A firm in perfect competition acts as a price taker so its demand curve is horizontal with AR=MR however market demand is downward sloping. A monopolistic firm, on the other hand, faces a downward sloping demand curve and there is no difference between demand curve for industry and for a firm.
Perfect Competition vs. Monopoly.
Equilibrium occurs when Supply is equal to Demand and in perfect competition, OPc is the equilibrium price with OQc the equilibrium output. If the industry is monopolised and costs are unchanged, the monopolist would produce where MC=MR, giving an equilibrium price of OPm and output of OQm. So under monopoly, price is higher and output is lower than under perfect competition assuming costs are unchanged. Under monopoly, productive efficiency is lower than under perfect competition, productive efficiency occurs at the lowest point on the AC curve, which is where firms produce in the long-run under perfect competition. Also, under monopoly, allocative efficiency is lower than under perfect competition because price is driven above marginal cost. Consumer surplus falls from area PcEp to PmB. Area PcPmBC represents a direct transfer of welfare from consumers to the producer, whilst area BCEp is lost to both groups- dead weight loss. This implies that society’s resources are not used in a way that would achieve maximum allocative efficiency.
Monopoly and Economies of Scale
Economies of scale provide potential gains in economic welfare for both producers and consumers. As monopoly producers are often supplying goods and services on a very large scale, they may be better placed to take advantage of economies of scale - leading to a fall in the average total costs of production. As illustrated in the diagram, the MC shifts to MC1 and price is lower at P1 and output higher at Q1 than if the market were perfectly competitive. This means that consumer surplus increases to P1D, and there is the large producer surplus- P1DFP0. Moreover, it can be argued that due to the enormous benefits from economies of scale, many markets can only sustain a few large firms and in extreme cases there may only be room for one large firm i.e. a natural monopoly e.g. regional water company, where the firm captures all the economies of scale available within the industry.
It is often argued that monopolies tend to become less efficient and innovative over time [less choice] and are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, , , and other companies were able to compete effectively in the long distance phone market and began to take phone traffic from the less efficient AT&T., becoming "complacent giants", because they do not have to be efficient or innovative to compete in the marketplace.—loss of personal service. Sometimes this very loss of efficiency can raise a potential competitor's value enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives.
How are the supernormal profits of monopoly used?
Undoubtedly some of the monopoly profits will be distributed to shareholders as dividends. This raises questions of equity as some low income consumers might be exploited by the monopolist because of higher prices. And, some of their purchasing power might be transferred via dividends to shareholders in the higher income brackets - thus making the overall distribution of income more unequal. But, some of the supernormal profits might be used to invest in research and development programmes that have the potential to bring dynamic efficiency gains to consumers in the markets. There is a continuing debate about whether competitive or monopolistic markets provide the best environment for high levels of research spending.
Domestic monopoly but international competition
Though a firm may have substantial domestic monopoly power, nevertheless it may face intensive competition from overseas producers. This limits their market power and helps keep prices down for consumers. A good example is the domestic steel industry-Corus produces most of the steel manufactured inside the UK but faces intensive competition from overseas steel producers.
Restrictive practices
A firm with monopoly power might conduct restrictive practices, which reduce competition by forming collusion, dictating prices at which retailers are to sell its goods [often used by motor vehicle manufacturers to their dealers], restricting access to raw materials [De Beers Corporation, controlling supplies of rough diamonds to cutters and polishes] and creating barriers to entry by limit pricing. However, because of the potential economic welfare loss arising from the exploitation of monopoly power, the Government regulates some monopolies. Hence, regulation can control annual price increases and introduce fresh competition into particular industries.
Contestability
The theory of argues that in some circumstances (private) monopolies are forced to behave as if there were competition because of the risk of losing their monopoly to new entrants. This is likely to happen where a market's are low. It might also be because of the availability in the longer term of substitutes in other markets. For example, a monopoly, while worth a great deal in the late eighteenth century , was worth much less in the late nineteenth century because of the introduction of as a substitute. Contestable market theory predicts that monopolists may still be competitive even if they enjoy a dominant position in their market. Their price and output decisions will be affected by the threat of "hit and run entry" from other firms if they allow their costs to rise and inefficiencies to develop.
Conclusion
In a perfectly competitive market, the market structure ensures economic efficiency is promoted. However, due to the absence of competition in a monopolistic market, it is unlikely that monopolies will achieve allocative and productive efficiency and the welfare effects can be negative on consumers. However, there are exceptions and regulation of monopolies ensures they promote economic efficiency.
