Now assume that the market structure changing from perfect competition to monopoly and the marginal cost curve remain the same. Since the monopoly is a price maker facing the whole market demand curve, marginal revenue will be lower than price. In figure B, it chooses the profit-maximizing quantity at the intersection of MR and MC at point F. It then finds the price at which it can sell this quantity Qm by consulting the demand curve. The product is sold at price Pm. The consumer surplus under monopoly is the triangle ApmC and the producer surplus is PmCFE. The economic welfare is consumer surplus plus producer surplus.
Compared with perfect competition, we can see that a single-price monopoly restricts output and charges a higher price. The consumer surplus decreased to the smaller triangle ApmC. This is caused by higher price and lower quantity produced and consumed. The monopoly takes part of consumer surplus. The rectangle PmPpcGC is the transferred from consumer surplus to the monopoly. It is not a loss to the society. But part of the original producer surplus is also lost. (Triangle GFB). The total welfare loss is the gray triangle CFB which is called deadweight loss. Part of the deadweight loss, the triangle CGB, is the loss of consumer surplus. The other part of deadweight loss (triangle GFB) is the loss of producer surplus. Because there is less output under monopoly. Obviously, monopoly is inefficient. The total surplus (economic welfare) is smaller under monopoly than under perfect competition. There is a deadweight loss to society when market structure changing from perfect competition to monopoly.
As well as allocative efficiency, perfect competition leads to productive efficiency. The graph below demonstrates the long-run equilibrium in a perfectly competitive market.
From the graph, we observe that price equals ATC, so the profit is zero. The firm is producing the quantity where ATC is at its minimum point. All firms wish to minimize the cost of producing a given quantity because reducing costs increase profits. If the firm did not choose to minimize the cost of producing its output by producing on its cost curves, ATC would increase and profit would be less than zero. So all firms under perfect competition are forced to produce at the quantity where its ATC is at the minimum point. But under monopoly, there is a productive inefficiency. The graph above shows the long-run equilibrium for a monopoly. Price is greater than ATC so the profit is greater than or equal to zero. The firm is not producing the quantity where ATC is at its minimum point. Therefore, the monopoly results in productive inefficiency.
On the other hand, in the long-run, monopoly has the incentive to innovation. Obviously, the innovation reduces TC and result in higher profits. The additional profit is the incentive to innovate to the firm. In perfect competition, the long-run equilibrium is where profit equals zero. If perfectly competitive firm innovates, profits rise. However, in the long-run the firm’s competitors will enter the market (copy the innovation) and force profits back to zero. So there is no incentive for innovation exists in perfectly competitive markets. But if monopoly firm innovates, profits rise. In contrast to perfect competition, monopolists have no competitors because of the existence of barriers to entry. Hence, the firm will obtain the profit from innovation and will have a significant incentive to innovate. If there is no patent system, monopoly is more efficient because they have an incentive to innovate.
The monopoly is inefficiency and creates a deadweight loss to society. Moreover, there is an additional cost of monopoly, which is called rent seeking. Rent seeking is the attempt to capture consumer surplus, producer surplus, or economic profit. There is no barrier to rent seeking. As long as the cost of create a monopoly is less than monopoly’s profit, an economic profit will be earned. So there is an incentive to rent seek. When the average total cost curve shifts upwards until it touches the demand curve, the profits are zero. In this situation, the deadweight loss of monopoly is increased which includes original deadweight loss plus the lost producer surplus. From the standpoint of society, the additional costs of monopoly are wasteful because rent seeking uses resources that do not produce any wealth.
Although monopoly results in inefficiency, when it practices price discrimination, it can obtain a significant profit. Price discrimination is defined to occur whenever a firm charges different prices for a single good or service. To be able to price discriminate, a firm must has some market power and can separate market into different segments. The products it sells cannot be resold. Assume that a single-price monopoly divide its consumers into three groups. In figure C1, the rectangle ABCD is the economic profit made by the single-price monopoly. The triangle EDC is the consumer surplus. In figure C2 the single-price monopoly practice price discrimination. The monopoly charges the maximum price that each group of consumers is willing to pay. We discover that there is an increased economic profit (the darker gray area) from price discrimination. Moreover, the monopoly captures the consumer surplus for itself. The consumer surplus has shrunk to the small gray area,
The above I have mentioned is imperfect price discrimination. When the price discrimination becomes perfect, the monopoly is more efficient than before. In perfect price discrimination, the price is decreased in order to sell a larger quantity. The monopoly sells only marginal unit at that price and subsequent units is sold for the highest price the consumers are willing to pay. In this way, the demand curve becomes the marginal revenue curve. The monopoly will still produce the output where MR equals MC. Now, since the price equals MR, it produces output where P equals MC, which is the allocative efficiency. In figure D we can see that monopoly extracts the entire consumer surplus. Producer surplus equals total economic welfare in perfect competition. Deadweight loss with perfect price discrimination is eliminated. So perfect price discrimination achieves efficiency. “The more perfectly the monopoly can price discriminate, the closer its output gets to the competitive output and the more efficient is the outcome.” (Economics, fifth edition, Michael P) But in perfect competition the economic welfare is the sum of producer surplus and consumer surplus while the producer gets it all under perfect price discrimination.
In conclusion, perfect competition results in allocative and productive efficiency. When market structure changing from perfect competition to monopoly charging a single price, there is a deadweight loss to the society. The resources are not used efficiently. Meanwhile, there is redistribution from consumers to the monopoly producer. Moreover, the monopoly leads productive inefficiency because of lack of pressure. But on the other hand, monopoly has the incentive to innovation. It may benefit from the economies of scale. From these standpoints, monopoly is more efficient than we thought. If monopoly practices price discrimination, the economic welfare will increase up to the total surplus in the perfect competition. The price discrimination increases the efficiency of monopoly. “The more perfectly the monopoly can price discriminate, the closer its output gets to the competitive output and the more efficient is the outcome.” (Economics, fifth edition, Michael P) However, there is a transfer of surplus from consumer to producer.
References
Essential of economics, second Edition, John, S., 2001, Pearson Education Limited, Essex
Economics, Fifth Edition, Michael, P., & Melanie, P., & Kent, M., 2003, Pearson Education Limited, Essex
The Applied Theory of Price, Donale N.McCloskey, 1982, Macmillan Publishing CO.Inc, USA
Extended-Coverage Topics,
www.occawlonline.pearsoned.com/bookbind/pubbooks/miller2001_aw1/medialib/dow…
Rent-Seeking Behavior
www.magnolia.net/~leonf/politics/rentseek.html
Monopoly and X-Efficiency. Justin Morton, Senior sophister
The Concise Encyclopedia of Economics
www.econlib.org/library/Enc/bios/Schumpeter.html
