Question

Explain what would happen to the deadweight loss to society if the monopolist's marginal cost was lower than that of a competitive firm industry. This question requires a graph.

Answer 1

Deadweight loss will increase.

A monopolist maximizes profit by equating MR with MC, while a competitive firm maximizes Price (Demand) with MC. In following graph, if both monopolist and perfect competitor faces same marginal cost MC1, monopolist maximizes profit at point A where MR intersects MC1 with price P1 & quantity Q1, and perfect competitor maximizes profit at point C where Demand intersects MC1 with price P2 & quantity Q2. Deadweight loss equals area of triangle ABC. But if monopolist faces a marginal cost lower than MC1, say MC2, monopolist will equate MR with MC2 at point X with price P3 & quantity Q3. Relevant profit-maximizing point for perfect competitor is at point Z where Demand intersects MC2 with price P4 and quantity Q4. Relevant deadweight loss is area of triangle XYZ.

It is seen that Area(XYZ) > Area(ABC), indicating an increase in deadweight loss.