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IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly

Which statement best explains why a monopoly is usually described as allocatively inefficient while a perfectly competitive market in long-run equilibrium is allocatively efficient?

A monopoly is allocatively inefficient because it sets price above marginal cost. Units that consumers value more than they cost to produce go unproduced, creating deadweight loss, whereas competitive firms produce where price equals marginal cost.

  1. AThe monopolist produces where price exceeds marginal cost, so some units valued above their cost are not producedCorrect
  2. BThe monopolist produces at the minimum point of its average cost curve
  3. CThe monopolist earns zero economic profit in the long run
  4. DThe monopolist always makes losses and so reduces output
  5. The monopolist produces where marginal revenue equals price

Explanation

Allocative efficiency requires P = MC. A monopolist sets MR = MC with P > MR, so P > MC, meaning consumers value additional units above their cost yet they are not produced, creating deadweight loss. The other options are false for a monopoly.

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