7.4: Social Cost and Benefits

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Page ID: 210855

Martin Medeiros
Chabot College

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In the last module we discussed the situation when a firm in a perfectly competitive industry made an economic profit. See figure 9.

A diagram of a profit and a profit lineDescription automatically generated with medium confidence

Figure 9

The small and profitable firm attracted new competition to the market. With new competition came more supply thereby shifting the market supply to right. The rightward shift of the market supply results in more output at a lower price. See figure 10.

A diagram of a marketDescription automatically generated

Figure 10

You can also see on the right side of figure 10 that the firm’s economic profit is now gone.

With the loss of profit, one could assume that the firm depicted in figure 10 is not happy with more competition. But is everyone unhappy?

Society benefits from greater competition. The benefits come in three forms:

lower price:
higher quantity
higher efficiency

Figure 10 shows how price falls and output rise when more firms, looking for economic profit, enter a market. This “more for less” outcome results in an increase in consumer purchasing power (economists call this result an increase in real income). More purchasing power leads to more spending, more output, and more employment.

Figure 11 shows how a firm, when faced with more competition, is forced to lower its price, and produce a rate of output that is productively efficient. Productive efficiency is achieved by producing a rate of output that minimizes the average total cost (see point x).

Now, what happens to the societal benefits when the market structure moves from perfect competition to monopoly?

A diagram of a graphDescription automatically generated

Figure 11

A monopolist produces a quantity of output (\(\mathrm{Q}_{\text {Mon }}\)) that is less than a perfectly competitive market (\(\mathrm{Q}_{\text {PC }}\)). This reduced rate of output is due to the barriers that keep profit-seeking firms from entering the market.

Also, notice that a monopolist does not produce a profit maximizing rate of output (\(\mathrm{Q}_{\text {Mon }}\)) that minimizes average total cost (see point z in figure 11). The reason why a monopolist is not as efficient as a perfectly competitive firm is because it is shielded from competitive threats.

When a perfectly competitive firm produced a rate of output that did not minimize \(\mathrm{ATC}\), it was vulnerable. If a rival firm, with lower \(\mathrm{ATC}\), undercut the price of the inefficient firm then the inefficient firm lost customers. And unless the inefficient firm managed to lower its average costs, it could not remain in business for long.

The monopolist, on the other hand, does not face the same consequences when average costs are not minimized. Because of barriers to market entry, the monopolist will not lose market share from lower priced rivals.

This productively inefficient rate of output is a cost to society because the monopolist is using more scarce resources than it would if it competed in a competitive industry.

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