increase in utility corresponding to the area C (they would now get A + C), and the producers would get an increase in utility corresponding to the area E (they would now get B + D + E). No group would lose anything. Therefore, the monopoly does not fulfill the Pareto criterion.


Ways to Reduce Market Power

To reduce the negative impact on society, governments often try to limit themarket power of monopolists. Some popular measures include

  • Price regulations. If it can be known what the market price would have been under perfect competition, or if the cost of production is known, the government can decide on a price ceiling at that price. Thereby, the equilibrium point is moved to the optimal point from society’s viewpoint. It is, however, very difficult to estimate the optimal price.
  • Increase competition. If the monopoly has been created through political decisions, the regulation can be changed.

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