Why are monopolies considered allocatively inefficient in microeconomics?

• A. Because monopolies set prices above marginal cost, resulting in underproduction relative to the socially optimal level.
• B. Because monopolies ensure perfect equality in resource distribution.
• C. Because monopolies always produce at the lowest possible average cost.
• D. Because monopolies maximize consumer surplus.

Answer: (A)

Verified step by step guidance

1. Understand the concept of allocative efficiency: Allocative efficiency occurs when the price of a good equals the marginal cost of producing it, i.e., \(P = MC\). This means resources are allocated in a way that maximizes total social welfare.
2. Recall how a monopoly sets its price and output: A monopolist maximizes profit by producing where marginal revenue (MR) equals marginal cost (MC), but since the monopolist faces a downward-sloping demand curve, the price (\(P\)) is set above marginal cost (\(P > MC\)).
3. Analyze the consequence of \(P > MC\): When price exceeds marginal cost, the quantity produced is less than the socially optimal level, leading to underproduction and a deadweight loss to society.
4. Compare this to perfect competition: In a perfectly competitive market, firms produce where \(P = MC\), ensuring allocative efficiency, unlike monopolies.
5. Conclude why monopolies are allocatively inefficient: Because monopolies restrict output and charge higher prices than marginal cost, they fail to allocate resources efficiently, causing a loss in total welfare.