Perfect competition and monopoly represent two extreme forms of market structures. Monopoly is one marked form under imperfect competition, where one or more features of pure competition are absent. Two other market forms of imperfect competition namely, monopolistic competition and oligopoly are discussed in the next two chapters. The smaller becomes the number of firms in the market, the more imperfect the market is.
The firm under perfect competition as well as monopoly strive for profit maximisation and employ marginalist rule of MC-MR equality. In both of these market forms, the number of buyers is quite large.
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However, the two market structures differ on the following grounds:
1. Number of Sellers:
Under perfect competition, there are a large number of sellers, each selling a small quantity of total supply. In other words, the competitive industry consists of a large number of firms. On the other hand, monopoly consists of a single seller.
The total supply of the product is within the control of the single monopoly firm. Thus, unlike the case of monopoly, the distinction between the firm and the industry is no longer there under monopoly. Here, the firm is the industry.
2. Nature of Product:
The product offered by all the firms in the industry under perfect competition is homogenous. In other words, the product produced by one firm is a perfect substitute for the product produced by another firm. On the other hand, the product offered under monopoly may or may not be homogenous. The monopolist sells a product, which has no close substitute.
3. Entry and Exit Conditions:
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Though entry and exit of firms is only a long-run phenomenon, entry as well as exit of the firms is assumed to be free under perfect competition. In the case of monopoly, entry is assumed to be blocked. The barriers to entry are so strong that no new firm can enter and compete with the monopoly firm. However, the monopolist suffering losses in the long-run may move out of the business.
4. Decision Variables:
The only decision and policy variable of the firm under perfect competition is the determination of its output. Every firm is a price taker and it can sell as much as it wishes at the prevailing price, determined by the demand and supply forces of the industry.
The variations in output will not affect the price. With the given conditions of a large number of buyers as well as sellers, homogenous product and free entry exit, the demand curve faced by a competitive firm is perfectly elastic. This curve is parallel to the X-axis at a distance equal to the prevailing market price.
Given additional assumptions of perfect knowledge about the market conditions among the various economic units and perfect mobility of the factors of production, there is no room for selling activities, advertisement, etc. under perfect competition.
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A monopoly firm has to determine either his output or price. Once, one of these policy variables is decided, the other is automatically determined from the demand curve. Unlike in the case of a perfectly competitive firm, a monopolist is not at the mercy of the market.
The monopolist does not have to take the market price as given and react to it. Instead, he has to set the price or rather select the price-output combination on his demand curve. Hence, the monopolist faces a trade-off between price and output. It, thus, follows that the monopolist is not a price taker; rather he is a price maker, who can, if so wishes, raise the price.
Unlike perfect competition, such a price rise will not cause him to lose all his customers. However, the higher his price, the lesser he can expect to sell. Under monopoly, the demand curve of the firm or the industry is common and slopes downward throughout its length.
The price elasticity of this demand (e) curve must be greater than one in equilibrium. If lei <1, the monopolist can raise his revenue by increasing his price. The corresponding marginal revenue curve also falls, but more swiftly and lies below the demand curve.
Further, unlike a perfectly competitive firm, a monopolist may undertake research and development, promotional activities or product modification to enhance sales and profits or for checking the potential entry of new firms. He may even follow price discrimination quite unlike under perfect competition.
5. Equilibrium:
Under perfect competition, marginal revenue (MR) is equal to average revenue (AR = P). In equilibrium, the output is chosen to equate MR or price (AR) to rising marginal cost (MC) curve. A firm under perfect competition may suffer losses or even earn excess profits in the short-run.
However, any such losses or profits are wiped out altogether in the long-run on account of the assumption of free entry and free exit of the firms. As a result, a firm under perfect competition manages to earn only normal profits (zero excess profits) in the long-run, which is included in the cost (including the opportunity cost of owner’s capital and labour).
Though, for a perfectly competitive firm, equilibrium is possible only when the MC curve is rising at the point of equilibrium, but monopoly equilibrium can be very well established, whether MC curve is rising, falling or remaining constant at the equilibrium output.
The second order condition of equilibrium (i.e., MC curve cutting MR curve from below) is satisfied under monopoly in all these three cases, since, unlike perfect competition, MR curve slopes downward here. Further, under monopoly, price is greater than marginal cost in equilibrium, as price (AR) is greater than MR here.
Although a monopoly firm may suffer losses or earn profits in the short-run, it will not remain in business, if, it suffers losses even in the long-run. In monopoly, profits are usually earned both in the short-run as well as in the long-run. Profits persist even in the long-run on account of strong barriers to entry.
6. Capacity Utilisation:
Perfectly competitive firm is in long-run equilibrium at the minimum point of the long-run average cost (LAC) curve. There are neither un-exhausted economies of scale nor diseconomies of large scale production. In other words, the economies of scale have been fully exhausted and diseconomies of large scale production have still not come into being.
Thus, a firm under perfect competition builds an industrial plant of optimal size and ensures economic efficiency in production. The perfect competition forces each firm to either be efficient or perish. With optimum average costs of production, there is no excess capacity under perfect competition.
Further, in the case of the competitive firm, marginal revenue or price in the long-run equilibrium is equal to both long-run marginal cost (LMC) and minimum of long-run average cost (LAC).
In the case of monopoly, the firm may not necessarily produce at the minimum point of the long- run average cost. It may operate with an underutilised sub-optimal plant or with an over utilised larger than optimal plant or at full capacity using an optimum plant.
