Compare the monopoly outcome (The Monopolist's Price and Output) with what a competitive market would do with the same costs. The comparison uses allocative efficiency, $P = MC$, from Allocative and Productive Efficiency.
Key idea
A monopoly produces less and charges more than a competitive market would: $P > MC$ at its output. The units between the monopoly quantity and the competitive quantity are worth more to buyers than they cost to make, but they aren't produced. That lost surplus is the deadweight loss. Much of the monopoly's profit is surplus moved from consumers to the firm, which is a transfer, not a loss.
Why it works
A competitive market with the same constant cost would produce until $P = MC$. The monopoly stops earlier because selling more would mean cutting its price on every unit. Consumer surplus shrinks for two reasons: buyers who still buy pay more (that part becomes the monopoly's profit), and some buyers who would have bought at the competitive price don't buy at all (that part is lost to everyone).
Worked example: Measure the deadweight loss
Demand is $P = 20 - Q$ and MC is a constant \$4. Find the competitive outcome, the monopoly outcome and the deadweight loss.
- Competitive: $P = MC = \$4$, so $Q = 16$.
- Monopoly (from the last lesson): $Q = 8$, $P = \$12$.
- $DWL = \tfrac{1}{2} \times (\$12 - \$4) \times (16 - 8) = \$32$.
Answer: Competition: 16 units at \$4. Monopoly: 8 at \$12. DWL \$32.
Worked example: Where did consumer surplus go?
In the same market, compare consumer surplus under competition with the monopoly outcome.
- Competition: $CS = \tfrac{1}{2} \times 16 \times (20 - 4) = \$128$.
- Monopoly: $CS = \tfrac{1}{2} \times 8 \times (20 - 12) = \$32$; profit $= \$64$; DWL $= \$32$.
- $\$32 + \$64 + \$32 = \$128$: the old consumer surplus is split among consumers, the firm and nobody.
Answer: \$128 becomes \$32 (consumers) + \$64 (monopoly) + \$32 (lost).
Common mistake
Counting the monopolist's extra profit as the deadweight loss. The profit rectangle is a transfer from buyers to the firm; society as a whole loses only the triangle. Check: an area someone receives (consumers, the firm, the government) is not deadweight loss.