Using a market defined by: QD = 50 ‒ P, and QS = ‒10 + 2PAt equilibrium, quantity demanded equals quantity supplied, i.e. QD = QSThus 50 – P = -10 + 2P60 = 3PP = 20With a price of 20, quantity demanded/supplied is 30 unitsEffects of a market transitioning from perfectly competitive to a monopolyThe market structure determines the pricing and profits gained by firms. Similarly, higher prices and profits for firms result from a concentration of the market. Large numbers of firms compete on the finite market in a pure competition market structure and in the course of developing the market, profit-making possibilities diminish as the equilibrium state the firms’ profits equals to zero.
Their profit being the ‘normal’ profit derived from the supply function computed from the firms’ opportunity costs. On the other side a monopolist in his market dominance gains greater positive profit by further increasing the price to relatively high levels. However, there are situations known as ‘industrial regimes’ which cause a monopolist to behave like firms competing in a pure market, and also prompt competitive firms to adopt monopolists’ strategies in pursuit of positive profit.
Figure 1 How monopoly reduces economic welfareThe effect of a market transitioning from perfectly competitive to a monopoly results in a loss of economic welfare; in form of consumer and producer surpluses. The difference between the maximum price a consumer is willing to pay and the actual price expected by the producer, is considered the consumer surplus. In a competitive market, all the consumers in the market enjoy the consumer surplus, as shown by the triangular area P1EA in the figure 1(a), above.
A fall in the price (from P1 to Po) increases consumer surplus, despite decreasing producer surplus, in turn increasing consumer welfare. Conversely, increases in prices reduce consumer surplus, and consequently lowering consumer welfare. On the other hand, producer surplus which refers to the difference between the minimum price a firms is willing to charge for a good and the actual price charged, measures the producer’s welfare. The triangular area FP1A in the figure 1(b) above represents the producer surplus enjoyed by all the firms in the market. Assuming there are no economies of scale, the reduction in economic welfare occurs when a monopoly replaces perfect competition, as depicted in the figure 1(b), above.
In a perfect competition, market equilibrium occurs at point A; price P1 and output Q1. For a monopoly, however, the equilibrium point where MR = MC exists at point B (where the marginal cost curve reflects the perfect competition market supply curve). The diagrammatic comparison between perfect competition and monopoly portrays the monopoly as restricting output (to Q2) and raising price (to P2). Furthermore, an investigation into how the consumer surplus and producer surplus (thus economic welfare) are affected reveals that the increase in price from P1 to P2 generates a rectangular consumer surplus P1P2CD to the monopolist.
Consequently, the producer surplus (considered monopoly profit) increases at the expense of consumer surplus. In spite of this transfer, a net loss is experienced in the net loss occasioned by fall in the quantity sold from Q1 to Q2. Thus the deadweight loss, represented by triangle CBA in the Figure 1 (b), combines the loss of consumer surplus and loss of producer surplus; loss of economic welfare.