Question

Is a monopolist allocatively efficient? Why or why not?

Short answer

A monopolist is not allocatively efficient because it produces a quantity of goods where its marginal cost (MC) is lower than the marginal benefit (MB) that consumers are willing to pay, represented by the market price on the demand curve. This leads to underproduction of goods, higher prices, and an inefficient allocation of resources, resulting in deadweight loss. In comparison, a perfectly competitive market achieves allocative efficiency as goods are produced where the marginal cost of production equals the marginal benefit paid by consumers.

Step-by-step solution

Allocative Efficiency Definition

Allocative efficiency occurs when the resources in an economy are allocated in such a way that consumer satisfaction is maximized, given the constraints in the market. In simpler terms, it means that goods are being produced and consumed at the right quantity, with no surpluses or shortages. Allocative efficiency can be achieved when the marginal cost (MC) of production is equal to the marginal benefit (MB), which is the price consumers are willing to pay for a good or service (represented by the demand curve).

Perfect Competition and Allocative Efficiency

In a perfectly competitive market, we have many producers and consumers, and each producer has no market power, meaning they must sell their goods at the market price. Perfectly competitive firms produce goods at the optimal quantity, where their marginal cost equals the market price (P = MC). As the market price represents the marginal benefit for consumers, this means the market will achieve allocative efficiency. In other words, resources are allocated most efficiently under perfect competition.

Monopoly and Allocative Efficiency

A monopolist, on the other hand, is a single seller in a market and has market power, meaning they can control the price and quantity of their goods. A monopolist will maximize their profit by producing goods where their marginal cost (MC) equals marginal revenue (MR), not where MC equals the price. Since the demand curve represents the marginal benefit for consumers, the monopolist's profit-maximizing quantity (Q_m) will occur where the demand curve is above the marginal cost curve (MB > MC). This means that a monopolist will produce less than the socially optimal output (Q*) and charge a higher price (P_m) than under perfect competition, which leads to allocative inefficiency.

Conclusion

Based on the analysis, a monopolist is not allocatively efficient because they maximize their own profit by producing a quantity of goods that results in marginal cost (MC) being lower than the marginal benefit (MB), which is the market price consumers are willing to pay on the demand curve. This leads to an inefficient allocation of resources in the economy, as there is underproduction of goods and an associated deadweight loss. In contrast, a perfectly competitive market achieves allocative efficiency, as goods are produced and consumed at an optimal level where the marginal cost of production equals the marginal benefit (price) paid by consumers.