Perfect Competition versus Pure Monopoly - Literature review Example

Perfect Competition versus Pure Monopoly Macro & Micro Economics 10/11 Introduction A market structure simply refers to the kind of economic setting in the market. What differentiates one market structure from the other is the degree to which sellers look for the demand of buyers, and the number of firms participating in the market. Equally, the market forces and the size of firms as well determine the market setting. Sometimes the ease to enter and exit the market also distinguishes the structures (Samuelson & Marks, 2012). The scale of competition is equally very important. In fact, market structures are rated from the ideal to the imperfect based on the degree of competition. Thus, a hypothetical market with the highest degree of competition is seen as the benchmark for the other markets. The scope of perfection then declines with the level of competition exhibited in subsequent structures. Other factors are product differentiation and market regulations, particularly government regulations. This paper discusses perfect competition versus pure monopoly. Basically, it concentrates on the economic and social dimensions and major characteristics that differentiate these two market structures. Perfect Competition Perfect competition is a market structure involving a number of firms, in which no single company is large enough to dominate the market (Samuelson & Marks, 2012). No one firm can set a product price, neither can it control or influence the costs. Prices are set by looking at the demand and supply curves. As such, all participants in the market are price-takers (McEachern, 2008). Besides, when the price of a homogeneous product is set by all participants none of them can decide to charge differently. They all charge the same, and each earns normal profits. This kind of a market structure is also known as pure competition. In an ideal market setting, it is recognized as a natural benchmark for the other structures. It has, in fact, been argued that it is only in this market setting that consumer interests and benefits are maximized (Hirschey, 2008). The reason is that when competition is maximised and demand equals supply, it necessarily follows that utilities are also maximized. Economic dimensions of a perfectly competitive market There are quite a number of economic dimensions in a perfectly competitive market. Essentially, it involves a large number of players (Samuelson & Marks, 2012). There are different consumers and suppliers with a motive to buy and sell at a certain price. This can be contrasted to a natural monopoly where only one supplier serves the entire market. Another economic dimension is that it is characterized by perfect information (Hall & Lieberman, 2012). All the participants are presumed to have the perfect knowledge of the market. Information is freely available to all the market players. Ultimately, with perfect information chances of taking risks are minimal. The third differentiating feature is that this market structure has no barriers of entry as well as exit (Samuelson & Marks, 2012). Hence, firms easily enter and walk out without being pinned down with obstacles arising from market dominance of other firms. Further, it is characterized by homogeneous products. This means that products in this market structure are produced by all, and are identical and perfect substitutes for each other. Thus, they have similar qualities and characteristics. Another feature is that in a perfectly competitive structure, market costs are minimal. For example, there are zero advertising costs. There are also no government regulations. Firms as well do not spend much on transport costs. In addition, there is perfect mobility in this hypothetical market setting. That is, there is no hindrance in terms of market powers or other forces. All the factors of production enjoy the free flow. Finally, and more importantly, there is true competition. No supplier is discriminated in the market (Vance, 2005). Assumptions in Perfect Competition A number of assumptions are made in a perfectly competitive market. To begin with, it is assumed that all market players have sufficient knowledge of product prices. Similarly, it is assumed that they are aware of the quality expectations for goods and services. Two, there is an assumption that no single firm is large enough to control the market share (Samuelson & Marks, 2012). This shows that each of the firms have insignificant impact in the market. As such, none of them can influence or control costs. Rather, all suppliers are participants in price taking. Another major assumption is that market entry and exit is free to all the suppliers. No single firm or even a few of them (as in the case of oligopoly) can be able to initiate economic barriers for other firms. Thus, in a perfectly competitive market competition is open to all without unfair economic restrictions. New firms have equal access to resources just as the existing firms. Further, it is assumed that all firms have the sufficient information regarding utility and the methods used in producing these goods and services. It is also assumed that there are no externalities in this market structure. This means that prices and benefits do not depend on private factors. Lastly, it is assumed that all the firms are producing identical products. Hence, products from one firm can be substitute to the products of the other firms (Hall & Lieberman, 2012). Market Efficiency in Perfect Competition Perfectly competitive markets produce the highest efficiency in the market. Ultimately, they promote social welfare. Because their prices commensurate with the product benefits, consumer surplus is kept high. Thus, for every increase in the unit price there is also an increase in benefit to consumers (Samuelson & Marks, 2012). They are also efficient because prices are negotiated. In order to be competitive firms in this market setting do not have fixed prices. Although the supplier may have a minimum acceptable price and the buyer the maximum price for the value of the product, a perfectly competitive market provides the arena for these two sides to negotiate a price that serves both interests (Samuelson & Marks, 2012). Therefore, the efficiency arises from the fact that the gains of both parties are met. Because of many suppliers in the market, the output level is also efficient. Pure Monopoly Monopoly is a market structure characterized by market power and dominance, such that only one firm supplies a particular product (Samuelson & Marks, 2012). In