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Explain how the pricing decision between a monopoly firm and a perfectly competitive firm differs because of differences in the levels of barriers to entry. [10]


A monopoly refers to a market where there is only one seller of one product that has no close substitutes. In perfect competition, there are many sellers and buyers selling one homogeneous product. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly exists because barriers to entry are very high, whereas a perfectly competitive firm exists because barriers to entry are very low or even non existent. In this Economics essay, I will explain the reasons for high and low barriers to entry for a monopoly and firms in perfect competition respectively, and how the price decision will thus differ between the two market structures.

A monopoly exists because barriers to entry are so high such that new firms are totally deterred from entering the market, and therefore there is only one dominant or major firm in the market. There are two types of barriers to entry: natural barriers and artificial barriers to entry. Natural barriers refer to inherent characteristics of the market which deter the entry of firms into a market. For example, the monopoly of diamond market, De Beers controlled more than 98% of the diamond resources last time and was able to deter any other firms from entering the market. Localised monopoly also has very high barriers to entry due to the fact that limited population does not demand so many firms for one good or service. Hence, in a small town, one firm is enough to fulfill the demand. For example, hairdressing shops can be considered localised monopolies.

Artificial barriers refer to deliberate actions taken by governments of firms to deter entry into a market. Governments may sell licenses to firms which want to enter a market in very high prices. For example, setting up one casino is very hard in most of the countries because governments will consider the negative externalities of opening a casino. Existing firms will set their prices lower than entering prices to deter new firms from entering the market. 

In perfect competition, barriers to entry are low so it is relatively easy for new firms to enter the market to produce. Therefore, so many small firms with each having an insignificant market share are present in perfect competition. Each firm’s market share is negligible due to the low barriers to entry and exit. Changes in a single firm’s output will not have effect on the market’s total supply and hence the market price.

Hence, as price takers, firms in perfect competition will take the price attained from intersection of demand and supply of the whole market. 

[Insert diagram for the Industry (Market)]

[Insert diagram for the Firm]

As shown in the diagrams above, the price decision in a perfect competition is taken by all the small firms at P0. P0 is the same as PE which is the intersection equilibrium price of demand curve D and supply curve S in the industry. 

If the industry has only one firm which is monopoly, it can decide the price as it wants due to the fact that there is no other firm to hinder its great market power. 

[Insert diagram on monopoly]

As shown in the diagram above, the price is determined when maximum profits can be generated. i.e. at the point where MC = MR. 

In conclusion, a monopoly firm and a perfectly competitive firm differs in terms of pricing because the barriers to entry confer market power (or the lack thereof), which leads to price setting ability or a price taking result. 

JC Economics Essays (H2 'A' Level Standard Economics Essay, part (a)): Economics tutor's comments - There are many important essay writing lessons that students can learn from this economics essay on monopoly, perfect competition, and profit maximisation. What is good, and what is bad, about the essay introduction? Was the introduction clear, addressing the topic, and defining key terms and concepts needed? What is good about the economic analysis in this particular paper, in the body of the essay? Did the analysis address the requirements of the economics question? What is good or less good about the writing style and approach taken in this economics essay? Is the essay well written? To a large extent, this is an excellently crafted essay, well written and clear, but there are some ways in which it could have been further developed and made even better - what are those ways? How would you do essay editing for this paper, if you were the economics tutor? How would you apply more of the economics knowledge, insights and analysis to make this paper more developed? Also, how would you mark this economics essay, if you were the examiner? Thanks for reading and cheers. Special thanks to contributions from students. 

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