My name is Andrew Steve Trens. I'm a student of Berkeley University in California. I wrote this research paper for my class. What do you think?MONOPOLY VS. PERFECT COMPETITION:
Is a Monopoly Necessarily Less Efficient?
Any student that enters into his or her first economics class is always taught that monopolies are bad for the market and perfect competition is the ideal situation that will drive economic progress. And it is a good point to be made -- if there is only one company dominating the market, what incentive is there for progress in their product? For instance, if one examines the American software company Microsoft during the 1990s, one will find a company that had a stranglehold on the software market with their powerful Windows operating systems. Microsoft continually came out with new operating systems during this time period, but none of the subsequent programs were vastly superior to the other. A general sense of apathy started to surround the computer industry because there were no other companies that could challenge Microsoft in their dominance -- Bill Gates had truly built a monopoly. However, Apple was waiting in the wayside during this time period, waiting and waiting to get their operating system correct because they knew that they only had one real shot at taking down Microsoft. What can be seen today is an overall dominance of Microsoft by Apple in the personal computing world.
So this brings to mind the following conundrum: is a monopoly necessarily less efficient than perfect competition? If Microsoft and Apple had been competing side-by-side for all of those years, would the computing world be the same today? The fact of the matter comes down to that first year economics professor being completely correct in his assertion. Perfect competition will always be more efficient for monopoly. In order to completely understand this idea, it is important to first define both monopoly and perfect competition and then through these definitions I will show how a perfect competition is always more efficient in the long run.
As W. Nicholson defines it, a "monopoly is a single supplier to a market [and it] may choose to produce at any point on the market demand curve" (Nicholson, 495). In other words, a monopoly is the only firm in the marketplace creating an output for a certain product. To go back to the previous analogy, Microsoft was the only producer in the computer software industry for a period of time and they produced at less than efficient points on the market demand curve. Since software is such a cutting edge technology, whenever there is a discovery in the marketplace that something needs to be done to make the product better, the market expects this correction to take place immediately. But since Microsoft was not in direct competition with anyone else, they had the ability to take their time and maximize the profits on each new product. In this sense, the firm has the ability to control the amount of output that enters into the market so that they make sure their profits are at the highest for each instance. While this proves to create super-normal profits, it by no means is efficient for the market.
Efficiency in the market place boils down to having a system where the firms in the market are constantly producing output to always meet with the demands of the consumer. No buyer or seller or in the marketplace holds a power over said market. It would be the opposite of the going analogy -- Microsoft and companies X, Y, and Z all produced at the same level and none had any power of the marketplace. Altogether they were creating the most efficient output, but one company was not vastly superior than the other. This idea derives from Adam Smith when he defined a perfectly competitive market as "one in which there is no impediment to free contracting and free entry and exit of productive resources" (Smith, 126). Thus, firms are not excluded from entering the market at any point. Companies can enter and leave the market as they wish because no single firm holds power over the market -- as one leaves, another will either enter or a different firm will pick up the slack.
A modern world example of a perfectly competitive marketplace would be the extremely popular auction website eBay. Anyone that wants to sell in the marketplace can and anyone who wants to purchase goods can as well. There is no such thing as real, competitive advertising on eBay because it would not do any good. If a person goes onto the website in order to try and find a new television, they will find hundreds of options for the same television -- thus, a competitive edge does not exist. Advertising would not help these "firms" because everyone else in the market is selling the same item for nearly the same price. Entry and exit to this marketplace is completely open, so one can sell and buy as they wish.
Now, it is important to realize that the biggest mistake that could come from this argument is confusing efficiency in the marketplace with maximizing profits for the firm. It is obvious that if a firm has a stranglehold on the market such as Microsoft that it is possible to achieve super normal profit levels. Obviously if they are only ones in the market producing any output, then consumers will be forced to only buy their product -- so this firm is pulling in 100% of profits from the marketplace. It is important to realize that this, in the short run, is also more efficient for production in the market place, but not allocation. It is the most efficient for production, because they will consistently be producing at the level that maximizes their profit, but never higher. For Microsoft, this meant continually meeting the demand they felt was present in the marketplace, but never producing at higher levels. It is less efficient in the short run for allocation because if we revert back to the eBay idea, there were always hundreds of choices for different items, so the market held several different buying options and the supply side of the curve is high in this case. Maximizing profits and creating an equilibrium in the marketplace through market efficiency are two different things. And if this paper was concerned with which of these two economic models could provide the highest profits, monopoly would win.
