Standard graphical analysis shows that monopoly creates a deadweight loss.
(i) How and why must this welfare analysis be modified when the firm is a natural monopoly?
(ii) How and why must this welfare analysis be modified when the firm's market power is acquired from a legal barrier to entry?
(i) The traditional deadweight loss area is not valid in the case of natural monopoly. Competition cannot survive under the conditions of natural monopoly, because firms will earn negative profits when they receive the competitive price. Thus the social gain under natural monopoly cannot be compared with the social gain under competition, because competition is not a viable alternative in this case.
(ii) The traditional deadweight loss area underestimates the welfare cost of a monopoly with a legal barrier to entry. Firms will compete with each other in an attempt to earn the monopoly rights offered by the government's legal barrier. This competition will result in lobbying and other forms of political pressure which use valuable resources without producing any offsetting social gains. These costs must be added to the traditional deadweight loss.
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