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Difficulty: EasyComparison of Market Structures: Economic Efficiency and Consumer Welfare

Compared to a perfectly competitive market, why does a profit-maximizing monopoly lead to a reduction in consumer welfare?

  1. It restricts output and charges a price that exceeds marginal cost.Answer
  2. B
    It produces at the minimum point of its average total cost curve in the long run.
  3. C
    It sets its price equal to marginal revenue to ensure allocative efficiency.
  4. D
    It eliminates deadweight loss by setting price equal to marginal cost.

Answer

A monopoly reduces consumer welfare because it restricts total market output and charges a price that exceeds marginal cost.
A monopoly reduces consumer welfare because it exercises market power to restrict production level below the competitive equilibrium. By charging a price higher than marginal cost (P>MCP > MC), the monopolist creates deadweight loss, reducing overall consumer surplus.

Step-by-Step Solution

1
Identify the efficiency condition under perfect competition.
In perfect competition, firms produce where price equals marginal cost (P=MCP = MC), maximizing consumer surplus and total economic welfare.
Allocative efficiency occurs when price reflects the marginal valuation of consumers relative to the marginal cost of production.
2
Analyze the pricing and output behavior of a monopoly.
A monopolist sets output where marginal revenue equals marginal cost (MR=MCMR = MC), but because demand slopes downward, price exceeds marginal cost (P>MCP > MC).
Market power enables the firm to restrict output to raise prices and maximize economic profit.
3
Evaluate the impact on consumer welfare.
Because output is lower and price is higher under monopoly than under competition, a portion of consumer surplus is lost and deadweight loss is created.
Consumer welfare drops due to under-allocation of resources relative to social optimum.

Key Concept

Monopolistic Inefficiency and Welfare Loss
Estimated Time:45s
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Topics

Comparison of Market Structures: Economic Efficiency and Consumer Welfare

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