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Private transactions between sellers and buyers start with the seller owning the

good and conclude with the buyer obtaining legal possession of the item in

exchange for payment. Besides individuals, firms and other organizations have

legal rights to undertake transactions, enter into contracts, and create new cor-

porate entities.

Private markets depend on the rule of law created and maintained by gov-

ernment and enforced by the police and the courts. Even today, property rights

can change. For instance, tradable pollution permits and rights in genomic

material are new types of property rights. Recent court rulings have held that

unauthorized downloading music over the Internet violates the property rights

of the music’s creators. In summary, well-functioning private markets could

not exist without the underpinning of government.

In Chapter 7, we showed that perfectly competitive markets are efficient,

that is, competitive markets provide the right amounts of goods and services at mini-

mum cost to the consumers who value them most highly. This is best thought of as a

benchmark. While many markets in the United States approximate the require-

ments of perfect competition, notable cases of market failure also exist. Market

failures usually can be traced to three causes: (1) the presence of monopoly

power, (2) the existence of externalities, or (3) the absence of perfect infor-

mation. In the next three sections, we examine each of these cases in turn.

MARKET FAILURE DUE TO MONOPOLY

Monopolistic markets (pure monopoly, monopolistic competition, or oligopoly)

deviate from the efficiency standard. Relative to pure competition, monopoly

power elevates prices, increasing the monopolist’s profit at the expense of con-

sumer welfare. Consumers lose more than monopolistic producers gain. Thus,

total welfare falls.

We can see this deadweight lossby turning back to Figure 8.3. Deadweight

loss is measured by the triangle MDE. The perfectly competitive outcome

(point E) delivers maximum social benefit in the form of the large consumer-

surplus triangle ACE. By contrast, under monopoly (point M), total social ben-

efit is measured as the sum of consumer surplus (triangle ABM) and the

monopolist’s excess profit (rectangle MBCD). The difference is measured by

the deadweight loss triangle MDE.

448 Chapter 11 Regulation, Public Goods, and Benefit-Cost Analysis

CHECK

STATION 1

Let industry demand be given by P  20 2Q and industry unit cost by AC MC 8.

Find output and price under pure monopoly and under perfect competition. Calculate

the deadweight loss due to monopoly.

Similar welfare outcomes occur in the intermediate cases of monopolistic com-

petition and oligopoly. When there is competition among a small number of

firms, prices are raised above the competitive level but fall short of the pure

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