Comparison of Perfect Competition and Monopoly - Essay Example

Introduction Market structure is considered as one of the central themes of economics as it attempts to define the behaviors of the various players in the market including both suppliers as well as consumers. Economics classify markets according to the industry within which the firms work and how they affect the overall economy of the country. However, on the other hand, industry is the combination of various economic variables which determine the overall nature, characteristics as well as extent of the competition within that particular industry. Traditionally economics define or classify markets into following four broader classifications of the markets. These are: 1) Perfect Competition 2) Monopolistic competition 3) Oligopoly 4) Monopoly These market structures are important in the sense that they affect the market outcomes because it has great impact on the motivation as well as decisions and other market outcomes therefore it is very critical that the market structures are perfectly identified and established to identify the correct resources which are to be directed towards them. There is also another dimension to the market structures which show their implications from a marketing perspective also. The defining characteristics of the market structures help organizations to shape their strategies as well as outline various strategies to gain competitive advantages in their respective market environment. This essay will look into two of the market structures i.e. Perfect competition and Monopoly by comparing and contrasting the various defining characteristics of both the market structures besides discussing the advantages and disadvantages of two market structures for the consumers. However, before comparing and contrasting the two market structures, it is very important to define them first. Perfect Competition Perfect competition is “a market structure in which there are large numbers of fully informed buyers and sellers of a homogenous product with no obstacles to entry or exit of firm in the long run”. (Swann and MeEachern, 2001). This definition therefore outlines following important and defining characteristics of the perfect competition: 1 Large number of buyers and sellers 2 Full information 3 Homogenous Product 4 No obstacles for entry and exit These four defining characteristics of the perfect market are considered as the cornerstone of the perfect market structure. However there are also assumptions underlying a perfect market structure. These assumptions are: (Swann and MeEachern, 2001). 1 “There are many buyers and many sellers so much that each buys or sells only a negligible fraction of the total amount exchanged in the market. 2 Firms produce a standardized or homogenous product. 3 Buyers and sellers are fully informed about the price and availability of all resources and products. 4 Firms enjoy free entry to and exit from the market which no barriers such as patents, licenses, high capital cost etc. 5 All resources, including labour as used by the firm, are completely mobile and can switch from market to market in a zero cost environment- that is, there is perfect resource mobility. 6 In product markets, firm seeks to maximize economic profits and consumers seek to maximize totaling utility.” Under these assumptions a firm is considered as a price taker as it has virtually no control over the market. Monopoly Another very important market structure is termed is monopoly which has very unique characteristics as well as impact on the economy as a whole. Monopoly is often characterized by the market power where monopoly as the ability to influence the market specially in terms of the total quantity produced and sold in the market. A monopoly “ is an industry that produce a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms”(Parkin,2002 ) The underlying assumptions for monopoly model of market structure are: 1) “There is strictly one seller in the product market facing many buyers. 2) The monopoly firm may sell either a homogenous product or a differentiated product. 3) Prohibitive barriers to entry preclude market competition from potential new entrants. 4) Resource mobility and market information may be influenced by the monopoly. 5) The monopoly is an economic profit maximiser confronting utility maximizing consumers in the product market. 6) The monopoly firm has no close substitutes for its products.” (Swann and MeEachern, 2001). Thus any monopoly is characterized by two most important characteristics of the no close substitutes as well as strong barriers to entry. Comparison and Contrast between Monopoly and Perfect Competition It is of great importance to note that monopoly and perfect market structures in their essence are two different economic phenomenon which tend to behave on their own. However there are key differences and similarities between both the market structures as, both attempts to define a certain market structure. Barriers to entry Perfect competition outlines that there are no barriers to entry to and exist from the market and firms can come and go according to their circumstances however monopoly is a market structure which is based on the fact there are strong barriers to entry. These barriers can be either technical or natural and legal barriers. Technical or natural barriers arise when a monopoly experience a diminishing average cost. This is because of the fact that monopoly over the period of time grow in size and cost of entry into this market is high therefore monopolies enjoy economies of scale to experience a natural barrier to entry which insulate them from other firms to enter the market. On the other hand there legal barriers are created through a matter of law as most of the governments tend to establish large monopolies such as utility providing organisations. This could be achieved either through a patent or through restricting the entry into that market. However, this is not the case with perfect competition market structure as there are no barriers to entry and the firms are allowed to enter and exit at their own will. However, firms in perfect market also tend to increase and improve on their competitive advantages to keep their market standing intact. Competitive advantages achieved by the firms therefore help create them natural barriers to enter the market as the firms start to build their core competencies which