12. Monopoly

Monopoly Efficiency and Deadweight Loss

12. Monopoly

Monopoly Efficiency and Deadweight Loss: Videos & Practice Problems

Topic summary

In a monopoly, the quantity produced is always less than the efficient quantity, leading to deadweight loss. Consumer surplus decreases due to higher prices, while producer surplus may increase, but not without losses in potential trades. Monopolies lack both productive efficiency, as they do not produce at minimum average total cost, and allocative efficiency, since marginal benefits exceed marginal costs. Understanding these concepts is crucial for grasping market structures and their implications on economic surplus and efficiency.

Monopolies do not produce the efficient quantity.

concept

Monopoly Efficiency and Deadweight Loss

Video duration:

12m

Monopoly Efficiency and Deadweight Loss Video Summary

The concepts of consumer and producer surplus are crucial in understanding market structures, particularly in monopolies compared to perfect competition. In a perfectly competitive market, firms produce at an efficient quantity where marginal cost equals marginal revenue, leading to maximum total surplus without any deadweight loss. Here, consumer surplus is represented by the area above the price and below the demand curve, while producer surplus is the area below the price and above the supply curve. The total surplus in this scenario is the sum of consumer and producer surplus, encompassing all trades made at the efficient quantity.

In contrast, a monopoly restricts output to maximize profits, resulting in a lower quantity produced than the efficient level. This leads to a higher price for consumers, which reduces consumer surplus. The consumer surplus in a monopoly is diminished as consumers lose the surplus represented by the areas that are no longer accessible due to the higher price and lower quantity. The producer surplus, however, may increase as the monopoly can charge a higher price for the limited quantity sold, but this comes at the cost of lost trades that would have occurred at a lower price.

The deadweight loss in a monopoly arises from the trades that do not occur due to the restricted quantity. This loss is represented by the areas of surplus that are no longer realized, specifically the areas that would have contributed to total surplus in a competitive market. Thus, the total surplus in a monopoly is reduced, highlighting the inefficiencies inherent in monopolistic structures.

When discussing efficiency, it is essential to differentiate between productive and allocative efficiency. Productive efficiency occurs when goods are produced at the lowest possible cost, typically at the minimum point of the average total cost curve. In a monopoly, firms do not achieve this efficiency as they operate on the downward-sloping part of the average total cost curve, failing to produce at the minimum cost. Allocative efficiency, on the other hand, is achieved when production aligns with consumer preferences, where the price equals the marginal cost. Monopolies do not reach allocative efficiency either, as they produce less than the efficient quantity, leading to a situation where the marginal benefit to consumers exceeds the marginal cost of production.

In summary, monopolies create a scenario where both productive and allocative efficiencies are absent, resulting in a decrease in total surplus and the presence of deadweight loss. Understanding these concepts is vital for analyzing the implications of monopolistic practices on consumer welfare and market efficiency.

Problem

An unregulated monopoly will sell:

30 tickets

50 tickets

60 tickets

100 tickets

Problem

If the monopolist's fixed cost is $25, the monopoly's total costs when maximizing profit is:

$35

$45

$85

$145

Problem

If the monopolist's fixed cost is $25, the monopoly's total economic profit when maximizing profit is:

$20

$45

The monopoly is incurring a loss

Problem

The deadweight loss created by the monopoly is:

$22.5

$45

$90

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Here’s what students ask on this topic:

What is deadweight loss in a monopoly?

Deadweight loss in a monopoly refers to the loss of economic efficiency that occurs when the equilibrium quantity of a good is not produced. In a monopoly, the firm restricts output to maximize profits, producing less than the efficient quantity. This results in a higher price and a reduction in consumer surplus. The trades that do not occur due to this restricted output represent the deadweight loss. Mathematically, deadweight loss can be visualized on a graph as the area between the demand and supply curves, from the monopoly quantity to the efficient quantity.

How does a monopoly affect consumer and producer surplus?

In a monopoly, consumer surplus decreases because the monopolist sets a higher price and produces a lower quantity compared to a perfectly competitive market. Consumer surplus is the area above the price and below the demand curve, and this area shrinks in a monopoly. Producer surplus, which is the area below the price and above the supply curve, may increase because the monopolist can charge a higher price. However, the total economic surplus (consumer surplus + producer surplus) decreases due to the deadweight loss, which represents the trades that do not occur.

Why do monopolies lack productive efficiency?

Monopolies lack productive efficiency because they do not produce at the minimum average total cost (ATC). Productive efficiency occurs when a firm produces at the lowest possible cost, which is at the minimum point of the ATC curve. In a monopoly, the firm produces at a quantity where the ATC is not minimized, often on the downward-sloping part of the ATC curve. This results in higher production costs and inefficiency compared to a perfectly competitive market where firms produce at the minimum ATC.

What is allocative efficiency and why don't monopolies achieve it?

Allocative efficiency occurs when the production of goods and services aligns with consumer preferences, meaning the marginal benefit to consumers equals the marginal cost of production. In a monopoly, allocative efficiency is not achieved because the monopolist produces less than the efficient quantity. The marginal benefit to consumers exceeds the marginal cost, indicating that more of the good should be produced to meet consumer demand. This misalignment results in a deadweight loss and a loss of economic welfare.

How does a monopoly create deadweight loss?

A monopoly creates deadweight loss by producing less than the efficient quantity of a good. The monopolist restricts output to raise prices and maximize profits, leading to a quantity that is lower than what would be produced in a perfectly competitive market. This restriction results in some mutually beneficial trades not occurring, which is represented by the deadweight loss. On a graph, deadweight loss is the area between the demand and supply curves from the monopoly quantity to the efficient quantity, indicating the loss of total economic surplus.

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