Welfare Effects of Monopoly (derived from video lecture by Jonathan Gruber)


So what is the welfare effects of monopoly? What we see is we know
that the competitive firm maximizes welfare. We learned that last time. We know that the best you can do
is to sell 8 units at a price of 16. What happens when you sell 6 units at a price of 18? What happens is consumer surplus falls
from A plus B plus C. So with perfect competition,
consumer surplus is A plus B plus C. With a monopoly, consumer surplus falls to the area A. So you lose B plus C with monopoly. Producer surplus under perfect competition
was the area D plus E. Now, under a monopolist, the producer surplus
is equal to D plus E plus B. The monopolist , in this case, gained the rectangle B, but gave up the rectangle E. The consumer lost the rectangle B,
that was a transfer to the monopolist. So there was a transfer of the rectangle B
from the consumer to the monopolist, but C plus E have disappeared. They’re a deadweight loss. They’re deadweight loss because
in the perfectly competitive equilibrium these are trades
that would have made both parties better off. That is, these are trades
which socially should happen. They are trades where the value to the consumer
exceeds the cost of producing that unit. Those seventh and eighth units are units —
so take the seventh unit. What’s that worth to someone? Well, it’s worth 17. We can read that off the demand curve. That’s a willingness to pay curve. People are willing to pay 17 for that seventh unit. What’s it cost to produce? It cost 14. So you have a unit which people want more
than it costs to produce, yet it’s not getting sold. That’s deadweight loss. So monopolists induce deadweight loss
because units that people value above their marginal cost doesn’t get sold.

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