Perfect Competition and Efficiency - Essay Example

?Introduction: Economists have been filling pages about the key ingredients to success of an economy, global benefit, societal benefit and environmental benefit; this intense research for years has concluded that perfectly competitive market is the key to success. However, there are opposing opinions to create unrest. According to George Watson, “Monopoly favors the rich (on the whole) just as competition (on the whole) favors the poor.” (Fitzgerald, 1988) On the one hand, the economist voice about perfect competition and on the other, monopoly is talked upon. There are pros and cons to both yet all reside on one opinion that the key to efficiency is competition. In order to present a concrete conclusion, we have to get into a profound discussion so as to compare pros with cons of perfectly competitive market and also discuss the variance it has with monopoly structure. Perfect Competition and Efficiency: According to Adam Smith perfectly competitive market works under “invisible hand” in which each individual in society seeks out for the personal interest. However, in order to preach it, he/she has to trade off his belongings with the individual who is willing to get benefited from it. This ultimately leads to benefit of society intentionally or unintentionally. Theoretically; there are many buyers and sellers, identical products, no barriers to entry as well as exit (Thomas E. Woods, 2011). Buyers and sellers both have the perfect information and hence they are the “price takers” which results in a perfectly elastic demand curve. This means that if a firm wants to maximize its profit it should sell its product at market price. This means that efficiency is required to keep the cost down and increase the net profit margin. Efficiency is realized when all opportunities to make someone better off without making anyone worse off are exhausted. It is also called ‘Pareto Efficiency’ in most of the global conceptions (Books Llc, 2010). Under ideal conditions in a perfectly competitive market or any other market which is functioning well, the market equilibrium maximizes the difference between the benefits society gets from the good and services and what it costs society to produce. A perfectly competitive market would always focus on the maximum net social benefit. Benefit is not only considered by the monetary return achieved from investments but also the implicit gain realized by the society as a whole. An efficient allotment of resources is accomplished if increment in society’s overall level of satisfaction by more of one good and less of another good is not possible. This is why competition is preferred as it mostly leads to favorable outcomes. Competition urges players to perform better than their rival which ultimately leads to better market mechanism. Such efficiency is realized by entities if the price of a good is equal to the marginal cost of the product. An elaboration of the above mechanism is as follows: We know from the above discussion that market supply shows the marginal cost of society of producing the good or service. Moreover, the demand curve is the marginal benefit to society from consuming the good or service. Therefore, the net social benefit would be maximized if the marginal social cost is equal to the marginal social benefit (Tucker, 2010). Considering the cost allocated to society, the market supply is the horizontal sum of each firm’s MC curve or in other words it shows what it costs to produce one additional unit of good. Economist says that if all the costs are digested by the firms, then supply equals the marginal social cost (Lambert M. Surhone, 2010). On the other hand, economists’ measure benefits in terms of the willingness of consumers to pay therefore, the market demand would be a representation of the total sum of willingness to pay for a unit of good at each level of consumption. The market demand mechanism focuses on maximization of social benefit illustrated below: All consumers whose WTP (willingness to pay) exceeds P will buy a good (or more if WTP at margin exceeds P). The Qth unit is purchased by the consumer whose WTP is just P. Society’s marginal benefit from good is equal to the benefit (WTP) that the consumer of the last unit enjoys. If less is produced/consumed, then MSC>MSC, which means that having more of the good adds to net social benefit, it will push suppliers to produce more. Similarly, if the MSC>MSB, then reducing the number of goods saves more in cost than those goods are worth. We need to keep in mind that perfectly competitive market equilibrium is at Therefore, each firm adjusts output to the point that price equals marginal cost which means that firm that produces the very last unit incurs a cost equal to the price of good. Consumption is taken to the point at which the last unit consumed is just worth the price paid by the consumer. As a result, in a perfectly competitive market . Equating both the equations we can conclude that perfect competition is efficient (Sweeny, 2011). Monopoly Walter Nicholson defines it, a "monopoly is a single supplier to a market [and it] may choose to produce at any point on the market demand curve". Monopoly is a firm that is a sole producer of a particular good or services in a particular market and with no close substitutes. It is large enough to impact the market price and charge higher than its marginal cost. The market demand curve is same as that of firm’s demand curve. Adding up, there are four primary advantages that allow the monopoly firm to enjoy power and restrict the other firms to enter the market. These are economies of scale, economies of slope, cost complementary and patents. It also restricts the amount of output so as to increase the prices above the competitive level (Metcalf et al., 1901). P MC Pm AR Profit ATC (Qm) DC Key differences: We can infer two key points from the discussion over perfect competition and monopoly pertinent to price. Firstly, the perfectly competitive market cannot increase their prices as producers will flood the market and eliminate any profit. This keeps the market utilization of resources efficient. On the other hand, monopoly can maintain a price above production cost for years even though their cost is substantially low. These increase inefficiencies in resource allocation (Gans, 2011). A recent news article about drug firms keeping prices high in times of distress proved to be an example. They enjoy monopoly in the region and continue to push prices up deliberately. However; government keep these companies restricted in increasing their prices abnormally by making stringent laws to avoid consumer exploitation (Hendricks, 2011). Secondly, there are no guaranteed economic profits for perfectly competitive firm. Their prices are set close to the cost of production and barely manage to make profit. On the other hand, monopoly can maintain a price above production cost and enjoy guaranteed returns. Conclusion: Our discussion has leaded us to conclude that efficiency is derived from the maximization of net social benefit. It focuses on the competition and hard earned profits. Moreover, it has also leaded us to conclude that although monopoly players enjoy higher returns but perfect competition pays off more in the long run for the society. It adds competition which leads to efficiency in the market. The resources are utilized in an effective manner which avoids residual and adds to economic prosperity. It is felt that monopoly can increase prices without any resistance but the fact is that they have an elastic demand curve and abnormal increase in prices can lead to reduced profits. This is why the monopoly is not the best market structure in the eyes of the consumer but it may be an apple for the eye for a producer. Works Cited Baumol, W.J. & Blinder, A.S., 2011. Economics: Principles and Polic. Cengage Learning. Beccary, 2009. Perfect Competition Market. [Online] Available at: http://perfectcompetitionm.wordpress.com/category/uncategorized/ [Accessed November 2011]. Books Llc, 2010. Perfect Competition: Substitute Good, Complete Information, Perfect Information, Atomistic Market. General Books LLC. Dewey, D., 1959. Monopoly in economics and law. Rand McNally. Fitzgerald, R., 1988. When government goes private: successful alternatives to public services. Universe Books. 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Strategic Learning: How to Be Smarter Than Your Competition and Turn Key Insights Into Competitive Advantage. John Wiley and Sons. Sweeny, C., 2011. Electric rates going up, thanks to Illinois Legislature. [Online] [Accessed 26 October 2011]. Thomas E. Woods, J., 2011. Ludwing Von Mises Institute. [Online] Available at: http://mises.org/daily/5779/The-FreeMarket-Economics-of-the-Late-Scholastics. Tucker, I.B., 2010. Economics for Today. Cengage Learning. Read More