Question

a) Explain why there are unexploited gains from trade in a monopoly market.

b) Why does a monopolist not increase output to achieve Pareto optimality even though there are potential gains from trade?

(10 marks)

Answer 1

1) Answer: Unexploited Gains from Trade occurs when quantity is below the equilibrium quantity. In a monopoly market there are "unexploited gains from trade" because if the firm were competitive it would have raised output in the long run.

2) Answer: The Pareto optimality crucial condition is that marginal rate of transformation (MRT) of the community among any two commodities must be equal to the marginal rate of substitution (MRS) between these commodities of every consumer. A monopoly does not ensure optimum allocation of resources and thus acts as an obstacle to the attainment of maximum social welfare. The main cause for this is that a monopolist does not equate price of the good with marginal cost of production; thus restricts output and charges higher price than marginal cost. Consequently under monopoly the marginal rate of transformation of the community among two commodities will not be equal to the marginal rate of substitution between them of the consumers. Thus monopolist does not increase output for achieving the Pareto optimality even though there are potential benefits from trade