Home Page Econ 2 Files Econ 2 Lecture Notes Lecture 25: Inefficiency of Monopoly

|  Search

Economics 2

Lecture 25 - Inefficiency of Monopoly

inefficiency of monopoly
regulation of monopolies
calculating the deadweight loss

Inefficiency of Monopoly

Social efficiency requires a balancing of the costs and benefits of any action. We create benefits for people by giving them something they value; the value of something is equal to what people are willing to pay for it. The demand curve tells us people's marginal willingness to pay. So, the benefits society receives from consuming a good are represented by the demand curve. The industry supply curve measures the social costs of producing the good. The industry supply curve is the same as the marginal cost curve. Therefore, the efficient level of output is given by the intersection of the demand and marginal cost curves. For levels of output below the efficient quantity, the benefits society receives from consuming a unit of the good are greater than the costs of producing a unit of the good; for levels of output greater than the efficient amount, the costs are greater than the benefits from consuming a unit of the good.

The monopoly output is where MR=MC. So, the monopoly produces too little output and charges too high a price compared to the efficient outcome. The deadweight loss is a measure of the inefficiency of a monopoly. It represents the net social benefits from the lost output from having a monopoly in the market rather than perfect competition. (Perfect competition results in efficient outcomes.) The deadweight loss may be overstated because the monopoly fears that entry or government intervention could occur. It may be understated if monopoly firms tend to operate inefficiently and devote resources to maintaining their monopoly positions.

Regulation of Monopolies

In some cases the government regulates the production of a monopoly in order to promote economic efficiency.

marginal cost pricing - require the firm to produce the efficient level of output (where P = MC) average cost pricing - if the firm would incur losses under marginal cost pricing, having the firm produce where P = AC (the quantity where the demand and AC curves intersect) permits the firm to earn a normal profit; however, the firm produces less than the socially efficient quantity marginal cost pricing with a subsidy - cover the firm's losses under MC pricing with a subsidy

Calculating the Deadweight Loss

 P	Q	TR	MR
$10	0	$0
  9	1	 9	$9
  8	2	16	 7
  7  	3	21	 5
  6	4	24	 3
  5	5	25	 1
  4	6	24	-1
  3	7	21	-3
  2	8	16	-5
  1	9	 9	-7
  0 	10	 0	-9

a. What price and quantity would the monopolist produce at if MC = $5?

The monopolist would produce the profit maximizing level of output which is where MC = MR. So, the monopolist would produce where Q = 3 and P = $7.

b. Calculate the deadweight loss.

1. Plot the profit maximizing price and quantity (P = $7 and Q = 3).
2. Plot MC at the profit maximizing level of output (P = $5 and Q = 3).
3. Plot the socially efficient level of output which is where P = MC (P = $5 and Q = 5).
4. Calculate the area of the triangle formed by these three points to get the deadweight loss. (1/2 x 2 x $2 = $2)

David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 DXL31@psu.edu www.yk.psu.edu/~dxl31