Monopoly is a firm which is the only seller of a unique product which has no close substitutes. In a market of perfect competition, the level of competition is very high, and each firm is a small entity, a price taker. There are four assumptions for a monopoly to exist: there is only one seller but many buyers, high barriers to entry (both natural and artificial), a highly differentiated product such that it is difficult or impractical to copy the product, and imperfect information. There are four main assumptions for a perfectly competitive market, which are: there are many sellers and buyers, low barriers to entry, homogenous product and perfect information. This essay attempts to explain the reasons for the high market power of a monopoly, low market power for a perfectly competitive firm, and the limitations of monopoly and the choice between a monopoly and a perfectly competitive market.
Yes, it is true that monopoly has very high barriers to entry while a perfectly competitive market has very low barriers to entry. Barriers to entry refer to the reasons which deter potential entrants from entering the market. There are two types of barriers, which are natural barriers and artificial barriers. Monopoly often has high barriers due to various reasons. Firstly, when there is very high economies of scale of the existing monopoly firm, the starting cost of potential entrants will be very high as a result, and this is often because of high fixed costs, such as massive initial capital outlay followed by declining LRAC.
Secondly, when there is limited and small market size, localized monopoly might arguably be present because the demand from the consumers is very low due to say a small population, which cannot support more suppliers. For example, there will be only one hairdressing shop in a small town because of its small population.
Thirdly, when there are network economies, it is very hard for potential entrants to enter the market because of existing networks among users. For instance, after Facebook, it is difficult to have any more of the same type of online social network websites because users have built up broad network on Facebook already.
These are main natural barriers. There are also artificial barriers to entry set up by governments and the existing firms as well. For example, patents, licenses, and regulations restrict potential entrants from entering. Existing will have limit pricing and predatory pricing to deter potential entrants from entering. Firms also can control retailers and suppliers to prevent potential firms. For example, deBeers controls the diamond resources of the world and can restrict diamond production. Therefore, a monopoly has very high barriers to entry to limit the number of existing firms to a very low number, i.e. one firm. The monopoly has very significant market share hence strong market power to control the price while a perfectly competitive firm has many competitors in the market and therefore their market share is insignificant as a result of this very low market power. Hence, a perfectly competitive firm is a price taker, whereas a monopoly can set output and accept a price, or set the price and accept the resulting output.
[Insert diagram on PC Industry and PC firm]
The perfectly competitive firm takes the price from the intersection of market demand and supply. To maximize profit, the firm will produce at MC = MR at price P. In the long run, a perfectly competitive firm will gain normal profits when LRAC = P at minimum efficient scale (MES).
Therefore, a perfectly competitive firm is productive efficient because it always produces along LRAC curve and every firm in the industry tries to produce at MES for maximized profits and minimized costs for survival. A perfectly competitive firm is also allocative efficient because P = AC. It gains maximum social welfare.
A perfectly competitive firm is also equitable because it gains normal profits in the long run. There are therefore good and solid reasons for the preference of a perfectly competitive firm than a monopoly. A monopoly is productive inefficient , allocative inefficient, and inequitable as explained below.
[Insert diagram on Monopoly Firm showing Supernormal profit and Deadweight loss]
A monopoly is productive inefficient because the firm has great market power and it can be X-inefficient, which means that it does not act energetically to curb its costs, for instance costs from lobbying for government intervention. It can produce above the LRAC curve due to overpaying for workers, building ostentatious buildings, or unnecessary perks.
A monopoly is allocative inefficient because of the deadweight loss resulting from monopoly power. At the profit maximizing point, MC = MR, and P > AC. Hence, there is a positive welfare to be achieved by promoting perfectly competitive firms.
A monopoly is not equitable to consumers because of its supernormal profits gained in the long run.
However, a monopoly can be preferred to a perfectly competitive firm because it is dynamic efficient. It has the willingness and ability to innovate and create to do research and development (R&D) and to improve its product variety through product proliferation. This is because of its supernormal profits in the long run, leading to its ability to conduct R&D. It also aims to utilise product proliferation to fill the product gap, and thereby prevent potential entrants from finding a niche to exploit in its market that it dominates. A perfectly competitive firm is also not willing to innovate because of perfect information in its market, so other firms can easily copy from it, so a monopoly does have some strengths.
[Insert diagram to compare PC firm and Monopoly]
A monopoly firm usually restricts output and set high price at maximized profit level, while a perfectly competitive firm has lower price and more output at the intersection point of its demand and supply. At this point in time, a perfectly competitive firm is preferred to a monopoly. However, in the long run, when a monopoly grows and exploits its economies of scale, it moves its (LR)MC curve downwards. It can then produce more output at a lower price. At this time, a monopoly is preferred to a perfectly competitive firm due to its dynamic efficiency.
In conclusion, it is not always preferable to have a perfect competition than a monopoly. Ostensibly there are many good points that perfectly competitive firms have, such as productive efficiency and allocative efficiency, among other ideal points, whereas monopoly does appear or seem not ideal, due to its lack of productive and allocative efficiency. However, a monopoly has more dynamic efficiency than a perfectly competitive firm and has the potential to have lower prices than a perfectly competitive firm. In addition, a perfectly competitive market is ideal but does not exist in the real world. Hence, monopoly is sometimes preferable to a perfectly competitive firm.
JC Economics Essays - H2 Economics essay on monopoly and perfect competition. Normally I would give detailed comments for essays and make some commentary or remarks on how good the essay is, or how it can be further improved by identifying particular points, arguments, or even sometimes, rarely, mistakes. Sometimes, I even ask difficult thinking questions about how the essay can be improved. However, for this particular essay done under timed examination conditions, I rather like its style and content, and so instead of giving my comments I will let you do most of the thinking: one simple question is - what can you learn from this economics essay? Thanks for reading and cheers.
