Question

Question 1: As a monopoly’s price is different than its marginal cost, too little output is produced and the society suffers a deadweight loss. Explain this statement with the help of a graph (properly labeled).

Answer 1

Under monopoly market, there is only one seller in the market. Monopoly is the highest degree imperfect competition. There are no close substitutes for monopoly goods are available in the market. It raises the element of monopoly power. Demand curve faced by monopolist is inelastic. Entry is blocked into monopoly market. Monopoly can attain maximum profit not because its price is higher than its marginal cost but the entry is blocked. Therefore monopoly can earn abnormal profit in long run. Monopolist always try to fix its price higher than its marginal cost. At higher price ,monopoly always try to reduce its supply of output. A monopolist will never produce an output with elasticity less than one because when elasticity is less than one marginal revenue is zero and if elasticity is less than one, marginal revenue will be negative. AR curve and MR curve of monopoly is downward sloping. Monopoly price and output are determined when MR=MC. Best level of output produced by monopoly is OQ and price is OP which is higher than marginal cost ( Under where MC curve cuts MR from below) Suppose a firm under perfect competitive market, industry supply curve is horizontal . Price and output are determined when supply and demand are equal and accordingly quantity is OQc and price OPc. The consumer surplus is PcMN. When competitive market is monopoly LS =MC= AC and accordingly monopoly output id OQm and price is OPm. PcSLPm is the monopoly profit and PmLN is the consumer surplus .LSM ( PcMN -PcSLM + PmLN is the deadweight loss of monopoly