Question

Monopolies are economically inefficient. List the consequences of this inefficiency as far as market price and quantity are concern:

Answer 1

The efficient market structure is perfect competition where profit is maximized (or loss is minimized) when market price equals marginal cost (MC). At the profit-maximizing output level, consumer surplus (CS) and producer surplus (PS) are each maximized, so total surplus (TS = CS + PS) is maximized.

But a monopoly maximizes profit (or minimizes loss) by equating Marginal revenue (MR) with MC. Since demand curve lies above MR curve, price is higher than MR, therefore higher than MC. As a result, inefficiency sets in, with following effects:

(i) Equilibrium price is higher in monopoly than under social optimum (perfect competition), and

(ii) Equilibrium quantity is lower in monopoly than under social optimum (perfect competition).