Measuring the Waste from Imperfect Competition

We can depict the efficiency losses from imperfect competition by using a simplified version of our monopoly diagram, here shown in Figure 10-6. If the industry could be competitive, then the equilibrium would be reached at the point where Me = P, at point E. Under universal perfect competition, this industry’s quantity would be 6 with a price of 100.

Now consider the impact of monopoly-perhaps one gained by a tariff, perhaps by a foreign-trade quota, or perhaps .because government prevented entry by regulation or allowed a labor union to monopolize the labor in the industry. Whatever the source, the monopolist would set its Me equal to MR (not to industry P), displacing the equilibrium to Q = 3 and P= 150 in Figure 10-6. The blue area GBAF is, the monopolist’s profit, which compares with a zero-profit competitive equilibrium.

We can measure the inefficiency from monopoly . by using the tools of consumer surplus (see Chapter 5). Economists measure the economic harm from inefficiency in terms of the dead weight loss; this term signifies the loss in real income that arises because of monopoly, tariffs and quotas, taxes, or other, distortions. Recall that for each unit of output reduction below E, the efficiency loss is the vertical distance between the demand curve and the Me curve. The total dead weight loss from the monopolist’s output restriction is the sum of all such losses, represented by the gray triangle ABE in Figure 10-6.

To see this, recall that the DD curve represents the good’s marginal value to consumers at each level of output, while the Me curve represents the opportunity cost of devoting production to this good rather than to other industries. For example, at Q = 3, the vertical difference between B and A represents the difference between the value and the cost of a small increase in the output of Q. Adding up all these differences from Q ~ 3 to Q = 6 gives the shaded region ABK’ . The technique of measuring the costs of market imperfections by “little triangles” of dead weight. loss, such as the one in Figure 10-6, can be extended to other areas. Similar analysis applies to foreign-trade tariffs and quotas, taxes and subsidies, and externalities.

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