Hi, I have the following doubt in Social optimum. I t would be very helpful if someone could please explain it. We know that, social optimum is where MC = P and welfare is when P > MC. Under perfect competition, firms produce at social optimum, does this mean that they do not have welfare?? Kindly clarify. If monopolistic firms sell less than social optimum, how then can welfare be calculated. Please help me understand this. Thanks.
We know the price is fixed in perfect competition. So those who are producing at lower cost will tend to have profits(welfare) and vice versa. This is in short run. Now those who were having losses will exit the market and thus the overall supply will reduce. This will result in an increase in the prices and the cost will just be covered(can be understood better with a graph covering price and supply curves) thus making normal Profits in the long run. So in perfect competition, firms make supernormal or higher profits(or losses) in the short run and normal profits in the long run, ie. They just cover their production costs
Look at Figure 7.8 in Module 7 of the Course Notes. If there are no external costs or benefits of production or consumption (see Module 12), then the D= AR curve measures the marginal social benefit of consumption (MSB), whilst the MC curve measures the marginal social cost of production (MSC). Social efficiency arises when MSB = MSB, which is at output QPC. However, the monopolist instead produces QM < QPC. The net loss of social welfare resulting from the monopolist producing less than QPC, the social optimum, is the triangle below D=AR and above MC between output levels QPC and QM. There's a more detailed discussion of this in Module 12 of the Course Notes.
