What are the main differences between Monoploy and Monopolistic Competition market structure - Essay Example

?A monopoly is a market situation where only one seller exists, producing a product which has no close substitutes. It is at the complete opposite end of the spectrum to perfect competition. In practice a monopoly situation can arise when a firm has a dominant position in the market in terms of its market share. For example, British Telecom enjoyed a monopoly until 1988 when the UK office of telecommunication decided to end it. The basis for a monopoly market is the existence of barriers to entry. These are factors that prevent new firms from entering the industry, or even if they do, will force them to close. Barriers can be of various forms. The high fixed cost or setup cost can be the toughest obstacle to tackle. The barrier here is access to capital. Only large firm will be able to fund the necessary investment. An established monopoly is likely to have developed specialized production and marketing skills. It is more likely to be aware of the most efficient techniques and the cheapest suppliers. In most cases, such firms have a major cost advantage because of economies of scale which allows them to operate on a lower cost curve. Advertising and brand names with a high degree of consumer loyalty may also prove a difficult barrier to overcome. The firm’s monopoly position may also be protected by patents and other legal protection such as various forms of licensing or tariffs, which may hinder entrance of local and foreign firms. Aggressive tactics and intimidation may also act as a barrier. For example, an established monopolist is likely to sustain losses for longer than a new entrant. Thus it can start a price war, mount massive advertising campaign, introduce new brands and so on. In some circumstances, the monopolist may also resort to various forms of harassment, legal or illegal, to sustain their market power (Sloman 1997). Other barriers such as sunk costs or collaboration between existing producers may also frighten the new entrants. True Monopoly is normally found only in markets that are controlled by the Government. Provision of civic services such as postal services or railway system could be an example. Monopoly in private business are relatively uncommon, and even then they only achieve monopolistic power bur are not perfect monopolies. However, another market structure that exists is the monopolistic competition. It is close to the competitive end of the spectrum. It is a situation where a lot numerous firms compete with each other, but where each firm does nevertheless has a certain degree of market power thus the term ‘monopolistic’ competition. In monopolistic competition, there are a large number of sellers and due to this no one seller has a control over the supply of the product in the market. Hence, a single firm cannot influence price or output in the market. In other words, the price and output policies of each seller are independent. The grocery retailing market in the UK is arguably monopolistically competitive. In 1991, there were approximately 62,000 food retailing businesses. All were competing for the same product however, each one attempted to offer something unique and different (Anderton 1995). Each firm in monopolistic competition produces similar, but not identical goods and sells differentiated products which are close substitutes to one another. The product is differentiated in a number of ways such as altering the quality of the product, offering supplementary and other services, changing the location of the firm or promoting the product through advertisements. (Gillespie 2002). Unlike monopoly, there are no barriers to entry or exit in monopolistic competition. Entrance becomes possible due to a lower startup capital or the nature of the product. Moreover, in monopolistic competition, the main form of competition is price. Each firm sets the price arbitrarily, usually reducing the price of the product to gain from higher sales. However, at times firms in this type of market also resort to non price competition such as advertising and promotions to capture the market. Unlike a monopolistic competitive firm, a monopoly can practice price discrimination to increase its revenue. Price discrimination is a practice whereby a firm sells its product or service at different process to different customers (Miller 1997). The primary condition for price discrimination is that price elasticity of demand among customers must be different. Price Discrimination would not be possible if all buyers have the same demand curve. Early bird discounts is an example of price discrimination. Airlines tend to do this as customers who book flights early (customer A) are more likely to get a cheaper flight. Whereas customer who book flights closer to the actual flight date (customer B) tend to pay extra for the flight because of their inelastic demand. Charging different prices for the same type of flight to the same destination is an example of price discrimination. The figures below illustrate how this is practiced by monopolies. Despite the differences in characteristics, these markets have a few things in common such as producing at the profit maximizing price and having a downward sloping demand curve. Let us have a look at a monopoly costs and revenues curve first. The monopoly’s costs curves are MC and ATC. They slope upwards because of the law of diminishing marginal returns in the short run. The revenue curves are MR and AR, which is also the demand curve. If we assume that the monopoly is profit maximizing, then it will produce at the output level where MC = MR. At this level profits will be maximized. In the diagram above, the monopoly is in equilibrium at output level at Q1 where it earns supernormal profits (difference between P1 and P2) in the short run as well as the long run. (Bamford 2002). The short run equilibrium of a monopolistic competition is the same as the monopoly’s except that the AR and MR curves will be more elastic because like all the other profit maximizers, they also produce where MC = MR. Therefore, it is possible for the monopolistically competitive firms to make super normal profit in the