Is Monopoly Necessarily Less Efficient Than Perfect Competition?
Is Monopoly necessarily less efficient than Perfect Competition According to SJ Grant’s Introductory Economics, Monopoly is the only sole supplier of the industry. They would not inherit any competitions as well as having no close substitutes. There are many reasons that cause the formation of Monopolists. Barriers to enter or exit discourages new firms to enter the market (patent rights creates a right to sell that product, abnormal profit, predatory pricing, raw material ownership, high fixed cost, government) being a price maker, firms either merge or get taken over by other firms and economies of scale.
In Perfect competition, there are many sellers and buyers; there are only homogenous goods and perfect information. They are price takers so no firm charges either below or above the ruling market price. The demand curve is perfectly elastic. In this type of market, there is consumer sovereignty and advertisement could not be used to influence consumer’s demands. However both of them are opposite extreme forms of the market structure and in the realistic world, they hardly ever occur. An economist would define efficiency as ‘nothing can be made better off without causing the loss of another’.
This is also known as Pareto efficiency. Meanwhile it is also when the resources are allocated in the best possible ways at the lowest possible average cost. Figure 1 Some people view Monopoly to be less efficient than perfect competition because they face no direct competition and so they would not work towards the interest of consumers. They would fail to apprehend productive efficiency using techniques and factors of production to produce at the lowest possible average cost per unit, because the cost of production is not a main concern to a Monopolist.
They would simply increase price or restrict output. Monopolies are able to do that because they are price makers; even though the setting price is determined by the demand, they are still capable of restricting output and increase the price. This demonstrated by figure 1 where the price is set against the AR curve rather than the MR. On the contrary, perfect competition means firms compete against each other: cost in this case is one of the main issues. The firms in that market would aim to produce at the lowest average cost because of the profit maximizing point, MR=MC.
But in a perfect competitive market, the firms in the long run would only get normal profit so total revenue equals total cost. Figure 2 Monopolists are able to attain abnormal profit in the long run due to barriers to entry or exit. It illustrates that monopolies have market power and the downward sloping demand curve is one of the causes as shown in figure 2. The quantity and price which the monopolist selects is largely dependent on the marginal revenue and marginal cost. But the marginal revenue curve would always be lower than the demand curve.
The reason for this can be illustrated by the figure 2; It shows that at any two random points and using the method of working out the total revenue (price X quantity), you would always get a negative gradient curve. Whilst differentiating the curve’s equation, you would always get the curve being below the demand curve. The quantity or price the firm chooses is based on the marginal revenue and marginal cost because, by increasing output, it causes two contrasting effects, price and quantity.
The quantity effect is that by producing one more unit and it being sold, it increases the total revenue by the price that it is sold at. But producing more units, it decreases the price of the good and makes total revenue fall: this is the price effect. The price effect means that the marginal revenue will not be constant and so it would be below the demand curve. Consequently price effect would always occur if the monopolist increases quantity. However in a perfect competition, the MR equals AR: the firms being price takers, they can only accept the ruling market price.
The AR curve is perfectly elastic because of consumer sovereignty. In figure 3, it shows that the firms only aim the price at the market demand; no firms would produce below the ruling market price because in the long run they would be earning a loss and eventually leave the market and in contrast, they would not set it above the market price because no consumers would buy from them when the goods are homogenous and other firms are there. Figure 3 Subsequently, with the MR curve always being below the demand curve, it causes the monopolist produce inefficiently.
This is because all firms desires to produce the profit maximizing point, MR=MC and when the monopoly produces at that point, it will always produce at the point that is lower than the efficient level and so monopolies misallocate resources. Hence deadweight loss occurs and this can happen both in the long and short run as there are no competition pressure for them to become allocatively efficient. Allocative efficient is when P=MC where the cost reflects the price. Another point would be that unregulated monopoly can overcharge consumers as well as not allocating resource in a satisfactory manner.
In a perfect competition market, firms are able to obtain allocatively efficient in the long run. Firms can misallocate in the short run due to them either earning abnormal profit or a loss but as soon as market competitions enhances firms to earn normal profit and produce efficiently, it becomes allocatively efficient. Barriers to entry prevent this discipline from market competition to happen to a monopolist and so they continue to misallocate resources. Figure 4 The idea of misallocation of resource closely links to the result of deadweight loss.
Deadweight loss is the net loss where there is a loss of goods being produced for the price that consumer pay at. For figure 4, it shows that due to the price being charged against the D curve instead of MR=MC, this causes the area of the consumer surplus , when consumer pay less for the good they were willing to pay for, to decrease and the producer surplus, the amount gained from selling a good to increase. This suggests that the monopolist is X-inefficient as consumer loses out, producers gain from it.
Furthermore it can be seen that there is an area of deadweight loss formed as well. Not all resources are used in the market. In comparison to perfect competition, figure 3, all the area above P1 is the consumer surplus and there is no deadweight loss, all the quantity produced is reflected towards to consumer demand. However Monopoly being less efficient than perfect competition is not always the case. The ability of economies of scale is a mass production of a good or when goods are distributed through network or grids (i. e. water supply).
This makes the cost of production cheaper thus brings the price down. They are called Natural monopoly and they are more technically efficient. In figure 5, Pm from monopoly is lower than the price from smaller firms and more quantity is produced. If these goods are provided by smaller competitive firms, the cost would be greater leading to the goods being more expensive. Figure 5 Monopolies can earn abnormal profits in the long run means that they can use the profit to invest in research and development. This is known as dynamically efficient.
They choose to invest for further development because it would make them become more efficient hence maintaining their market position and also to improve their differentiated goods making demand become more inelastic. In reality, Microsoft uses their profit and invests in the development area. They are a well established company and have customer loyalty due to the quality of their goods and the patent rights they impose. In contrast to perfect competition, firms would not be able to invest because they only earn normal profit.
However it is not guaranteed that monopolist would make abnormal profit; it is also possible that they only earn normal. In conclusion, through analyzing the efficiency in productive, allocative, technical and dynamical, monopoly is not necessarily less efficient than perfect competition. Although they can misallocate resources, resulting in deadweight loss, increase price or restrict output in order to gain profit there are other monopolies that are efficient like natural monopolies.
One of the main reasons that monopolies produce less than the efficient level is because they lack competition pressure. If the firm is regulated by the government maybe it would act in the best interest of the society. However others may argue that because of the government, the monopoly is being protected by them. While monopolies is not always less efficient than perfect competition, most of the time is it and that is the reason governments regulate monopolies and prevent firms merging together or get taken over by.
