Monopoly is less efficient than perfect competition.' To what extent to you agree/disagree with this statement?

Price

        MC

        AC

        MR=AR=D

          P*

        Q*                Output

The diagram shows that the perfectly competitive firm is producing at output level Q* and price level P*. At This level the firm is allocatively efficient as it is producing at the minimum point on its AC curve. The firm is also being technically efficient as it maximising output, by producing where AR=AC, but is doing this by producing with minimum input cost, as it is producing at the output level where the MC curve is equal to the AC curve. So we can say that, perfectly competitive firms within a perfectly competitive industry are both technically and allocatively efficient.

The complete opposite to the perfectly competitive industry is the monopoly industry. In a monopoly there is only one firm. The firm in essence is the industry. The firm is the only seller in the industry and hence is the price maker. Barriers to entry exist. The Supernormal profits are available in the long run. There are no substitutes of goods. There are few different reasons why a monopoly exists. If one firm has the control of all inputs necessary to make a product then it has the potential, with the right management, to monopolise the industry for that good, as no one else is able to make the goods. If the government gives a licence to one supplier to make a certain good then the government has created a monopoly, as it only gives one firm the right to produce the good. A monopoly can occur naturally. Certain industries like the water industry, due to size and scale of them, have declining average total cost curves, so if the industry would not be producing efficiently if there were more firms in it as operating costs would be too high. The average revenue curve of a monopoly is downward sloping. It means that if the monopoly firm wants to increase sales, it must bid down the price of all the other previous units. The marginal revenue curve of the monopolist is also downward sloping, but is twice as steep as the average revenue curve. There are still some similarities between the monopoly and the perfectly competitive industry. Perfect knowledge exists and the monopoly produces at the profit maximising level of output, where MR=MC. The above information can be shown on the diagram below.

        Price

 

        MC

             P*M                                                                    AC

        SP

              C*M        

        Q*          MR        AR        Output

The diagram above shows the monopoly diagram. It shows that the monopoly produces at the profit maximising level of output Q*. The diagram also shows that the firm charges at the price level P*M. The supernormal profit of the firm is the difference between the price level P*M and the cost C*M, multiplied by the output quantity Q* and is the area SP. The diagram also shows that the monopoly is being inefficient. The monopoly is not producing at the lowest point on its AC curve, so it is being allocatively inefficient. The monopoly is technically inefficient as well. Its not producing at a level where MC=AC=AR, thus not getting maximum output from minimum input. So with the diagrams, we can say that perfect competition is more efficient than a monopoly. Perfect competition is technically and allocatively efficient. A monopoly isn't. Another reason why perfect competition is more efficient than a monopoly is due to externalities. In perfect competition society's costs where AC=MC is equated with society's benefits where AR=MR. In perfect competition the each firm produces the socially efficient level of output. Business practice will tell us that competition is healthy and promotes efficiency. If you have no one else in the industry, you can't benefit from the external economies of scale of other firms in the industry. The monopoly can't benefit from seeing other firms mistakes, which it can avoid, and the monopoly can't benefit from seeing other firms' good ideas, which it can copy. Without any benchmarks inefficiency's will almost always set in.

However it can be argued that in certain ways monopolies can be more efficient than perfect competition. Monopolies can benefit from economies of size that perfect competition can't. By being bigger monopolies can reduce average costs, by spreading costs over a larger output. Certain industries like the water industry is a natural monopoly because the costs of start up and running would be so large that having any other form of market structure would have such high costs per firm that water would be provided at a really high price and would be allocatively inefficient. The ability for monopoly's to retain supernormal profits means that they are able to undertake research and development. The importance of research and development shouldn't be underestimated as a major breakthrough can lead to more efficient techniques in producing capital and consumer goods. On balance it seems that perfect competition is more efficient than a monopoly.

This essay has looked at the structure of both a perfectly competitive firm and a monopoly. We have looked how each of these firms chooses to produce at their output level and price of the good they have produced. We have found out that the perfectly competitive firms are technically and allocatively efficient whereas the monopoly is not. Also discovered was that the perfectly competitive firm produces at the socially efficient level of output but the monopoly does not. However we have found out that the monopoly industry can be efficient by benefiting from economies of size and possible research and developments. So in conclusion the most efficient industry out of perfect competition and monopoly will be the one who's benefits are greatest.

References

Economics – J.Sloman

Managerial Economics – H. Davies

Managerial Economics – H.Craig, Peterson / W.Cris Lewis 4th Edition.

Managerial Economics and Business Strategy – Michael.R.Baye 4th Edition

Economics – Michael Parkin 6th Edition