A2 Revision – Monopoly and Deadweight Loss

A topic in the A2 syllabus is Market Failure with special emphasis on Monopoly and Deadweight Loss.

In Perfect Competition we stated that the force of supply and demand establish an equilibrium situation in which resources are used most efficiently – MC (Supply) = AR(Demand) . Furthermore, in perfect competition the firm produces at MC = MR (profit max) which is also the same as producing at MC = AR (allocative efficiency). This is because AR and MR are the same in perfect competition. Therefore the same output represents allocative efficiency and profit max. Remember that long-run Perfect Competition is a significant output as it is where:
MC = MR – Maximum Profit or Minimum Loss
MC = AR – Allocative Efficiency (Supply = Demand)
AC = MC – Technical Optimum – Productive Efficiency

However for a monopolist because the AR and the MR curves are different we get separate outputs for Allocative Efficiency and Profit Max. The graph below shows that at profit maximising equilibrium, output Q2 is less than that in a competitive market (Q1), and the demand and supply (MC) curves do not intersect. Q1 represents the Allocative Efficiency level of output and P1 the price. The shaded area therefore represents the loss of allocative efficiency or the deadweight loss.

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