Comparison of economic efficiency of the model of perfect competition with that of monopoly markets - Essay Example

?Running Head: Economic Efficiency Economic Efficiency [Institute’s Economic Efficiency Introduction The views of economists and public do not converge on a variety of issues. However, the same is not the case with the evaluation of monopoly markets. Both, economists and public, share their common dislike of monopoly. Consumers prefer to have more options and many price sensitive customers do not prefer the approach of the monopoly seller to charge higher prices and restrict the output. Economists are sceptical of monopolies because of the fact that they are less efficient, in various ways, as compared to monopolistic, oligopolistic and especially, industries with perfect competition1. This paper is an attempt to explore the economic efficiency outcomes of monopoly markets with that of perfect competition markets. Furthermore, the paper would also attempt to present a possible government policy to improve efficiency within the markets. Discussion One of the biggest reasons why monopoly results in inefficiency and loss of economic welfare is shown in above figure. The figure on the left shows the consumer and producer surplus that would be there within a perfectly competitive market. However, the same is lost in a monopoly market because the monopoly seller is charging a price where buying the product is actually forcing the consumers to incur a net loss since the marginal benefit that the product brings is less than its marginal cost. Therefore, the deadweight loss represents the potential gains that could have been exploited with perfectly competitive markets but due to monopoly, they neither went to the seller or the consumers2. In other words, monopolies create an environment where the producer profits less than what he could have earned under perfectly competitively markets and customers have to pay more price than they would have paid under perfectly competitive markets. Furthermore, when businesses expand their production, they are able to take advantage of economies of scale and learning curve that enables them to decrease their cost per unit, thus leading to efficiency. This is one of the reasons why large companies and businesses are better able to sustain the shocks of recessions and business cycle fluctuations. Moreover, their ability to exploit economies of scale also allows them to sell their products at very low prices which are often less than the cost price of other sellers, thus allowing the larger companies to easily drive them out of the business3. However, monopoly seller, as mentioned earlier, is highly likely not to satisfy the complete demand for its product so that it could charge a premium price. Therefore, the monopoly seller fails to take the full advantage of economies of scale, unlike many firms in monopolistic, perfectly competitive and oligopolistic markets4. Other than technical, allocative and productive inefficiencies, monopolies are also likely to be X-inefficient. American Economist Liebenstein argued that regardless of the level of production, monopolies are always X-inefficient because of the absence of competitive pressures5. Therefore, there costs of production are always higher than it would be within perfectly competitive on even monopolistic markets. The same is true because monopolies sellers are most likely to own technologies, assets, and machines that are not operating at their fullest or which are not needed. Furthermore, they are also likely to overpay people, thus leading to cost inefficiencies6. In presence of competition, firms spend great deal of time and energy over ensuring that they decrease their costs to utmost possible. Consider the example of the US airline industry where strong competitive pressures have forced companies to seek more cost effective pressure. Competition forced Southwest Airlines to create a new business model aimed at cost effectiveness where the company flies its aircrafts for more than 11 hours a day, uses same aircrafts for reducing maintenance and training costs, flies short haul, uses dynamic pricing and has created a fun culture to motivate employees to go out of the way to support Southwest’s business model7. As evident from the discussion above, there is no such need for government policy within perfect competition. Then again, perfect competition is abstract and unreal state of market, something that cannot be achieved. Therefore, the only policy that governments should pursue is to ensure that monopolistic and oligopolistic markets could move towards a perfectly competitive market. Interestingly, in many cases, it is the existing government policy and structure, which creates the costs and hurdles for new entrants to enter into the market. Therefore, governments all over the world should try to follow the economic models of countries like Hong Kong, Singapore, Australia, New Zealand and Switzerland where the government intervention within the markets is minimal8. Furthermore, the cost of starting up a business, running the business and winding up the business are also much lesser than the rest of the world. The legal systems are strong and effective and there is less corruption and stronger property. Therefore, the ideal government policy should be to decrease its intervention within the markets and make it easier for businesses to conduct their day-to-day activities with maximum speed and minimal cost9. On the other hand, in case of monopolies, the focus should be on inducing competition in those industries and supporting the industries with substitute products and services. However, policymakers should draw a line for their intervention. Even in the worst times, direct government intervention or control is not a viable long-term option for creating efficiency because not only it is inefficient but also ineffective. Consider the example of the Pakistan during the 1960s and 1970s. During much of the 1960s, Ayub Khan, a military dictator, assumed the control of the country and followed capitalistic policies. Pakistan did enjoy significant progress but the result was concentration of wealth into the hands of 22 families, which ended up controlling more than 70 percent of the country’s wealth. They created monopolies in various industries and thus, the same led to inefficiencies, unsatisfied demand and higher prices. Bhutto came into power in the early 1970s with his socialistic agenda of redistribution of wealth and ended up nationalizing all of the industries in an attempt to break the monopolies. The result was immense damage to the economy and its productivity10. The point here is that governments should follow an indirect and implicit policy to break monopolies. These should be aimed at reducing the barriers to entry for new entrants and existing businesses. Many monopoly sellers set up significant barriers to entry, especially through significant investment expanding the scale of business11. Government can provide low interest loans to hopeful business aiming to compete with the monopoly seller. They can subsidise, assist or undertake the research and development process aimed at developing substitute products and services or alternatives to the goods and services provided by the monopoly seller. At many occasions, a monopoly in one economy or country is able to sustain primarily because of the absence of free trade. Foreign sellers are likely to have better or alternative solutions to customer problems and either importing those products or allowing foreign companies to set up businesses in the country usually assists in challenging the monopoly seller12. Conclusion Therefore, at given point in time and at level of production, perfectly competitive markets are highly likely to be much more efficient that monopoly markets. As Adam Smith noted, “Monopoly, besides, is a great enemy to good management”. Whether it is technical efficiency, allocative efficiency, cost or productive efficiency or X-efficiency, monopoly markets and monopoly seller have a tendency to exhibit inefficiencies because of the absence of competitive pressures. The tendency of monopoly seller to produce less also restricts its ability to take advantage of economies of scale, which further increases the cost from where it would be in a perfectly competitive market or any other industry structure. Therefore, competition is the key to efficiency in markets which in turn translates into the greater public and societal welfare as well. For that reason the focus of policymakers should be at creating policies and programs that facilitate competition within various markets, especially within monopolies markets. Nevertheless, policymakers should be able to draw a line that where should they stop with their intervention in the markets because too much government intervention in any industry would only lead to inefficiency13. The focus should be on reducing the excessive costs and time required to start, operate and wind up a business, opening up borders to other companies, facilitating free trade and research and development. References Arnold. R. A. Microeconomics. Cengage Learning, 2010. Bowles, S. Microeconomics: Behavior, Institutions, and Evolution. Princeton University Press, 2006. Boyes, W., & Melvin, M. Microeconomics. Cengage Learning, 2012. Hall, R. E., & Lieberman, M. Microeconomics: Principles and Applications. Cengage Learning, 2009. Hirschey, M. Fundamentals of Managerial Economics. Cengage Learning, 2008. Krugman, p., & Wells, R. Microeconomics. Worth Publishers, 2010. Mankiw, N. G. Microeconomics. Cengage Learning, 2011. Mankiw, N. G. Microeconomics. Elsevier, 1998. Mankiw, N. G. Principles of Economics. Cengage Learning, 2011. McEachern, W. A. Microeconomics: A Contemporary Introduction. Cengage Learning, 2010. Read More