Question

What are the main differences between a monopoly and a perfectly competitive market? Use an appropriate market mechanism diagram to show and explain these differences. Show the deadweight loss on the diagram and provide a brief definition.

Answer 1

Following points make clear difference between both the competitions:

1. Output and Price:

Under perfect competition price is equal to marginal cost at the equilibrium output. While under monopoly, the price is greater than average cost.

2. Equilibrium:

Under perfect competition equilibrium is possible only when MR = MC and MC cuts the MR curve from below. But under simple monopoly, equilibrium can be realized whether marginal cost is rising, constant or falling.

3. Entry:

Under perfect competition, there exist no restrictions on the entry or exit of firms into the industry. Under simple monopoly, there are strong barriers on the entry and exit of firms.

4. Discrimination:

Under simple monopoly, a monopolist can charge different prices from the different groups of buyers. But, in the perfectly competitive market, it is absent by definition.

5. Profits:

The difference between price and marginal cost under monopoly results in super-normal profits to the monopolist. Under perfect competition, a firm in the long run enjoys only normal profits.

6. Supply Curve of Firm:

Under perfect competition, supply curve can be known. It is so because all firms can sell desired quantity at the prevailing price. Moreover, there is no price discrimination. Under monopoly, supply curve cannot be known. MC curve is not the supply curve of the monopolist.

7. Slope of Demand Curve:

Under perfect competition, demand curve is perfectly elastic. It is due to the existence of large number of firms. Price of the product is determined by the industry and each firm has to accept that price. On the other hand, under monopoly, average revenue curve slopes downward. AR and MR curves are separate from each other. Price is determined by the monopolist.

8. Goals of Firms:

Under perfect competition and monopoly the firm aims at to maximize its profits. The firm which aims at to maximize its profits is known as rational firm.

9. Comparison of Price:

Monopoly price is higher than perfect competition price. In long period, under perfect competition, price is equal to average cost. In monopoly, price is higher as is shown in Fig. 11. The perfect competition price is OP₁, whereas monopoly price is OP. In equilibrium, monopoly sells ON output at OP price but a perfectly competitive firm sells higher output ON₁ at lower price OP₁.

10. Comparison of Output:

Perfect competition output is higher than monopoly price. Under perfect competition the firm is in equilibrium at point M1 (As shown in Fig. 11 (a)), AR = MR = AC = MC are equal. The equilibrium output is ON1. On the other hand monopoly firm is in equilibrium at point M where MC=MR. The equilibrium output is ON. The monopoly output is lower than perfectly competitive firm output.

Deadweight Loss

A deadweight loss is a cost to society created by market inefficiency. Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources. Price ceilings, such as price controls and rent controls; price floors, such as minimum wage and living wage laws; and taxation can all potentially create deadweight losses

Causes Of Deadweight Loss

There are three main causes of deadweight loss:

Price ceilings - These are government sanctioned price controls that prohibit a seller from charging above a set amount for a good or service. An example of a price ceiling is rent control. This occurs when the government sets a maximum amount of money that a landlord can charge for rent.

Price floors - These are government sanctioned price controls that prohibit a seller from charging below a set amount for a good or service. An example of a price floor is minimum wage. This occurs when the government sets a minimum amount of money that a person can sell their hourly labor for.

Taxes - This is the money that the government charges above the selling price of a good or service. An example of this would be the sales tax that some states charge on the sale of certain goods.

Price ceilings, price floors and taxes all cause deadweight loss by altering the supply and demand of a good through price manipulation. A rent-controlled building will have more people who want to live there than apartments available (demand is greater than the supply). A minimum wage will create unemployment because there will be some unemployed workers who are willing to work for a certain wage, and employers who need employees but