1.1 Monopolies and pricing
A monopoly prices its products where marginal costs meet marginal revenues to maximise profits. Due to the fact that this price is higher than the market price in perfect competition, many consumers are not able or willing to buy at the higher price. This deadweight loss is an allocative inefficiency.
Figure 1: Pricing in monopolies and perfect competition
The consumer surplus in perfect competition is 1+2+4, and the producer surplus is 3+5. The consumer surplus in a monopoly is 1, the producer surplus is 2+3, and the deadweight loss is 4+5.
1.2 Monopolies and productive efficiency
In theory, a monopoly does not have to be less (productive) efficient than perfect competition. In reality, however, almost all monopolies tend to be inefficient. This may be for the following reasons: 1.2.1 Pressure for productive efficiency
In perfect competition the price within an industry is determined by the market, or in other words, by demand and supply. Profit maximisation is achieved where the marginal cost curve intersects the demand curve (see figure 1). This means that in perfect competition, the company maximises its profit at the minimum point of its average cost curve. A company in a perfectly competitive environment tries, therefore, to be as efficient as possible in order to meet the minimum average cost. This causes a lot of pressure to achieve productive efficiency. A company in a monopolistic environment is able to change not only its cost, but also its prices. There is far less pressure for productive efficiency. 1.2.2 Diseconomies of scale
A monopoly may increase its output to the point where it exceeds the minimum point of cost on its long-run average total cost curve. In this case, diseconomies of scale occur. 1.2.3 X-inefficiency
In perfect competition, X-inefficiency of one market participant will have almost no influence on the market and the market price....