Changes

Due to a lack of competition, a monopoly increases its profits by reducing its output and raising the price.  Consumers suffer a social cost because there is less of the good available.  An example is Microsoft Word.  In a perfectly competitive market, the price of Microsoft Word would be equal to its marginal cost (MC), which may be only $20.  But instead Microsoft, by virtue of its near-monopoly, can sell it for perhaps $200.  Fewer copies of Microsoft Word are available at that high price, and many computer users go without it.

Due to a lack of competition, a monopoly increases its profits by reducing its output and raising the price.  Consumers suffer a social cost because there is less of the good available.  An example is Microsoft Word.  In a perfectly competitive market, the price of Microsoft Word would be equal to its marginal cost (MC), which may be only $20.  But instead Microsoft, by virtue of its near-monopoly, can sell it for perhaps $200.  Fewer copies of Microsoft Word are available at that high price, and many computer users go without it.

It is a challenge to quantify the social cost of a monopoly.  But it can be done as follows.

It is a challenge to quantify the social cost of a monopoly.  But it can be done as follows.

In a perfectly competitive market, this particular unit would sell at price P=MC.  In that transaction society would enjoy a windfall benefit of (P-MC), because it was willing to pay an extra amount of (P-MC) for that same unit.

In a perfectly competitive market, this particular unit would sell at price P=MC.  In that transaction society would enjoy a windfall benefit of (P-MC), because it was willing to pay an extra amount of (P-MC) for that same unit.

When the good is withdrawn from the market, society loses that same benefit of (P-MC) that it would have enjoyed in a perfectly competitive market.  Thus the loss to society when a monopoly withdraws that particular unit is (P-MC).

When the good is withdrawn from the market, the net loss to society is its total benefit from that unit minus its overall cost.  Its total benefit is what society was willing to pay for that unit:  the price P.  Its total cost is what society paid to make that unit:  MC.  Thus the net loss to society from a withdrawal of that unit is (P-MC).

To find the overall loss to society imposed by a monopoly, we do the same calculation for every unit that goes unsold due to the monopoly's higher price.

To find the overall loss to society imposed by a monopoly, we do the same calculation for every unit that goes unsold due to the monopoly's higher price.

The social loss can also be described in graphical form as the area under the demand curve between the points P and MC, and above a price line equal to MC.  The summation can be performed by doing an integral in calculus.

The social loss can also be described in graphical form as the area under the demand curve between the points P and MC, and above a price line equal to MC.  The summation can be performed by doing an integral in calculus.

Here is an example:

Here is an example: