Q28+Micro

28. Discuss and evaluate the proposition that perfect competition is a more efficient market structure than monopoly.

Perfect Competition is a market structure where there are a very large number of small firms, producing identical products. No individual firm is capable of affecting the market supply curve and thus cannot affect the market price. Because of this, the firms are price takers. There are no barriers to entry or exit and all the firms have perfect knowledge of the market. Monopoly is a market form where there is only one firm in the industry, so the firm is the industry. A monopoly is capable of affecting the market supply curve and can affect the market price. Because of this, the monopolistic firm is a price maker. In a monopoly, there are usually many barriers to entry and exit and the consumers do not have perfect knowledge of the market. A PC Market is a more efficient market structure than a monopoly for many reasons. First, the Demand Curve for a PC firm is perfectly elastic, this leads to average revenue equaling marginal revenue and forces the PC firm to charge the same price as charged by the other firms in the market, making it a price taker. A monopoly by contrast faces a downward sloping demand curve that leads to MR > AR and also bestows the power of the market to the monopoly to set the market prices as high as possible, making it a price maker. Second, the profit maximization output of a Monopoly is less than that of the PC firm, leading to wastage of scarce resources. Third, a PC firm can only make abnormal profits in the short run, which is a level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service, as there are no barriers to entry and exit. This leads the PC firm to only make normal profits in the long run, which is the amount of revenue needed to cover the total costs of production including the opportunity costs (AR = AC). A monopoly can make abnormal profits even in the long run due to high barriers to entry and thus can ensure that no firm can compete the profits away. Fourth, the PC firm operates at minimum Average Cost as the condition for survival is operating efficiently and this establishes the fact that no PC firm can continue to make losses in the long run. A monopoly faces no competition and continues to operate at a high average cost wasting the scarce resources. Therefore, a monopoly has no incentive to increase its output that will lower its costs. As seen from the Diagram above, a PC firm is productively efficient as ATC = MC, allocatively efficient as the Selling Price = MC, and makes ‘Normal Profits’ in the long run, which is the average revenue needed to cover the total costs of production, including the opportunity costs. In comparison with the PC Market, monopolies are highly undesirable as they produce lesser output for a higher price P. In addition, they convert consumer surplus into abnormal profit, even in the long run. They operate at a high average cost curve ATC, which leads to a high wastage of resources, causing productive inefficiency. The Long Run position for a monopoly is also inefficient as the selling price is greater than the Marginal Cost (P > MC), and AC does not equal to MC (at ‘Quantity Produced’). Furthermore, Demand and Supply are not at equilibrium, this reduces the total welfare in the form of consumer surplus and producer surplus being lost (Dead Weight Loss). Thus, a PC market is more efficient than a monopoly. However, under certain circumstances, a monopoly can act as a more efficient market than perfect competition. This is in reference to Natural Monopolies, which is a situation where there are only enough economies of scale available in a market to support one firm.

As seen from the diagram above, a monopoly firm which can attain economies of scale result in a lower price and higher output than is possible when competing firms have too small a portion each to benefit from scale economies. Society benefits from ‘paying less for more’. By producing a quantity, which is a result of falling LRAC, the monopoly firm can produce a higher quantity (QM) at a lower price (PM) than the perfectly competitive market. Thus, a large quantity of smaller competing firms could not attain large enough scale to be able to compete with a single monopoly firm. Monopolies invest heavily in Research and Development and invent products for consumers enhancing their living standards. Eventually, these products get copied saving other firms’ resources. Finally, there is the distinct possibility that the monopolists’ outcome of higher prices and lower output actually benefits the society. This would be in the case of harmful goods and services, i.e tobacco, alcohol etc. Therefore, a monopoly firm might well produce less of the good and thereby have less negative impact on society than would a perfectly competitive market.