Source: p 312, Principles of Microeconomics (7 Ed, 2014) by N G Mankiw

Welfare in a monopolized market, like all markets, includes the welfare of both consumers and producers. Whenever a consumer pays an extra dollar to a producer because of a monopoly price, the consumer is worse off by a dollar and the producer is better off by the same amount. $\color{red} {[1.]} $ This transfer from the consumers of the good to the owners of the monopoly does not affect the market’s total surplus— the sum of consumer and producer surplus. In other words, the monopoly profit itself represents not a reduction in the size of the economic pie but merely a bigger slice for producers and a smaller slice for consumers. Unless consumers are for some reason more deserving than producers—a normative judgment about equity that goes beyond the realm of economic efficiency—the monopoly profit is not a social problem.

The problem in a monopolized market arises because the firm produces and sells a quantity of output below the level that maximizes total surplus. $\color{green} {[2.] \text { The deadweight loss measures how much the economic pie shrinks as a result. }} $ This inefficiency is connected to the monopoly’s high price: Consumers buy fewer units when the firm raises its price above marginal cost. But keep in mind that the profit earned on the units that continue to be sold is not the problem. The problem stems from the inefficiently low quantity of output. Put differently, if the high monopoly price did not discourage some consumers from buying the good, it would raise producer surplus by exactly the amount it reduced consumer surplus, leaving total surplus the same as could be achieved by a benevolent social planner.

On p 311, Mankiw discusses the deadweight loss (hereafter DWL) of a monopoly, which 2 above concerns. So what does 1 mean? It appears to contradict 2. DWL reduces the total market's surplus, and so the size of the economic pie.


2 Answers 2


Consider the following two examples:

There is a consumer who is willing to pay 50 dollars for a good. (Reservation price is 50.) There is a seller who is willing to sell for 30 dollars. (Marginal cost is constant 30.) If they make a deal at any price $p$ the total surplus they enjoy will be $(50 - p) + (p - 30) = 20.$ The individual surpluses need only be non-negative because otherwise one party would probably not consent to the deal. The price that is finally reached depends on their bargaining power. With a monopoly all the bargaining power is on the seller's side, so the price would be $p = 50$. Total surplus is still 20. So there's no loss.

However if there are two consumers, one with a reservation price of 50 and the other with 31 then at price 50 only one of them (the former) will buy the good. At price 30, both of them would buy the good and total surplus would be $(50 - 30) + (31 - 30) + (30 - 30) = 21$. But the monopoly's profit is 20 dollars if it sets $p = 50$, and 0 dollars if it sets $p = 30$. So it will choose the former. Because of uniform pricing, a good that would increase the total surplus is unsold, creating deadweight loss.


What that source is saying is that there are two attributes of the single-price monopoly: the higher price payed by consumers that make trades with the monopoly, and the dead-weight loss resulting from consumers that do not make trades with the monopoly who would if the price were at-cost.

It makes more sense if you consider a non-single-price monopoly - ie a monopoly using price discrimination. Such a monopoly can often still use a higher price for most of its customers, but price discrimination allows it to theoretically capture all mutually beneficial trades, thus maximizing pareto efficiency and eliminating the dead-weight loss entirely.

In this case, because the monopoly is still using a higher price for most of its customers, the surplus (difference between the price and the cost) is mostly going to the monopoly, whereas in classic perfect competition, the surplus goes entirely to the buyers. What the exposition around #1 means is that economists are neutral on whether the buyer or seller should get all, some, or none of the surplus. In other words, the matter of who gets the surplus doesn't effect allocative efficiency, and so is treated as a non-factor in policy making.


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