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Discuss, using examples from the United Kingdom, whether high levels of research and innovation are best achieved in competitive compared to monopolistic markets. (25 marks)


This Economics paper argues that high levels of research and innovation are best achieved in monopolistic markets, compared to competitive markets, because dynamic efficiency is best achieved when companies have the willingness and ability to conduct costly research and development (R & D).

First, what is dynamic efficiency? Dynamic efficiency means that companies can invest in education, research, innovation, and other creative processes that help them increase their efficiency over time, and in the long run will help them earn supernormal profits above opportunity costs and explicit costs. Competitive markets are markets with low barriers to entry, and can be idealised using the model of perfect competition.

What is perfect competition? Perfect competition is the market structure where there are many buyers and sellers of a single homogeneous product with perfect substitutes, low barriers to entry, suggesting that they earn normal profits in the long run, and where there is perfect information.

This is in contrast with monopoly, which in theory is a firm that sells a product with few close substitutes, with high barriers to entry, and which thus earns supernormal profits in the long run.

It can be argued that competition might not lead to research and development. Taking perfect competition to benchmark competitive firms in the UK, because they earn normal profits in the long run, they have neither the incentive nor the willingness to invest in research and innovation. For instance, small shops along the streets of London, especially monopolistic competitive firms, will not engage in research. 

However, having said that, if these firms are able to borrow from capital markets or get funding, or perhaps even due to external events causing temporary supernormal profits due to changes in demand and supply, they could have the willingness to invest in innovation so that they can because more “monopolistic”, when they produce a highly differentiated product.

It can be argued that monopolistic markets have firms that earn supernormal profit, because of their high barriers to entry. They therefore have both the ability and willingness to innovate to keep their monopolistic position. First, they have the ability because they earn supernormal profits, and can allocate massive funds to R&D. Second, they have the willingness because if they are in monopolistic markets that could potentially be contested by more efficient firms that could displace them to take over their market, they need to innovate to maintain their long term dynamic efficiency. 

For instance, Rolls Royce which manufacturers engines and aeroplane systems is a dynamic company probably because it has incentive and ability to innovate. BAE Systems plc is also another such company, and in fact both Rolls Royce and BAE are multinational companies, companies that span international borders with their unique product chains that require high levels of research and development. In fact, it can be said that some monopolies are monopolies because they have developed a product that is unique, differentiated, and wanted by consumers.

However, having said that, on the other hand contestable markets are usually perfectly competitive or competitive in nature, and as such competitive markets could help dynamic efficiency better in that respect. Thus competition might also lead to research and innovation, but the level could be lower than that of monopolies that have incentive and ability to do research and innovation.

Also, there are problems with monopolies. It can be argued that monopolies sometimes have x-inefficiency, where they do not act energetically to curb costs, and they could therefore become slothful and inefficient firms. This is because they may preserve their position through the use of patents, laws, legislation, and other legal means that have nothing to do with their level of technology or the sophistication of their product.

In the final analysis, this paper argued that high levels of research and innovation are best achieved in monopolistic markets, compared to competitive markets, because dynamic efficiency is best achieved when companies have the willingness and ability to conduct costly research and development, even though there are indeed some limitations to monopolies such as x-inefficiency. Competitive markets may have the incentive to conduct some research, but their levels are lower, and most of the time they neither have willingness nor ability due to the lack of barriers to entry which ensure supernormal profit. 

JC Economics Essays (H2, H3 A levels): Economics Tutor's Comments - This Economics paper on research and development and comparison of monopolistic and competitive firms was crafted under model examination conditions and has a few good points that one can learn from, but also some problematic areas, such as simplistic analysis and lack of many other relevant examples from UK manufacturing or service industries. Do think: if you were an Economics tutor, what advice would you give this student to help him make the Economics essay better? Perhaps you could focus on an area of improvement, such as the structure or organisation of this essay. Think of how this Economics paper could be made better. Thanks for reading and cheers!

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