Similarities Between Monopoly and Perfect Competition Market Structures - Essay Example

Name: xxxxx Tutor: xxxxx Title: I Reflective Journal Institution: xxxxx Date: xxxxx Introduction Monopoly and perfect competition clearly represent the two extremes along a continuum of the market structures. At one extreme is the perfect competition that represents the ultimate of efficiency achieved through an industry with extensive competition and without market control. On the other extreme is monopoly which represents the ultimate inefficiency caused by the absolute lack of competition as well as extensive market control. This implies that in monopoly market structure there is a single seller referred to as monopoly who controls the supply-side of a market. In contrast, perfect competition is a market structure represented where each firm has completely no market control. As a result, no firm within the perfect competition can control the market price (Antony & Cline 2005). Similarities between Monopoly and Perfect competition market structures Although monopoly and perfect competition represent the extremes of market structures, several points of similarity exist. For instance, they all minimize cost and maximize profits, thus both have the same cost function. In addition, both monopoly and perfect competition have the same shutdown decisions and they are assumed to face the perfectly competitive issues of markets. One major assumption that economists make when they undertake a comparison between monopolies and perfectly competitive firms is that marginal cost incurred in production by a number of small firms is equivalent to a given marginal cost of production incurred by a single large firm, at the entire and potential levels of output. Such an assumption is basic because without its application, it implies that the marginal cost curve to be illustrated for the monopolist could emerge to be totally different from all the curves which could be represented for a competitive industry. Since they are different theoretically, it is becomes impossible to consider that monopoly output will be less compared to the perfectly competitive output, thus the price for monopoly will become higher. In addition, the difference suggests that monopoly output will be greater, while the monopoly price lower in comparison to the competitive price, though the competitive firms may have initially set the marginal cost equal to the market price. This is illustrated in the figure below where all the small and competitive firm’s marginal cost curves is higher than the monopoly’s marginal costs curves. Consequently, the competitive industry is in charge of setting the price equal to the marginal cost, where output of Qpc is less is less compared to the monopoly output of Qm, though the monopoly's price is much higher than the marginal cost. This is also the case with the competitive price where (Ppc) exceeds its monopoly price (Pm) (Andreas 2006). From the above illustration, the marginal cost curve for a monopoly is not identically equal to the marginal cost curves for the competitive firms. Differences between Monopoly and Perfect competition models Perfectly competitive firms have the zero power, particularly in setting prices. This implies that all the firms within a perfect competition market are the price takers, thus price is set through the interaction of demand and supply at an aggregate level. Therefore, individual firms take the price that is determined by both market and produce quantity of outputs used to maximize a firm’s profits. On the other hand, a monopoly has substantial, though, not unlimited market power. This suggests that a monopoly has all the powers to set either prices or quantities based on his or her own circumstances but not the interaction of demand and supply, thus existing as a price maker. In a perfectly competitive market structure, market price equals to the marginal revenue. This is in contrast with the monopolistic market structure in which the marginal revenue is less than the market price. Product differentiation is completely not practiced in the perfectly competitive market. This indicates that each product found in the market is perfectly homogenous and perfect substitute. However, in a monopolistic market there is more to absolute product differentiation which totally eliminates the availability of substitutes for monopolized goods. Within the perfectly competitive markets, there is existence of a high number of competitors since it is populated with an infinite number of both buyers and sellers, while in monopoly is controlled by a single seller(Sloman & Sutcliffe 2004). Based on the aspect of barriers to entry, perfectly competitive markets have the freedom of entry and exit. This indicates that there are no barriers to competition, entry or exit from the market. On contrary, monopolies have comparatively high barriers to entry. Therefore, in monopolistic market structure, barriers are required to be very strong so as to prevent any potential competitor from entering a given market. A successful monopoly faces a relatively inelastic demand curve which is a low coefficient of elasticity and an indication of effective barriers to entry. However, this is not the case with a perfect competition firm which is faced with a perfectly elastic demand curve. This implies that the coefficient of elasticity for any perfectly competitive demand curve is expected to be infinite. A perfectly competitive firm stands a chance to make excess profits within a short run, though, excess profits greatly attract competitors