Price discrimination in a monopoly is also one of the huge disadvantages for the marketplace. If a firm has a hold on the market, then they can charge whatever they feel the market can withstand. This does not necessarily reflect the true value of the product being sold. In a perfectly competitive market, the price of the item will be driven by exactly what the marketplace deems it is worth. Since there are so many different firms selling in the competitive market, they do not have the ability to set their own prices for the output, they have follow the supply and demand of the item in order to determine what the consumers will pay for their item in the marketplace. While price discrimination once again provides the monopolistic firm the ability to maximize their profits, the detriment comes to the consumer because they are more than likely being charged more than what the product is truly worth.
It is important to realize also the in the short run, a perfectly competitive market is less efficient than a monopoly when it comes to producing output. As Nicholson writes, "because fixed costs do not exist in the usual long run analysis and equilibrium profits under perfect competition with free entry are also zero, short-run producer surplus is, by definition, zero" (Nicholson, 351). In other words, in the short run, there is an equilibrium between the barrier costs to enter the market (0) and the producer surplus in the market (0). Since the firm in the perfectly competitive market is attempting to maximize their profits as well, they are trying to produce where marginal cost is equal to their marginal revenue:
However, taking a look at this diagram can help show that firms can make a profit in the short run because the price (P) is above cost (C). So even though there are inefficiencies when it comes to the production, it is still advantageous for the firm in a perfectly competitive market because they have the ability to make a profit -- albeit not as high of a profit that could be made by a monopoly.
With this last point in mind, it is important to realize the crux of the argument at hand. Efficiency in the marketplace should be defined over the long run due to equilibrium in the long run helps to create a more stable marketplace. In a perfectly competitive market, efficiency exists in both production and allocation over the long run. Since each firm is trying to maximize their profits, each firm will produce where the marginal cost is equal to their marginal revenue -- hence, each firm will be producing nearly the same amount of homogenous products. Since they are in equilibrium when it comes to their production there will always be a higher efficiency in allocation since the firms will be producing to meet the ever changing needs of the market. Moving back to Microsoft, they continually produced at the level that produced the best profits for themselves, not necessarily what the market wanted. The produced at lower points on the demand curve because it allowed them to keep the prices higher in the market. Since the prices were higher in the market due to a sense of scarcity, Microsoft was able to make even more money because of their ability to engage in price discrimination.
In a perfectly competitive market, there is no ability to engage in price discrimination. The moment a firm tries to raise their price to certain segment of the market, the consumers will turn their backs on them and move to one of the many other producers of the same product. It is important to realize that perfect competition is important for progress and invention. If one firm had a hold of the market with one product, their would be no incentive for that firm to create a better product. However, in a perfectly competitive market, if a firm were to come up with a better product than their competitors, the competing firms would be forced to either create a new product that is up to par, or drop out of the market. For instance, if one were to look on eBay for a television auction, someone selling a tube television would be near the bottom of the pile since the newer technology has produced high-definition flat screened televisions. This is the same in the market, if a firm is selling an outdated product that has been surpassed by the other firms in the market, then they will not have the same success. This competition is what drives the incentive to always create better products so that a firm can compete more efficiently in the marketplace.
So, if a firm is looking for a chance to create super-normal profits, then creating a monopoly is more than likely the easiest way to go about achieving those ends. However, when it comes to pure market efficiency, a pure competition has a monopoly beat because it allows for several different parties to enter and leave the marketplace as they see fit.
Image 2 - chart, profits
As seen by this chart which represents the profits in the long run by a firm in a perfectly competitive market, the firm cannot achieve the super normal profits that a monopoly could otherwise enjoy. Through the expansion of existing firms and addition of new ones, the firm will only make normal economic profit.
To conclude, equilibrium and efficiency is always the aim of firms in the marketplace because it allows them to maximize their profits. While it does not necessarily provide for higher than normal profits, it does allow the firms in the competitive market to stay in the game. Having the ability to decide price is the "distinction which differentiates perfectly competitive markets from imperfectly competitive ones." (Kreps 1990, p. 265). In perfectly competitive, efficient market, price is driven by the consumer -- hence, each item produced by the firm will have the price determined by the market which will in turn tell the firm how much of the product needs to produced in order to create equilibrium with the market. Just as every student in their first year of economics learns that monopolies are tough on the marketplace, they also learn that striving towards equilibrium is the driving goal of firms in the market -- something which can only be achieved through the efficiency of a perfectly competitive market. WORKS CITED -
1.) Kreps, D.M.. A Course in Microeconomic Theory. New York: Harvester Wheatsheaf, 1990.
2.) Nicholson, W. Microeconomic Theory: Basic Principles and Extensions. 9th. United States: South-Western College Publishers, 2006.
3.) Smith, Adam. The Wealth of Nations. Bantam Classics. New York: Bantam Publishing, 2003.