AP_Krugman_Textbook

Panel (b) shows the results for the same market, but this time assuming that the in-

dustry is a monopoly. The monopolist produces the level of output, QM,at which mar-

ginal cost is equal to marginal revenue, and it charges the price, PM.The industry now

earns profit—which is also the producer surplus in this case—equal to the area of the

green rectangle, PSM.Note that this profit is part of what was consumer surplus in

the perfectly competitive market, and consumer surplus with the monopoly shrinks

to the area of the blue triangle, CSM.

By comparing panels (a) and (b), we see that in addition to the redistribution of

surplus from consumers to the monopolist, another important change has oc-

curred: the sum of profit and consumer surplus—total surplus—is smallerunder

monopoly than under perfect competition. That is, the sum of CSMand PSMin

panel (b) is less than the area CSCin panel (a). Previously, we analyzed how taxes

could cause deadweight lossfor society. Here we show that a monopoly creates dead-

weight loss equal to the area of the yellow triangle, DWL.So monopoly produces a

net loss for society.

This net loss arises because some mutually beneficial transactions do not occur.

There are people for whom an additional unit of the good is worth more than the

marginal cost of producing it but who don’t consume it because they are not willing

to pay the monopoly price, PM.Indeed, by driving a wedge between price and mar-

ginal cost, a monopoly acts much like a tax on consumers and produces the same

kind of inefficiency.

So monopoly power detracts from the welfare of society as a whole and is a source of

market failure. Is there anything government policy can do about it?

Preventing Monopoly Power

Policy toward monopolies depends crucially on whether or not the industry in ques-

tion is a natural monopoly, one in which increasing returns to scale ensure that a big-

ger producer has lower average total cost. If the industry is nota natural monopoly,

the best policy is to prevent a monopoly from arising or break it up if it already exists.

618 section 11 Market Structures: Perfect Competition and Monopoly

(a) Total Surplus with Perfect Competition (b) Total Surplus with Monopoly

D

MC = ATC MC = ATC

QC Quantity

PC

CSC

QM

PMCSM

PSM DWL

D

MR

Quantity

Consumer surplus

with monopoly

Consumer surplus with

perfect competition

Price,

cost

Profit

Deadweight

loss

Price, cost,

marginal

revenue

figure 62.1 Monopoly Causes Inefficiency

Panel (a) depicts a perfectly competitive industry: output is QC,and

market price, PC,is equal to MC.Since price is exactly equal to each

producer’s average total cost of production per unit, there is no pro-

ducer surplus. So total surplus is equal to consumer surplus, the entire

shaded area. Panel (b) depicts the industry under monopoly: the mo-

nopolist decreases output to QMand charges PM.Consumer surplus

(blue area) has shrunk: a portion of it has been captured as profit

(green area), and a portion of it has been lost to deadweight loss (yel-

low area), the value of mutually beneficial transactions that do not

occur because of monopoly behavior. As a result, total surplus falls.