who may freely enter the market, and thus drive down the market prices reducing the excess profits to zero. Contrarily, a monopoly is able to preserve the excess profits since barriers to entry discourage competitors from entering the market (Antony & Cline 2005). A perfectly competitive firm maximizes production profits where price equals to the marginal costs, while a monopoly maximizes its production profits where the marginal revenue equals to marginal costs. This means that the rules used in the two market structures are not equivalent. Therefore, the demand curve for a perfectly competitive firm is perfectly elastic or flat. Within a perfectly competitive market there is a clear definition of supply function with the one to one relationship between market price and the quantity supplied. However, in a monopolistic market there is no existence of such supply relationship. It is very difficult for a monopolist to trace out any short-run supply curve since for any price there is no distinctive quantity supplied (Antony & Cline 2005). The most significant difference between a perfectly competitive firm and a monopoly should be that monopoly faces a downward sloping type of demand curve and not the commonly considered perfectly elastic curve of the perfectly competitive firm. Practically, the entire variations identified above relate to this fact. In case of a downward sloping demand curve, through necessity there is a unique marginal revenue curve. Since a monopoly faces a downward sloping demand curve, it implies that the link between the total revenue and output for any monopoly is considerably different than of competitive firms. On the other hand, a competitive firm is faced with a perfectly elastic demand curve. The total revenue is more proportional to the output. Therefore, the total revenue curve for the competitive firm is perceived to be in a ray with a slope equal to the market price. This suggests that a competitive firm can opt to sell all the output that it desires at a market price, while for a monopoly to raise its sales it is required to reduce its price. As a result, the total revenue curve for a monopoly is considered to be a parabola which instigates at the origin and attains a maximum value afterward continuously falls until the total revenue gets back to zero (Sloman & Sutcliffe 2004). Under the monopolistic competition, very limited opportunities exist for the economies of scale because of the small size of the involved firms as well as no barriers to its entry and exit. In a short run firms that are in monopolistic competition may face either abnormal profits or losses. The above diagram illustrates a case where firms face positive economic profits. From the illustration, it can be noted that the downward sloping of the demand curve is faced with a representative firm and occurs due to the fact that all the units are priced at the same cost. This is under the perfect competition where the price is equal to the average revenue. Therefore, the difference in price results from the product variation. This enables the producers to compete based on whether or not the products they offer generate extra utility for their respective customers as opposed to competing on the basis of price, a case with perfect competition. The firm as profit maximizing, produces at a point where the marginal cost equals to the marginal revenue, thus charges at the profit maximizing price P1. The distinction between the perfectly monopoly diagram and the monopoly diagram within the short run is that in the monopolistic competition, there are several firms within the market which suggests that is a specific level of interdependency that does not exist under the monopolistic state (Das 2007). Conclusion Although monopoly and perfect competition represent the extremes of market structures, several points of similarity exist. Perfectly competitive markets have the freedom of entry and exit. This indicates that there are no barriers to competition, entry or exit from the market. Monopolies have comparatively high barriers to entry. The coefficient of elasticity for any perfectly competitive demand curve is expected to be infinite. A perfectly competitive firm can make excess profits within a short run, though, excess profits greatly attract competitors who may freely enter the market, and thus drive down the market prices reducing the excess profits to zero. A monopoly is able to preserve the excess profits since barriers to entry discourage competitors from entering the market. In the monopolistic competition, very limited opportunities exist for the economies of scale because of the small size of the involved firms as well as no barriers to its entry and exit. A perfectly competitive firm maximizes production profits where price equals to the marginal costs. A monopoly maximizes its production profits where the marginal revenue equals to marginal costs. A competitive industry must ensure that price equal to the marginal cost, where output of Qpc is less than the monopoly output of Qm, though the monopoly's price may be much higher than the marginal cost. Bibliography Antony, D & Cline, T., 2005, A Consumer Behavior Approach to Modeling Monopolistic Competition, Journal of Economic Psychology, 26, 797–826. Andreas, K., 2006, Comparison of the models of perfect competition and monopoly under special consideration of innovation, University of Bradford. Das, S.P, 2007, Microeconomics for Business, Sage Publications, New Delhi. Sloman, J & Sutcliffe, M, 2004, Economics for Business, Prentice Hall, New York. Read More