Question

How does the exercise of monopolistic power prevent efficiency from being attained?

Answer 1

The socially efficient outcome is obtained when price is equated with Marginal cost (MC) of production, which ensures that total surplus (= Consumer surplus + Producer surplus) is maximized. However, a monopolist, facing a downward sloping demand and marginal revenue (MR) curves, exercises monopoly power by equating MR with MC. Since MR curve lies below demand curve, the equality of MR and MC ensures that price is higher and output is lower than the socially efficient price and output, respectively. This gives rise to a deadweight loss, which lowers social efficiency by decreasing consumer surplus and increasing producer surplus.