Monopoly Inefficiency

The restriction of output by the monopoly is inefficient. This inefficiency is shown in the following figure:

Figure 5

We can explain the inefficiency of monopoly by using the concept of consumers' surplus, using the diagram. There are three areas, the lightly (green) shaded area above the profit rectangle, the lightly (red) shaded area to its right, and the profit rectangle itself. Before the industry is monopolized, consumers buy 21,000 widgets at $40 per widget and their consumers' surplus is the sum of the three areas. After the monopolization, the consumers buy 11,500 widgets at $70, and their consumers' surplus is the area of the (green) upper triangle.

Let's add up the benefits of monopolization. After monopolization, the net benefits from widget production have two components: the profit rectangle plus the upper (green) consumers' surplus triangle. But the opportunity cost of monopolization is the consumers' surplus the consumers would have enjoyed if they had continued to buy at $40 -- the sum of the three areas. Thus, the benefits of monopolization are less than the costs, and the difference -- the excess cost -- is measured by the area of the (red) triangle to the right.

This loss of consumers' surplus is called the "deadweight loss" (meaning the monopoly profits are not enough to offset it) or the "welfare triangle" and is a measure of the waste due to monopoly restriction of output. In this very simplified example, it is half of the monopoly profits.