Depending upon the prevailing market conditions, the monopolist firm may attain its long-run equilibrium on the falling portion of the LAC curve, where some economies of scale still remain un-exhausted. Alternatively, it may even expand beyond the minimum point of the LAC curve, wherein, diseconomies of scale start operating.
In the former case, there would be an excess capacity under monopoly. In the latter case, the monopolist would actually be over utilising his industrial plant. In both of these cases, the allocation of resources remain distorted from the efficiency standard of economic welfare and the monopolist continues to charge a price higher than its long-run average cost as well as long-run marginal cost.
In the words of Barnaul and Blinds, “because it is protected from entry, a monopoly firm earns profits in excess of the opportunity cost of capital. At the same time, monopoly breeds inefficiency in resource allocation by providing too little output and charging too high a price. Thus, some of the virtues of laissez faire evaporate, if an industry becomes monopolised”.
7. Supply Curve:
As perfectly competitive firm produces where MR = Price = Rising MC (as long as price exceeds average variable cost), the firm’s short-run supply curve is given by the rising portion of its MC curve over and above its average variable cost (AVC) or shut-down point. In the long-run, the firm’s supply curve is its LMC curve above its LAC curve. At any lower price, the firm eventually leaves the industry. Thus, a competitive firm has a unique and defined supply curve.
A monopolist, however, has no unique supply curve. It maximises its profits by producing an output at which its marginal revenue (MR) is equal to marginal cost (MC). Since, price exceeds MR the monopolist’s MC curve does not give a unique price-quantity relationship as required along a supply curve.
The same quantity may be demanded at different prices or the same price may be charged for different quantities, depending on the demand in the market and the given cost structure of the monopolist firm. Thus, there is no unique supply curve under monopoly.
8. Price Output Comparison:
Price charged under perfect competition is invariably lower than the one under monopoly, assuming same demand and cost conditions in the two market structures. According to Joan Robinson “perfect competition would bring all the economies which monopoly could introduce”. That is why; competitive price is always lower and competitive output always higher than that under monopoly, inspire of economies of large scale in the latter.
9. Resource Allocation and Welfare:
Under perfect competition, allocation of resources is optimum and therefore social welfare is maximum, since a perfectly competitive firm equates the price with its marginal cost. On the contrary, monopoly leads to a deviation from the socially desirable resource allocation. Unlike a competitive firm, a monopolist restricts output to raise the price, so that he could gain at the expense of the consumers.
The welfare of the consumers goes down, since the payment of a higher market price in effect causes a reduction in their real purchasing power, resulting in a redistribution of income in the economy in favour of the monopolist.
The loss in the welfare of the consumers on account of restricted output produced by the monopolist is in addition to the loss they suffer from paying a higher price for the available output in the market. The net loss in consumer welfare arising out of a restricted output under monopoly is generally referred to as the dead weight loss of monopoly. The loss cannot even by captured by the monopolist, but results in loss of consumer’s surplus.
The dead weight loss is illustrated in Fig. 14.15, where AR shows the average revenue or demand curve faced by a perfectly competitive industry. For the sake of analytical convenience, it is assumed to be a constant cost industry having same average cost (AC) of production irrespective of the level of production.
The marginal cost (MC) for this constant cost industry coincides with its average cost curve, since constant average cost at each level of output implies that each additional unit of the product can be produced at the same cost. Constancy and equality of AC and MC at every output level is shown by the horizontal line LRS = AC = MC in Fig. 14.15, which also represents long-run supply curve of the competitive industry.
The long-run equilibrium of the concerned competitive industry is attained at point EC in Fig. 14.15, where its demand or average revenue (AR) curve intersects the long run supply curve LRS. Consequently, OPC and OQC are determined as the equilibrium price and equilibrium quantity under perfect competition.
The level of the consumer surplus under perfect competition is given by the difference between the amounts of money that the consumers are willing to pay (represented by the area OCEC QC) and the amount they actually pay (represented by the area OPC EC QC). This difference or consumer surplus under perfect competition is shown by the area of the triangle PCCEC.
With same demand and cost conditions, the monopolist would have attained long-run equilibrium at point EM, where the marginal cost (MC) curve cuts the marginal revenue (MR) curve of the monopolist from below. As a result, equilibrium price of OPM and equilibrium quantity of OQM are determined. The amount of consumer surplus under monopoly has fallen down to the area of the triangle PMCB in Fig. 14.15.
It is clear from the Fig. 14.15 that competitive price OPc is lower than the monopoly price OPM, while the competitive output OQZ is greater than the monopoly output OQM. Further, the net loss in consumer surplus under monopoly in comparison to perfect competition is represented by the area PCPMBEC in Fig. 14.15.
Out of this net loss in consumer surplus under monopoly, an amount shown by the area PCPMBEM has been taken away by the monopolist as monopoly gain in the form of excess profits by charging a higher price of OPM. The remaining amount of loss, as shown by the shaded triangular area EMBEC in Fig. 14.15 represents the net loss in consumer welfare on account of a lesser output OQM being produced under monopoly vis-a-vis perfect competition, which is a true measure of the dead-weight loss of consumer welfare under monopoly. The dead weight loss due to monopoly, like the dead weight loss due to a tax, measures the value of the lost output by valuing each unit of lost output at the price that the people are willing to pay for that unit.
Between OQM and OQC levels of output, consumers are prepared to pay higher price and thus derive higher marginal utility as indicated by the position of demand curve in this region than the corresponding marginal cost of production.
For optimum allocation of resources, OQC amount rather than OQM amount of the product should have been produced. Therefore, monopoly causes misallocation of resources resulting in loss of consumer welfare.