allow them to have a better position in the market as compared to other players in the market despite the fact that both the firms tend to work in same market with the status of a price taker. Thus perfect competition as well monopoly show differences as well as similarities in this regard with each other because in one case barriers to entry may be natural where in perfect markets firms over the period of time gain competitive advantage which provide them a diminishing average cost- a characteristic of monopoly. No substitutes In a perfect market all the sellers sell the homogenous product i.e. all the products sold are same however in monopoly, the seller only sells one product and have monopoly over it. However, as outlined above that the monopoly can sell homogenous product also- a characteristic of perfect market. Though both monopoly as well as perfect market structure can sell homogenous products however in no monopoly there are no close substitutes of the product or service being sold by the firm whereas under perfect market, there can be substitutes. Demand Curve One of the most important feature of perfect market structure is the fact that the price set up by the market is equal to the marginal revenue that is P=MR whereas in monopoly, the price is always above the marginal revenue. This also means that a monopoly always sell above the marginal revenue and charges price above its marginal cost as under monopoly firm tend to work as a price maker rather than price taker as in the case of perfect market. Consumer Surplus One of the defining characteristics of the perfect market is the fact that it offers greatest consumer surplus however consumer surplus in monopolies is less than the perfect competition. (Kwasnicki, 2008). Advantages and Disadvantages to the Consumers Perfect Markets It is believed that perfect competition is something where resources are efficiently utilized and efficiency is achieved as perfect market tends to maximize the total utility of the consumers. The productive efficiency ensures that whatever is being produced is produced in most efficient manner therefore when minimum resources are employed to achieve the maximum output, the consumers tend to be at the most beneficial stage. As discussed above that in perfect market, the consumers tend to maximize their total utility and that the consumer surplus is highest in perfect competition therefore consumers are believed to be the greatest beneficiary of the perfect market. Since in a perfect market, sellers work as price takers rather than price makers therefore they have no or restricted ability to raise the price on their own because one of the basic assumptions of perfect competition is that there are many sellers and buyers therefore buyers have the option to go to the other sellers to make a buying decision at relatively lower price. It is also important to note that under perfect market competition, there is a free flow of information to buyers and sellers which give them an option to integrate new information into their buying as well as selling decisions therefore consumers when faced with new information tend to modify their buying decisions in order to accommodate the new information. This further allows them to look for sellers which can offer best possible solution to the consumer which is within the budget constraints of the buyers. One of the most important disadvantage of the perfect competition to the consumers is the fact that there are homogenous products to buy therefore they often fall in trap of branding. Despite the homogeneity of the products and services, branding by the firms help them to achieve abnormal profits sometimes therefore consumers may face dilemma of purchasing branded products which otherwise could have been purchased at much lower price. Monopoly As discussed above that monopoly sells above the marginal cost therefore it has the ability and chance to earn abnormal profits. This also means that a monopoly firm has the ability to charge higher prices which ultimately reduce the consumer surplus for the firm. However on the other hand, since monopolies tend to achieve a lower average cost therefore the overall prices charged by the firm may be lower than perfect markets. Economies of scale allow monopolies to produce at much lower cost however production by monopolies is not considered as as efficient as in the case of perfect market therefore on much bigger scale consumers may face the consequences of the inefficient utilization of the resources in the economy. It is also important to note that consumers may get advantage out of monopoly because of the fact that a monopoly faces a downward demand curve which means its marginal revenue is always less than its market price therefore in order to generate an extra unit of sale; monopoly must reduce its price. This reduction in price allows consumers to take advantage of the lowered prices and hence attempt to maximize its surplus. Further, it is also important to note that monopoly firms often involve themselves into price discrimination that is selling identical units of output at various prices therefore attempt to circumvent the market and reverse the impacts of the downward demand curve. This therefore further reduces the overall advantages to consumers. Conclusion There are different market structures which define the various and unique characteristics of the different market structures present in the economy. Monopoly and perfect competition are two of the most important market structures which are present in the economy offering different advantages and disadvantages to the consumers. Perfect competition is mostly characterized by the efficient allocation of the resources of the economy therefore perfect markets are considered as the market structures which are desirable however practically perfect markets are difficult to build. Monopolies on the other hand may be protected by the governments even despite the fact that they are inefficient as compared to perfect markets. References Swann, Michael and McEachern, William A. (2001). Microeconomics: A Contemporary Introduction. Victoria: Nelson Thomson Learning Parkin, Michael (2002). Economics. New York: Addison – Wesley Kwasnicki,Witold (2008) Monopoly and perfect competition-there are two sides to every coin [Online]: Available at http://prawo.uni.wroc.pl/~kwasnicki/todownload/MonopCompet.pdf [ accessed 12 August 2008] Read More