Q&A 16.1 shows that a regulated price ceiling set below the optimal regulated price causes a loss in total surplus compared with optimal regulation. The diagram illustrates only a lower bound for the loss of surplus. Explain why the loss in consumer surplus is likely to be even greater than B + D.

Q&A 16.1

Suppose that a government regulates a monopoly by setting a maximum price, p₂, that is below the economically efficient level, which is p₁ in the figure, but above the monopoly’s minimum average cost. How do the price, quantity sold, quantity demanded, and total surplus under this regulation compare to those under optimal regulation?

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Market demand MC A B e, Regulated demand P2 E MR' MR Q, Q, Excess demand Q, Units per day Monopoly with Optimal Regulation Monopoly with a Low Regulated Price Change С -В A + B C +D+E A +B +C +D+ E Consumer Surplus, CS A +C Producer Surplus, PS E -C -D Total Surplus, TS = CS + PS A +C +E -B –D = - DWL ---- ..... p,$per unit