Monopoly – Abnormal Profit and Welfare Loss
A diagram illustrating a monopolist earning abnormal profit. The firm restricts output to Qm where MC = MR and sets price Pm, resulting in welfare loss and consumer surplus loss compared to a perfectly competitive outcome.
ar
AR = D: The average revenue or demand curve, downward sloping due to price-setting power.
mr
MR: Marginal Revenue, lies below AR for monopolies.
mc
MC: Marginal Cost, intersects MR at the profit-maximizing quantity Qm.
atc
ATC: Average Total Cost, used to calculate the firm's level of profit.
q
Qm: The monopolist's profit-maximizing quantity where MC = MR.
p
Pm: The price charged by the monopolist at Qm, found on the AR curve.
pc
Pc: The allocatively efficient price that would exist in a perfectly competitive market, where MC intersects the AR (demand) curve.
A monopolist maximizes profit where marginal cost (MC) equals marginal revenue (MR), producing quantity Qm.
The price Pm is set by extending a vertical line from Qm up to the demand curve (AR = D).
Since Pm is greater than average total cost (ATC) at Qm, the firm earns abnormal profit (shown in pink).
The price Pc represents the price that would exist under perfect competition, where MC = AR. This is the allocatively efficient point.
The shaded welfare loss triangle represents the loss of societal welfare due to the monopolist underproducing relative to the socially optimal quantity.
Monopolies lead to market failure because they do not produce at the socially efficient output (MC ≠ AR).
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