Why Perfectly Competitive Firms Cannot Make Supernormal Profits in the Long Run - Essay Example

TOPIC: EXPLAIN WHY PERFECTLY COMPETITIVE FIRMS CANNOT MAKE SUPERNORMAL PROFITS IN THE LONG RUN BUT MONOPOLIES CAN TABLE OF CONTENT INTRODUCTION……………………………………………………………………………………………………….. Perfect competitive Market……………………………………………………………………………….. Monopolistic Market………………………………………………………………………………………………. EQUILIBRIUM OF FIRM……………………………………………………………………………………….. EQUILIBRIUM IN PERFECT COMPETITION AND MONOPOLY IN THE LONG RUN…………. COMPARISON BETWEEN MONOPOLY AND COMPETITIVE EQUILIBRIUM OR PERFECT COMPETITION INTRODUCTION: Monopoly and Perfect competitive firms have different ways to deal with. They both target the market for maximum profit thus they have different approaches to make it successful. A brief outlook of both firms will help in understanding the topic thoroughly. Perfect Competitive Market: A place where there are minimum barriers for new comers and the product offered to customers is homogenous. It makes truly perfect when the size of the firm is relatively small to the capturing market and all suppliers and buyers have good communication about the cost and profit margins. Producers are only interested of taking their cost and resources are easily mobilized. Thus it makes a perfect combination. The most interesting part is that Perfect Competitive market has growth levels to improve their quality and revise their prices which make them vulnerable and devoted towards their product. This is observed and practice because a lot of firms comes in and introduce their new may be advanced product to customers and if you fail to offer something equivalent then customers simply turns their backs. These are some positive gestures which you receive from the market to improve further or bring something new to attract the customers. All conditions are to be fulfilled to make it a Perfect Competitive Market. Monopolistic Market: It is a place where only one party holds the system and moulds it accordingly. There are several other problems that occur for consumers if the market is monopolistic like supply constraints are faced often and prices are fixed according to their will, mostly high and excessive barriers are being laid for new comers which is a hindrance in getting new offers and sufferers are only customers as they can’t help buying the product available. This type of markets are usually said to be in telecommunication or media industry sectors as they lay strong foundation by investing a huge amount which cannot be easily challenged. But they are bad for themselves in a way that they do not face competitor, which does not make them realize to go for innovations or advancements. The best example here is American Software Company known as Microsoft which ruled the software sector for decades because of its Windows Operating System. They were later challenged by Apple with extra ordinary efforts for which Apple waited for years and today it is in dominance. Remember efficiency is not the only factor affecting monopoly. Monopolies can still achieve a good profit ratio then Competitive markets in the long run. EQUILIBRIUM OF THE FIRM: This term can be defined in two ways, theoretically and will graphical illustrations. It becomes clearer when you can understand the concept of its curves and the theory related to it. The theory explains that a firm under perfect competitive conditions faces infinite elastic demand curve or the price of the commodity is given in the market of product from an individual firm. While the firms calculates the extra cost incurred on producing extra unit by making changes in the amount of variable factors. Marginal cost and marginal revenues shall be compared to determine the equilibrium of the firm. If the Marginal Revenue is greater than the marginal cost, it is in complete favor of firm to increase its production. As production increase from its fixed units, marginal cost increases after a certain limit. When both marginal cost and marginal revenue cost are equal, firm is considered to be in equilibrium. Following equilibrium equation, MC=MR, Graphical Presentation is given below: Price Y MC P T P MR=AR=P Quantity (output) 0 Zʹ Z X On x-axis, quantity of the production is shown and y –axis is interpreting Marginal Revenues. The curve is intersecting at two points with the marginal revenue which is showing that firm was in equilibrium at Z and Zʹ and at that certain point and it was still earning profits. When the curve stretches beyond Z, Marginal Cost increases then the Marginal Revenue, thus it disturbs the equilibrium. It can be proved mathematically as well that Z is an equilibrium output: Let Z be the output, TR the revenue and TC the cost. Profits are calculated as Π = TR – TC. To maximize the profits we need For example, MR = MC, and For example, Slope of MR < Slope of MC. EQUILIBRIUM IN PERFECT COMPETITION AND MONOPOLY IN THE LONG RUN: We are heading to evaluate how either firms or market generates different profits in the long run. For this we will have a constant cost and market demands and to analyze the situation in simple conditions we’ll consider the Average cost in both cases. Marginal cost is equal to Average cost (MC= AV). In perfect competition, the equilibrium will be at the point where demand is equal to supply. At this point AC is equal to MC and generally, statement of equilibrium in perfect competition is: P = AR = MR = MC = AC Where P = Price of the commodity, AR = Average Revenue, MR = Marginal Revenue, MC = Marginal Cost, and AC= Average Cost. In monopoly, equilibrium is maintained when Marginal Revenue is equal to Marginal Cost. Marginal cost curve cuts the Marginal revenue curve with an additional statement that says that MR will be less than the price. Thus graphical representation shows the best that both markets are at equilibrium in the long run. This Graph states the comparison of profit in both markets in the long run In perfect competition, price is fixed but output is different to the supply curve is horizontal. The equilibrium point is the price for competitive is Pc, where MR =MC and the output is Qc. Equilibrium for monopoly is same where MR=MC but the output level Qm. The price level is Pm, where we can observe that at low outputs, profit is higher and vice versa in perfect competition. In short: "monopoly is a single supplier to a market [and it] may choose to produce at any point on the market demand curve" (Nicholson, 495) COMPARISON BETWEEN MONOPOLY AND COMPETITIVE EQUILIBRIUM OR PERFECT COMPETITION: According to the comparisons done by economist: Monopoly is in equilibrium when Marginal cost is equal to Marginal revenue as in perfect competition. Monopoly has control over production and its cost, where as perfect competition has to follow and sell at price fixed by the intersection of the forces. Monopoly can earn supernatural profits in short and long runs. The firm does not have to equate AR to the minimum point of AC in the long run. In Perfect Competitive market, firms can earn abnormal profits in the beginning but can only earn normal profit in the long run. No chance of earning supernatural profit in the long run due to several reasons. Monopoly firm is a price seeker, for which it does not have a supply curve because it decides the output and price where maximum profit is available, and perfect competitive firm is a price taker and have a supply curve, where the portion of marginal cost curve is above Average cost curve. Monopoly stands at a level above in the long run because of its authority to fix prices and the consumer will pay, where as in long run perfect competitive firm will suffer and get a normal profit. REFERENCES: Principles of Microeconomics: N. Gregory Mankiw – {2011 - 856 pages}. "monopoly is a single supplier to a market [and it] may choose to produce at any point on the market demand curve" (Nicholson, 495) Read More