Because it enjoys barriers that block potential rivals, a monopoly firm wields considerable market power. The objections to monopoly run much deeper than worries over economic efficiency and high prices. Regulatory efforts imposed in monopoly cases often seek to reduce the degree to which monopoly firms extract consumer surplus from consumers by reducing the prices these firms charge. Should it be allowed to extract these gains from consumers? We will see that public policy suggests that the answer is no. Is such a transfer legitimate? After all, the monopoly firm enjoys a privileged position, protected by barriers to entry from competition. But the transfer of a portion of consumer surplus to the monopolist is an equity issue. The fact that society suffers a deadweight loss due to monopoly is an efficiency problem. But consumers also lose the area of the rectangle bounded by the competitive and monopoly prices and by the monopoly output this lost consumer surplus is transferred to the monopolist. Part of the reduction in consumer surplus is the area under the demand curve between Q c and Q m it is contained in the deadweight loss area GRC. With monopoly, consumer surplus would be the area below the demand curve and above P mR. If the industry were competitive, consumer surplus would be the area below the demand curve and above P cC. It is measured by the area under the demand curve and above the price of the good over the range of output produced. Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. Figure 10.11 “Perfect Competition, Monopoly, and Efficiency” shows that the monopolist charges price P m rather than the competitive price P c the higher price charged by the monopoly firm reduces consumer surplus. The monopoly solution raises issues not just of efficiency but also of equity. That is the potential gain from moving to the efficient solution. Subtracting this cost from the benefit gives us the net gain of moving from the monopoly to the competitive solution it is the shaded area GRC. Thus, the total cost of increasing output from Q m to Q c is the area under the marginal cost curve over that range-the area Q mGC Q c. Because the marginal cost curve measures the cost of each additional unit, we can think of the area under the marginal cost curve over some range of output as measuring the total cost of that output. An increase in output, of course, has a cost. The benefit to consumers would be given by the area under the demand curve between Q m and Q c it is the area Q mRC Q c. Society would gain by moving from the monopoly solution at Q m to the competitive solution at Q c. Output is lower and price higher than in the competitive solution. It maximizes profit at output Q m and charges price P m. The monopoly firm faces the same market demand curve, from which it derives its marginal revenue curve. Assume the monopoly continues to have the same marginal cost and demand curves that the competitive industry did. Our perfectly competitive industry is now a monopoly. Now, suppose that all the firms in the industry merge and a government restriction prohibits entry by any new firms. It also transfers a portion of the consumer surplus earned in the competitive case to the monopoly firm. Reorganizing a perfectly competitive industry as a monopoly results in a deadweight loss to society given by the shaded area GRC. The monopolist restricts output to Q m and raises the price to P m. The perfectly competitive industry produces quantity Q c and sells the output at price P c. The marginal cost curve may be thought of as the supply curve of a perfectly competitive industry. Given market demand and marginal revenue, we can compare the behavior of a monopoly to that of a perfectly competitive industry. A perfectly competitive industry achieves equilibrium at point C, at price P c and quantity Q c.įigure 10.11 Perfect Competition, Monopoly, and Efficiency The short-run industry supply curve is the summation of individual marginal cost curves it may be regarded as the marginal cost curve for the industry. To contrast the efficiency of the perfectly competitive outcome with the inefficiency of the monopoly outcome, imagine a perfectly competitive industry whose solution is depicted in Figure 10.11 “Perfect Competition, Monopoly, and Efficiency”. Because a monopoly firm charges a price greater than marginal cost, consumers will consume less of the monopoly’s good or service than is economically efficient. Efficiency requires that consumers confront prices that equal marginal costs. The fact that price in monopoly exceeds marginal cost suggests that the monopoly solution violates the basic condition for economic efficiency, that the price system must confront decision makers with all of the costs and all of the benefits of their choices.
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