Welfare Aspects of Monopoly

Under perfect competition, the perfectly competitive equilibrium is efficient in resource allocation because it maximizes the sum of producer surplus and consumer surplus. But the situation is entirely different under a monopoly which maximizes its profit by producing an output where the price is more than the marginal cost. This results in higher prices and lower quantities and makes the firm better off and consumers worse off.

Monopoly is often criticized because it results in economic inefficiency in resource allocation. Economic efficiency is achieved when resources are allocated among the production of goods such that it maximizes social welfare.

Under a monopoly, resources are misallocated and resulting in a loss of social welfare. When a product is sold under conditions of monopoly, the price that consumers are paying is more than the marginal cost. Due to this higher price, the monopolist gains at the expense of consumers.

This is shown in Fig 1. The perfectly competitive equilibrium would occur at point Ec where the price is equal to the marginal cost. The perfectly competitive price is OPc, and the quantity is OQc.

At price OPc,

Consumer Surplus = Area 1 + Area 2+ Area 3

Producer Surplus= Area 4 + Area 5

The monopolist is in equilibrium at point Em where MR is equal to MC. The monopolist price is OPm, and the quantity is OQm. Now because of the monopoly, the price rises to OPm, and consumer surplus reduces in Areas 2 and area 3. Consumers are losing area 3 because the output is reduced to OQm from OQc. Consumers also lose area 2 because now the price has risen from Pc to Pm, and that area is now transferred to the monopolist.

Producer Surplus under competitive equilibrium is the sum of area 4 and area 5. Now because of the monopoly, the price has risen to OPm from OPc and the producer surplus reduced by area 5 because output has now been reduced from OQc to OQm. And monopolist gains area 2 from the consumers because of higher price. The loss to the producer is less than its gain. Thus area 3 and area 5 are loss to society.

Deadweight Loss from Monopoly Power

At perfect competitive price OPc,

Consumer Surplus=1+2+3

Producer Surplus=4+5

At Monopoly Price OPm,

Consumer loss=2+3

Producer Gain=2-5

The Dead Weight Loss to the Society= -5-3=-(5+3)

The deadweight loss from monopoly power is given by shaded areas, i.e. area 3 and area 5. The deadweight loss resulting from monopoly accounts for its Allocative inefficiency.

Read More- Microeconomics

1. Microeconomics: Definition, Meaning and Scope
2. Methods of Analysis in Economics
3. Problem of Choice & Production Possibility Curve
4. Concept of Market & Market Mechanism in Economics
5. Concept of Demand and Supply in Economics
6. Concept of Equilibrium & Dis-equilibrium in Economics
7. Cardinal Utility Theory: Concept, Assumptions, Equilibrium & Drawbacks
8. Ordinal Utility Theory: Meaning & Assumptions
9. Indifference Curve: Concept, Properties & Shapes
10. Budget Line: Concept & Explanation
11. Consumer Equilibrium: Ordinal Approach, Income & Price Consumption Curve
12. Applications of Indifference Curve
13. Measuring Effects of Income & Excise Taxes and Income & Excise Subsidies
14. Normal Goods: Income & Substitution Effects
15. Inferior Goods: Income & Substitution Effects
16. Giffen Paradox or Giffen Goods: Income & Substitution Effects
17. Concept of Elasticity: Demand & Supply
18. Demand Elasticity: Price Elasticity, Income Elasticity & Cross Elasticity
19. Determinants of Price Elasticity of Demand
20. Measuring Price Elasticity of Demand
21. Price Elasticity of Supply and Its Determinants
22. Revealed Preference Theory of Samuelson: Concept, Assumptions & Explanation
23. Hicks’s Revision of Demand Theory
24. Choice Involving Risk and Uncertainty
25. Inter Temporal Choice: Budget Constraint & Consumer Preferences
26. Theories in Demand Analysis
27. Elementary Theory of Price Determination: Demand, Supply & Equilibrium Price
28. Cobweb Model: Concept, Theorem and Lagged Adjustments in Interrelated Markets
29. Production Function: Concept, Assumptions & Law of Diminishing Return
30. Isoquant: Assumptions and Properties
31. Isoquant Map and Economic Region of Production
32. Elasticity of Technical Substitution
33. Law of Returns to Scale
34. Production Function and Returns to Scale
35. Euler’s Theorem and Product Exhaustion Theorem
36. Technical Progress (Production Function)
37. Multi-Product Firm and Production Possibility Curve
38. Concept of Production Function
39. Cobb Douglas Production Function
40. CES Production Function
41. VES Production Function
42. Translog Production Function
43. Concepts of Costs: Private, Social, Explicit, Implicit and Opportunity
44. Traditional Theory of Costs: Short Run
45. Traditional Theory of Costs: Long Run
46. Modern Theory Of Cost: Short-run and Long-run
47. Modern Theory Of Cost: Short Run
48. Modern Theory Of Cost: Long Run
49. Empirical Evidences on the Shape of Cost Curves
50. Derivation of Short-Run Average and Marginal Cost Curves From Total Cost Curves
51. Cost Curves In The Long-Run: LRAC and LRMC
52. Economies of Scope
53. The Learning Curve
54. Perfect Competition: Meaning and Assumptions
55. Perfect Competition: Pricing and Output Decisions
56. Perfect Competition: Demand Curve
57. Perfect Competition Equilibrium: Short Run and Long Run
58. Monopoly: Meaning, Characteristics and Equilibrium (Short-run & Long-run)
59. Multi-Plant Monopoly
60. Deadweight Loss in Monopoly
61. Welfare Aspects of Monopoly
62. Price Discrimination under Monopoly: Types, Degree and Equilibrium
63. Monopolistic Competition: Concept, Characteristics and Criticism
64. Excess Capacity: Concept and Explanation
65. Difference Between Perfect Competition and Monopolistic Competition
66. Oligopoly Market: Concept, Types and Characteristics
67. Difference Between Oligopoly Market and Monopolistic Market
68. Oligopoly: Collusive Models- Cartel & Price Leadership
69. Oligopoly: Non-Collusive Models- Cournot, Stackelberg, Bertrand, Sweezy or Kinked Demand Curve
70. Monopsony Market Structure
71. Bilateral Monopoly Market Structure
72. Workable Competition in Market: Meaning and Explanation
73. Baumol’s Sales Revenue Maximization Model
74. Williamson’s Model of Managerial Discretion
75. Robin Marris Model of Managerial Enterprise
76. Hall and Hitch Full Cost Pricing Theory
77. Andrew’s Full Cost Pricing Theory
78. Bain’s Model of Limit Pricing
79. Sylos Labini’s Model of Limit Pricing
80. Behavioural Theory of Cyert and March
81. Game Theory: Concept, Application, and Example
82. Prisoner’s Dilemma: Concept and Example