Calculating Deadweight Loss

 Review: Deadweight loss is the social benefit that is lost when a monopolist operates at
its profit-maximizing output/price combination.

 Monopolies create deadweight loss by producing lower output and charging a higher price
than what a competitive market would produce and charge.

Monopolists must often engage in rent-seeking behavior to maintain their monopoly

positions.

Graphed on the left is a competitive firm’s

market for restaurant meals at an airport.
Assume that the marginal cost for each meal is
$3 (as shown on the vertical axis) and that
that price represents the social cost of
producing each meal.

Assume also that each point on the demand

curve represents consumers’ reservation
prices. In a competitive market, the
equilibrium price is $3, and the firm will sell
five meals.

The competitive market is creating $13 in

economic value. The economic value is seen
on the left as the total of the difference
between each customer’s reservation price
and the marginal or social cost of the meal. To
calculate consumer surplus, you simply sum
the differences up to the point at which
another unit adds no more economic value.
In this case, there is no producer surplus. All
economic value is in the form of consumer
surplus.
Now assume that the firm selling meals at the
airport is a monopolist. The socially beneficial
output and price is not the monopolist’s profit-
maximizing output and price. In fact, at $3
and five meals, the firm is making zero
economic profit.

The monopolist’s profit-maximizing output

is two meals at $7 each. The monopolist’s
profit at that output is TR – TC =
$14.00 - $6.00 = $8.00.

When there are monopoly profits, society loses

the economic value of the triangular shaded
area on the left. This is value that is gained
when this market is a competitive market
because it represents customers who are
willing to pay for meals but are not served.
In this case, the deadweight loss is $3
because the monopoly has created only $10 in
economic value as opposed to the $13 created
under competition.

Another loss of economic value occurs under

monopoly: because the monopolist has
economic profit, other firms will want a
franchise. (Recall that economic profit is any
revenue greater than average costs.) To
protect its monopoly, the firm has to engage
in non-price competition, or rent-seeking
behavior. Rent-seeking activities are those
that involve political lobbying, bribery, or other
non-price activities that will ensure
continuation of the monopoly.

These activities are another form of social loss.