Perfect competition

113. Using appropriate diagrams, discuss whether monopoly is more efficient
or less efficient than perfect competition
Monopoly- there is only one firm producing the product so the firm is the
industry. There are high barriers to entry that stops new firms from entering the
industry and maintains the monopoly. As a consequence of barriers to entry the
firm can make abnormal profits in the long run.
Perfect competition- the industry is made up of a very large number of firms.
Each firm is so small, relative to the size of the industry that it is not capable of
altering its own output to have a noticeable effect upon the output of the industry
as a whole. Individual firms have o sell at the industry price and are called “price
takers.” All firms produce identical goods. There are no barriers to entry or exit
and there is perfect knowledge of the market.
Scarcity is the fundamental problem of any economy. It is therefore important to
consider the efficiency on economies. A monopoly is less efficient than perfect
competition. Consider Graph 1 where a firm in the PCM is in long run
Graph 1:
The firm in this industry takes the price P1 from the industry and because its
demand is perfectly elastic P=D= AR=MR. productive efficiency is one of the
efficiency measure used by economists. A firm is said to be productively efficient if it
produces at the lowest possible unit cost or average cost. In Graph 1 at the output
q1, the firm is able to produce at the most efficient level of output, so q1 is the
productively efficient level of output. MC always cuts the AC at its lowest point or
minimum so we say that productively efficient level is where marginal cost (the cost
of producing one more unit) is equal to average cost (the cost of each unit of output)
as depicted in Graph 1.
A firm is allocatively efficient when suppliers are producing the optimal mix of
goods and services required by consumers. In Graph 1, the firm is allocatively
efficient. In a PCM a firm can be allocatively efficient if marginal cost (the cost of
producing one more unit) is equal to average revenue (the price received for a unit).
Productive efficiency is import in economics. At the productively efficient level of
output a firm is combining its resources as efficiently as possible and resources are
not being wasted by inefficient use.
Allocative efficiency is important in economics. If a firm a producing at the
allocatively efficient level of output there is a situation of “Pareto optimality” where
it is impossible to make one person better off without making someone else worse
Unlike perfect competition, the monopolist produces at the level of output where
there is neither productively efficiency nor allocative efficiency. This is why they a
monopoly is less efficient than perfect competition. This is show in Graph 2.
Graph 2:
The monopolist is producing at the output level of q1. Output is being restricted in
order to force up the price and to maximize profit. However, the productively
efficient level of output at q2 and the allocatively efficient level of output at q3 are
not being achieved. Because the monopolist produces at q1 and price P1, higher
prices and lower output prevail under monopoly. A perfectly competitive market, on
the other hand, will produce at price P1 and quantity q1 as shown in Graph 1 where
the industry supply meets the industry demand.