short run. Just how much profit the firm will make in the short run depends on the strength of demand. The further to the right the demand curve is relative to the average cost curve, the less elastic the demand curve is, the greater will be the firms short run profit. New firms enter the industry in the long run with supernormal profits as an incentive. As new firms enter, some customers disperse from the existing firms. This causes the existing firms demand to fall hence their demand (AR) curve will shift to the left where only normal profits remain as seen in the figures below (Begg 1997). Often it is argued that the monopolies and monopolistic competitive firms are not in the public interest. At its equilibrium point, it can be seen that the price at this output is higher than the MC. In economic terms, it is called allocative inefficiency. It means that output is not at the level where society’s satisfaction can be maximized, from the consumption of this good. As long as what people pay (the price that represents the satisfaction consumer desires) is greater than the cost of producing the last unit, the market is not efficient. It is only when output is at the level where P = MC then there is allocative efficiency. Also, a single price monopoly restricts output and creates dead weight loss (Parkin 1998). Similarly, there is allocative inefficiency in both the short and long run in the case of monopolistic competition also. This is because price is above marginal cost in both cases, that is, output is produced at MC = MR. In the long run, however, the firm is comparatively less allocatively inefficient. In all cases, the socially ideal output level is where P = MC. Both know that profits can only be made at the expense of consumers therefore they create a shortage so that price rises faster than AC. The difference between the two is the profit margin. It is only in a perfectly competitive market situation that one has allocative efficiency. Competition forces prices down till output is at the point where P = MC. However, in all imperfect markets there will be various degrees of allocative inefficiency depending on the level of competition. Another reason why the monopoly does not produce at the socially optimum level is because output is not at the productively efficient level. Looking at figure 1, output is on the sloping left side of the ATC curve and not at its minimum. The firm has excess capacity where allocated resources are not fully utilized. In a competitive situation, output would be at the lowest ATC. It is socially ideal to produce at optimum capacity. Even in a monopolistic competitive industry, there is a tendency for excess capacity because firms are unable to fully exploit their fixed factors because mass production is challenging. Hence, even they prove to be productively inefficient in both the long and short run (Powell 2000). However, it is not always the case that society is a victim when monopoly or several monopolistic competitive firms exist. It is true that both are allocatively and productively inefficient than firms in other market structures, particularly a perfectly competitive market, however, both the market structures have several advantages and may prove to be beneficial for consumers. For instance, monopoly can enjoy economies of scale (EOS) that firms in other market situations may not. The monopoly enjoys EOS because it is the only supplier in the market. Increased output leads to a reduction in average costs of production that is then passed on to consumers in the form of lower prices (Case 1996). Moreover, supernormal profits earned by monopolies can be used for research and development. Successful research can result in better products and reduced costs in the long term. For example, Telecommunications and Pharmaceuticals. Consumers also tend to gain when a local monopoly faces intensive competition in the global market. This enables monopolies to limit their market power and keep prices low for consumers. As far as the monopolistic competitive market structure is concerned, it is comparatively more efficient than monopoly. Moreover, it is also known to be dynamically efficient which means that they are highly innovative in terms of new production processes and new improved products. For example, retailers frequently have to develop new methods to draw and retain customers. Furthermore, since there are no significant barriers to entry, it makes this market relatively contestable. Also, differentiation between similar products creates diversity, choice and utility. For example, different boutiques in London’s Kings Road compete with each other over the same product. However, they all stand apart from each other due to difference in variety (Lipsey 2003). Like all other market structures, monopoly and monopolistic competition have their own pros and cons. However, if gauging it in terms of consumer welfare, I think monopolistic competition tends to be more socially desirable. Firstly, a monopolistic competitive firm, usually, provides it consumers with lower prices and more quantity of the product compared to a monopoly. In addition, it is more economic efficient in contrast to monopoly which means it is less allocative and productive inefficient. Lastly, consumers also gain in terms of adversity and variety in similar products. Thus, on the basis of price charged and output produced and several other factors, monopolistic competition seems more favorable than monopoly. REFERENCES Bamford, C. et al., 2002. Economics: AS and A Level. Cambridge University Press. Sloman, J., 1997. Economics, 3rd ed. Prentice Hall Europe. Gillespie, A., 2002. AS & A Level Economics. Oxford University Press. Lipsey, R. and Harbury, C., 2003. First principles of economics, second edition. Gopsons Papers Ltd. Anderton, A., 1995. Economics, second edition. The Alden Press, Oxford. Parkin, M., 1998. Economics, fourth edition. Wesley Publishing Company. Case, K. and Fair, R., 1996. Principles of Economics, fourth edition. Prentice Hall. Miller, R., 1997. Economics Today, ninth edition. Wesley Educational Publishers Inc. Powell, R., 2000. A- Level Economics. Bath Press. Begg, D. et al., 1997. Economics, fifth edition. Bath Press. Read More