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Competition leads to a more efficient use of resources. Discuss.

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Competition leads to a more efficient use of resources. Discuss. The word "efficiency", in economists' dictionary, is often interpreted into the degree of an economy allocates scarce resources to meet the needs and wants of consumers. As we can see that a free market economy is the one in which resources are allocated based on the principle of self-interests. Where there are profits, there are firms, and where there are firms to produce identical goods and services, inevitably, there is competition. The degree of competition determines the market structure which is the main determinant of the behaviour or conduct of firms. This in turn determines the efficiency in the use of scarce resources. It is often argued that competition leads to a more efficient use of resources. I agree with the statement, but not totally. In my opinion, competition would lead to efficiency and best use of resource by encouraging firms to improve productivity, to reduce price and to innovate, but in certain industries, particularly industries where the impact of economies of scale is distinctive, for example industries with great indivisibilities, monopoly is more favourable. Economic efficiency can be seen to maximizing total utility from a given amount of scarce resources. ...read more.


(Low, p54) However, monopoly is another kind of extreme market structure where there is only one firm in the industry. The firm therefore has the power to decide the market price in relation to its amount of output and the firm's average revenue is the market downward-sloping demand curve. This is shown in figure 2. The profit-maximizing monopolist will produce an output of Qm and charge the price at Pm, where MC=MR (point A). Yet, only price equals marginal cost which is at Q3 and P3 (point E), can allocative efficiency be achieved and only MC equals AC which is at Q2 and P2, can productive efficiency be achieved. So a monopolist would produce less and charge higher than firms under perfect competition. A monopolistic economy, in this way, would be much more inefficient than a perfectly competitive economy. Just like Adam Smith noted: "The monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate. (Resource: Smith The Wealth of Nations. ...read more.


(Shepherd, p203) By whatever process innovation or product innovation, the monopolist has not only enhanced its own surplus but also increased consumer's surplus by setting a lower price and a higher output, as we can see the enlarged darker areas showing the increase in both producer's and consumer's surplus in figure 5. Therefore, in these circumstances, although competition would lead to efficiency, monopoly may be viewed as being preferable to perfect competition because of the efficiency gained in forms of scale economies and the incentives of research and development. To sum up, firms under perfect competition produce at the price of the lowest cost and optimal output which would lead to both allocative and productive efficiency and maximize social utility. However, as the competitive firms are too small to make any impact on the market, they are not able to produce goods and services at a even lower level, whereas monopoly who has the full control over the market is big enough that it will lead to scale economies which can push the cost to a lower level-even lower than that in perfect competition in certain industries, even though it is not efficient at its own production level because it still can get supernormal profit by setting a higher price and a lower output compared with its own optimal output. ...read more.

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