So we know that the monopolist is going to face a downward sloping demand curve. So we put quantity on our x, dollars on our y, and we put our downward sloping demand curve for the monopolist. Remember, this demand curve for the monopolist is also the market demand curve.
Because the monopolist is the market, there is no competition. So if a consumer wants to purchase from this particular firm, this is their only choice. So the demand curve represents all of the...
consumption in the market. We know that this demand curve is also equal to their average revenue curve. We also know that their marginal revenue curve falls everywhere below the demand curve, and it should be twice as steep as the demand curve. We can now add in our cost equations as well. So we can put in our average total cost and our marginal cost.
So we have our marginal cost and our average total cost. Now, profit maximization. Profit maximization is going to occur where we're looking at marginal cost and marginal revenue. So again, our steps for profit maximization set that marginal revenue equal to marginal cost to get our quantity. So here we look at that intersection point.
We can go down and we'll get our profit maximizing Q. In step two, We use the demand to get the price. Why?
Because the monopolist is choosing quantity. The monopolist does not choose price. The monopolist says, here's the quantity that's going to give me the most profit.
Now, what are consumers willing to pay for it? So we use the quantity and we go up to the demand curve, which reflects the willingness to pay of a buyer, in order to get the price that the consumers are willing to pay. Finally, in order to get profit, again, we use that formula P minus ATC times Q in order to determine our profit.
So we ask, what is the average total cost of that profit maximizing quantity Q? Go up to the intersection point with your ATC curve and you get the average total cost of that quantity that the monopolist is choosing to produce. Graphically, that then gives you the profit area. for the firm. So this monopolist is making positive economic profit.
Now the question is, what are the impacts on society? When the monopolist chooses to produce this profit maximizing quantity, they're imposing cost on society. Specifically, we can look at the fact that the monopolist is charging a price higher than the marginal cost. This means that in comparison to perfect competition, They're charging a higher price and producing a lower quantity. Remember, in perfect competition, the market is determined by the equilibrium of the supply and the demand, which is really for the monopolist where the marginal cost and the demand curve intersect.
So if this market were perfectly competitive, it would be produced, or the quantity that would be produced, would be the quantity represented by, we'll call it PC, or socially optimal quantity. This is the point where total surplus would be maximized. But this monopolist is charging a price that's higher than that price and producing a quantity that's smaller. Additionally, the monopolist limits consumer choice.
Because there's only one seller and they're preventing others from coming in and producing a product that might meet some consumers'tastes or preferences better, they're limiting the choice of those consumers. and as a result that reduces the welfare of society. Imagine, for example, if every phone looked identical or every car looked identical, every house looked identical.
That would not necessarily meet the needs, tastes, and preferences of each individual in our economy. Finally, the rent-seeking leads to a misallocation of resources. Now that's a very economic phrase.
When we say rent-seeking, we're essentially talking about obtaining profits off... otherwise misused resources, essentially. In other words, we're trying to make money, is what it amounts to. But because we are inefficient in our production, because we are using resources inefficiently, we're not maximizing total surplus. This rent-seeking or profit-seeking, if you will, causes a misallocation.
In other words, we're using too few goods to produce these, and it's too expensive in the market. If we go back, we can see that if we were in a perfectly competitive market You could argue that here's your demand curve and the marginal cost curve is essentially supply. If we connect it down, all of this area should represent total surplus in the market if we were in a competitive. But in actuality, we're losing out. We're losing out on some of the gains of total surplus that we could have as a result of this monopolist charging a price that's higher than socially optimal and producing a quantity that's less.
This is what economists call deadweight loss. The deadweight loss occurs because the monopolist is setting that price above marginal cost, and it places a wedge between the consumer's willingness to pay and the producer's cost. So this idea is that when we look at our graph, we can see that for the consumer, for example, we know that consumer surplus is the area that's below the demand.
but above the price up to the quantity that they're consuming. So all of this area would represent the consumer surplus. What about producer surplus?
Producer surplus is the area below the price, but above the supply curve up to the quantity. So all of this area would represent producer surplus. So we've got a good number of the areas that are represented, but we're missing one. We're missing this last area over here that is the area that we're referring to as deadweight loss. The area that occurs because we're producing less than socially optimal and we're charging a price that's greater than marginal cost.
This is the deadweight loss for the monopolist. And that deadweight loss can be significant. If the demand is very steep, the steeper the demand, the more significant is the deadweight loss, because the greater the ability of the monopolist to charge a price greater than marginal cost.
Again, the deadweight loss refers to this loss of surplus that we're not receiving as a result of the monopolist's actions to charge a price higher than marginal cost and to produce a quantity that's less than socially optimal. So when we identify... our deadweight loss triangle.
To identify it, you want to point out the three corners of your deadweight loss. The first is here, where your marginal cost and your demand curve intersect. This is again what we're referring to as that socially optimal quantity. And social optimality refers to maximization of total surplus. The second point is down here, where your marginal cost and your marginal revenue intersect.
That is signifying the quantity that the monopolist is producing, but it's also representing that marginal cost that the monopolist is going to be able to charge a price higher. Finally, where the price intersects the demand curve up here. So 0.3, 2, and 1. That's the price that the monopolist can charge and that gives us that price above marginal cost.
So we have our price above marginal cost. and our quantity that's less than socially optimal. And those represent the three corners of that deadweight loss triangle. Identifying those three corners will always give you that triangle. And the triangle is not always what you think it is.
So following those three steps or those three points will always give you the same deadweight loss triangle each time or the accurate one.