Monopoly & Efficiency

Deadweight Loss Analysis

Efficiency Analysis• Allocative Efficiency is when P = MC

– No DWL, socially optimal

– Monopolies fail as P > MC Competitive Firms always pass P = MC

• Production Efficiency is when P = min. of ATC– Monopolies fail as P > min of ATC

– Competitive Firms achieve it only in long run

Quantity

Price

0

P1P1P1

ATCATCMCMC

Perfect Competition

P = MC (always)

P = min of ATC (long run)

QuantityQ QQ0

Costs andRevenue

DemandDemand

Average total costAverage total cost

Marginal revenueMarginal revenue

Marginalcost

Marginalcost

Marginalcost

Monopolyprice

QMAX

BMonopoly

price

QMAX

BB

AA

Monopoly

P > MCP > min of ATC

Deadweight Loss

• Deadweight loss is caused by a monopoly, a tax and a subsidy– Unless the tax or subsidy is correcting a market failure!

• There is never a deadweight loss when P = MC (MB = MC)

– If P > MC => market is too small • Example: misplaced tax or monopoly

– If P < MC => market is too big• Example: misplaced subsidy

Allocative Efficiency

Quantity0

Price

Demand(marginal benefit: value to buyers)

Marginal cost

Value to buyersis greater thancost to seller.

Value to buyersis less thancost to seller.

Costto

monopolist

Valueto

buyers

EfficientQuantity MC = MB

Welfare isMaximized!

MC = MB

Identical Market Demand Curve• The market demand curve for a good/service is exactly the same whether an

industry is a monopoly or a competitive industry.

• Therefore the market demand curve below for T-Shirts could be for a monopoly or a competitive industry

Market

1 Firm

In a competitive industry market demand = MR

Monopoly:market demand > MR

Inefficiency of Monopoly

Quantity0

Price

DWL P > MC

D = Market Demand Curve

MR

MC

Competitive quantity

Monopolyprice

Monopolyquantity

Allocative Efficiency P = MC

EM

ECCompetitive

PriceFor competitive industry P = D= MRMarket demand is MRSo @ Ec MR = MC

Deadweight Loss Analysis• Revenue from a tax is transferred from producer/consumer => to Government

• Revenue from a subsidy is transferred from Gov’t => to producer/consumer

• Monopoly excess profit is a transfer of consumer surplus => to private firm

QuantityQ QQ0

Costs andRevenue

DemandDemand

Average total costAverage total cost

Marginal revenueMarginal revenue

Marginalcost

Marginalcost

Marginalcost

--------------------------------------

PM

PC

-

------------------------

Excess profit => some consumer surplus turns into monopoly profit

QM

---------------------------

Deadweight Loss as P > MCMonopoly Price

Competitive Price

QC

Worksheet

• Monopoly & Deadweight Loss