Question

Using an appropriate graph, explain how a subsidy to a monopolist might increase efficiency.

Answer 1

Monopoly firm operates where MR = MC while perfectly competitive market equates where P = MC. Thus, output in monopoly tends to be lower than the perfectly competitive market. Therefore, monopoly firm is considered as inefficient.

Government can address inefficiency by offering subsidies to monopoly firms thereby it will increase its output level.

Following is diagram:

In above diagram, Deadweight loss is caused in monopoly firm, and hence monopoly is inefficient. If government offers subsidies, it will induce firm to increase output close to perfectly competitive ones.