Question

Explain the connection between competition and deadweight loss by comparing a highly competitive market with a highly uncompetitive market. Explain the roles of incentives and consumer/producer surplus.

Answer 1

On comparing the deadweight loss between monopoly and perfect competition one finds that if there is a firm that is perfectly competitive then the firm takes price =Pc and produces Qc and similarly monopoly firm produces at Qm and price=Pm and Qc >Qm . (See figure1) where area of abc shows the deadweightloss in case of monopoly.

The consumer surplus in perfect competition = area of the triangle efc

The consumer surplus in monopoly = area of the triangle fda

Since,area of the triangle efc >area of the triangle fda

Hence,The consumer surplus in perfect competition >The consumer surplus in monopoly

Producer Surplus in case of perfect competition = gbce

Producer Surplus in case of monopoly = area of gbad

Produces Surplus in case of perfect competition is more if the area of gbce > area of gbad

Produces Surplus in case of monopoly is more if area of gbce <area of gbad

Now,government can give incentive the monopoly firm to produce at a higher output Qc than Qm by giving tax breaks or public subsidies .The government by giving incentives to the monopoly and encouraging it to produce at Qc increases the level of efficiency in the economy and also increases the consumer surplus.