Question

Does Monopoly reduce economic efficiency? Explain and show graphically.

Answer 1

Monopolist is a price Maker. He will determine the quantity of output that will maximize revenue. The monopolist faces a downward sloping demand curve because he can sell more if he lowers the price. The profit maximizing price and output is where marginal revenue equals marginal cost, then it is extended to the market demand curve to determine what market price corresponds to that quantity.

Allocative efficiency because P=MC. Price is the willingness to pay by a consumer, which is the social benefit. MC is the cost to the producer, which is the social cost of producing the good. Allocative efficiency occurs when social benefit equals social cost. Allocative efficiency means that resources are used most efficiently in an economy.

Monopoly is not allocatively efficient. There is a deadweight loss. A monopolist produces where MR= MC. MR is less than price for a monopolist as he faces a downward sloping demand curve. The price is higher and output is smaller for a monopolist than perfect competition.

A perfectly competitive firm will produce at the point of intersection of MC and D. The output is higher and price is lower. MR= P in perfect competition as it is a price taker.