addition, in this setting a single firm is large enough to control the market. As such, it is the sole price taker. It sets and influences how prices are made. Because of the market force that it enjoys, it also creates barriers for other new firms to enter the industry. When there is reduction in the economies of scale, this kind of a market structure is called natural monopoly (Vance, 2005). Generally, natural monopolies are able to sustain themselves in the market as the sole suppliers because they operate at lower average costs. Thus, they have the economic muscle to supply the entire market. This also enables monopolies to provide high efficiency than if the same product was left to multiple firms. Moreover, a monopolistic firm earns supernormal profits (Baumol & Blinder, 2011). Characteristics of Pure Monopolies Monopolies are characterized by a number of factors. One, as indicated there is only one supplier of a particular product in the market. Two, this single firm is also the price taker. Because of its market power, it sets, influences, and controls price of a particular item (Baumol & Blinder, 2011). Three, there is absence of competition in this market structure. Four, it is characterized by price discrimination. Typically, a monopoly will increase prices, not based on demand but for the sake of profit maximization. As such, the market demand and supply curves are hardly there. Five, it is typified by economic barriers. When a single dominates the market, it creates hindrances for other firms to enter the industry. It also requires high costs in terms of advertising and transport costs. Finally, in a monopoly there are no substitute commodities. As such, consumers do not have alternatives if they are dissatisfied with a product price or quality (Samuelson & Marks, 2012). Factors leading to natural monopolies Basically, natural monopolies bank on the economies of scale. Depending with the market environment, it is sometimes necessary to have one firm supply the market to increase efficiency (Samuelson & Marks, 2012). In other words, having many firms in certain market environments would simply reduce efficiency considering, for instance, standards of utility and service delivery. Another important factor leading to natural monopolies is the lower average cost of production (Vance, 2005). Because of market power they enjoy from the economies of scale, they sometimes charge lower prices in order to prevent other suppliers from joining the industry. Even if new firms were to join, they wouldn’t sustain themselves for long because they would need to spend a lot in the cost of production, thus incurring higher average costs. In view of this, Samuelson and Marks point out the decline in the average cost of production as one of the major factors ensuing to natural monopolies (2012). Inevitably, when natural monopolies enjoy an overwhelming cost advantage, they create barriers for other firms, thus are able keep themselves as the sole suppliers in the market. How governments address monopolies Essentially, governments address potential abuses and unfair market behaviours by natural monopolies through regulations. These economic laws draw boundaries within which market players operate. Thus, these mechanisms serve to protect consumers and promote healthy market environment. They also serve to prevent market failures induced by firm-caused monopoly. An example of government regulation can be price control, so that price taking is not left to the discretion of a single firm (Samuelson & Marks, 2012). Putting caps in the amount of money that can be charged for a particular product, for example, restricts monopolies from raising prices. Hence, they are denied that right which gives them the exclusiveness to increase prices without added benefits to the consumers. However, government regulations may also have their weaknesses depending on how they set. For instance, setting a fixed price for a particular commodity may discourage rather than encourage consumer purchase. The best government regulation of prices is by setting average pricing of commodities. Sometimes regulations may also limit true competition, especially if they restrict market entry and exit (Baumol, W., & Blinder, 2011). Secondly, governments standardize natural monopolies by setting up government production. This not only ensures that consumers get quality products, but also at affordable prices (Samuelson & Marks, 2012). It also weeds out potential market abuses and unfair market dominance of monopolies. Nevertheless, while government production offers an alternative to a natural monopoly, it does not provide the best solution to it. For one, there is likelihood that government production, just as natural monopoly, will lead to poor service delivery in the absence of competitors. Certainly, it equally restricts competition. There is also the possibility that governments may raise commodity prices whenever they need to generate more tax revenues, hence exploiting the consumers (McEachern, 2008). Therefore, rather than establishing government production, natural monopolies can be best addressed by removing all economic barriers that may restrict or discourage market entry and exit. It can also be addressed by encouraging healthy market competition so that firms provide quality and affordable prices that meet the consumer demand (Samuelson & Marks, 2012). The demand and Supply Curves in Perfect Competition versus Pure Monopolies In perfect competition, the demand and supply curves play very important roles in price determination. The demand curve here stands for the total quantities that customers are willing to buy, while the supply curve refers to the total quantities that firms are willing to produce (Samuelson & Marks, 285). Firms in a perfectly competitive market either raise or lower prices by looking at the fluctuations of these curves. Thus, any change in demand or supply affects the market price. In normal circumstances, when the demand expands, usually the price also goes up. Consequently, an increase in demand also leads to an increase in supply. There are, however, a few circumstances where an increase in demand does not necessarily lead to a shift in product price. In contrast, in pure monopolies the demand and supply curves are hardly there. Even if they are visible, monopolists do not use them to determine prices. Whether they produce less or more output, they can still raise prices. According to Samuelson and Marks, there are two factors that shift the demand and supply curves. The first factor is the economic conditions (Samuelson & Marks, 287). When the economic conditions are favourable to the market, normally both the demand and supply curves shift upwards. This leads to reduction in prices. However, when the conditions are consumer unfriendly, usually the prices go up. The second factor is the technological improvement (Samuelson & Marks, 287). Under a perfect market setting, improvements in technology are supposed to help reduce product prices because there is high efficiency and minimal production costs. While firms in perfectly competitive markets obey the shifts in demand and supply curves caused by these two factors, firms in pure monopolies hardly consider the changes as far as prices are concerned. How demand and supply curves affect product prices in perfect competition Social concerns arising from unregulated monopolies versus perfect competition One of the disadvantages to the society as a result of monopoly over perfect competition is high commodity prices. Because of the absence of competition, prices in the monopolistic market are not negotiated, neither are they arrived at by looking at the demand and supply curves. In fact, there is no supply curve. As such, prices are not determined by the output level. Whether the amount of output is less or more, a monopoly can still raise commodity prices (Hall & Lieberman, 2012). Concisely, it enjoys the exclusive rights to increase prices; for one, because there is no substitute product, and two, because of the absence of competition. Accordingly, when the product prices are high, the consumers find themselves in an odd situation where they have no alternative but to purchase the commodities at the raised prices. On the other hand, if the market structure is a perfect competition, the society enjoys not just low prices but also alternatives to other products. If one firm was to increase its prices, for instance, the consumers would simply move on to the next buyer for the same product but at lower price. Thus, this latter market structures guarantees the society better product prices (Samuelson & Marks, 2012). The second loss to the society is limited product output. In a monopolistic marketplace, the supply of commodities is usually much lower compared to the supplies in a perfect market. The reason may not be necessarily the absence of other firms, but the intentional refusal of a monopolistic firm to produce enough products that is commensurate to the consumer demand. The idea is that when the output is limited, the demand increases, making it easy to raise prices. Thus, limited output leads to high prices, which inevitably gives a monopolistic firm high profit (Samuelson & Marks, 2012). In contrast, in a perfect market setting, the output is usually high because there are a large number of players supplying the market. Moreover, the output is arrived at by looking at the demand curves. Hence, the market is constantly supplied with the products. Accordingly, the consumers get to have enough products for their wellbeing. The third social disadvantage as a result of monopoly over perfect competition is the reduction in the consumer surplus. For one, monopolistic firms increase prices with no added benefits to the society. Two, because of limited output with high prices, they significantly exploit the society. Three, they earn much more than what they give back to the society. They are driven by profit maximization at the expense of the gains of the consumers. Consequently, low consumer surplus leads to a reduction in consumer social welfare (Samuelson & Marks, 2012). Fourth, monopolies are potentially abusive. Because of the imminent lack of regulation, monopolies easily make their money at the expense of society. For one, monopolies promote price discrimination. Two, they discourage investment because they create barriers for new firms to join the market. Consequently, consumers are forced to put up with flaws of one supplier. Three, monopolies destabilize the market. Because they control the market and are the major price takers, they develop reluctance in competence. This results to poor quality in service production and delivery, ensuing to poor social welfare of the society (Baumol & Blinder, 2011). Conclusion Evidently, market structures are differentiated by the scale of competition, product differentiation, the degree to which sellers seek the demand of buyers, the number of firms participating in the market, the market forces, freedom of entry and exit, the scope of perfection, and market regulations, particularly government induced restrictions. Thus, a perfectly competitive market will be contrasted with a natural monopoly, for instance, by looking at the spectrum of competition between the two markets. In brief, each market is characterized by specific features. In a perfectly competitive market, competition is maximized, there are multiple firms, and freedom to enter and leave the market is not restricted. In addition, they are qualified by perfect information, homogenous products and minimal costs. In a monopoly, there is only one supplier of a particular commodity, price taking is not shared, completely no competition, price discrimination, economic barriers in terms of entry and exit, and the lack of substitute products. In a monopolistic competition, there are many suppliers, but sell differentiated products. Product prices are also set by looking at the demand and supply curves. Finally, in oligopolies the industry is concentrated by a few companies. Considering all these market structures, perfect competition is perceived as the ideal market setting and the benchmark for the other structures. On the other extreme, pure monopolies are considered the worst scenario of a market setting. Considering however the real-world firms, monopolistic competition is most preferred. Oligopoly comes third in the degree of preference. References Main Book Samuelson, W.F., & Marks, S.G. (2012). Managerial Economics. Massachusetts, MA: John Wiley & Sons, Inc. Accessed on 10/11/2012). Web Link: https://www.sendspace.com/file/qgpjji Additional Sources Baumol, W., & Blinder, A. (2011). Microeconomics: Principles and Policy. Ohio, OH: Cengage Learning. Hall, R., & Lieberman, M. (2012). Microeconomics: Principles and Applications. Ohio, OH: Cengage Learning. Hirschey, M. (2008). Managerial Economics. Ohio, OH: Cengage Learning. McEachern, W.A. (2008). Economics: A Contemporary Introduction. Ohio, OH: Cengage Learning. Vance, D.E. (2005). Raising Capital. New York, NY: Springer Science & Business Media. Internet Source Web Link: www.economicsonline.co.uk. Accessed on 10/11/2014. Read More