Which is a major criticism of a monopoly as a source of allocative inefficiency?
A) A monopolist fails to expand output to the level where the consumers’ valuation of an additional unit is just equal to its opportunity cost.
B) A monopolist has no incentive to produce efficiently, because even the inefficient monopolist can be assured of economic profits.
C) A monopolist will always make profits and that means that prices are too high.
D) A monopolist has an unfair advantage because it can purchase labor at a lower price than competitive firms in other industries.
The correct answer and explanation is :
The correct answer is:
A) A monopolist fails to expand output to the level where the consumers’ valuation of an additional unit is just equal to its opportunity cost.
Explanation:
A monopoly is often criticized for causing allocative inefficiency because it restricts output and charges a higher price compared to a perfectly competitive market. In a perfectly competitive market, firms produce at the point where Price (P) = Marginal Cost (MC), ensuring that the value consumers place on an additional unit is equal to the cost of producing it. This leads to optimal resource allocation and maximum total welfare.
However, in a monopoly, the firm maximizes profit by producing where Marginal Revenue (MR) = Marginal Cost (MC), rather than where Price = MC. Since a monopolist faces a downward-sloping demand curve, MR is always less than Price (P). This results in a lower quantity of output and a higher price than in perfect competition. The monopolist restricts supply to increase price, leading to a deadweight loss—a measure of lost economic efficiency where some consumer and producer surplus is not realized.
This failure to produce where P = MC means that there are consumers willing to pay more for an additional unit than its cost of production, but they cannot buy it because the monopolist has limited output. This results in a loss of potential welfare in the economy.
While option B (lack of incentive to be efficient) and option C (high prices leading to monopoly profits) describe other problems of monopolies, they are not directly related to allocative inefficiency. Option D (lower labor costs) is incorrect, as monopolies do not necessarily have advantages in purchasing labor.
Thus, the main criticism of a monopoly in terms of allocative inefficiency is that it fails to expand output to the socially optimal level, leading to deadweight loss and reduced consumer welfare.