Perfect competition and monopoly EV - Economic Welfare

Question 1

Economic welfare

Answer 1

Human happiness or utility.

Question 2

Consumer surplus

Answer 2

A measure of economic welfare enjoyed by consumers. Consumer welfare increases whenever consumer surplus increases.
Difference between maximum price consumer prepared to pay and actual price he or she need to pay.

Question 3

Producer surplus

Answer 3

A measure of economic welfare enjoyed by firms or producers.

Difference between minimum price a firm is prepared to charge for a good and actual price charged.

Question 4

Higher prices…

Answer 4

Reduce consumer surplus and welfare.

Question 5

How formation of a monopoly effects economic welfare

Answer 5

• assume no economies of scale
• monopoly restricts output to Q2, and raises price to P2… hence case against monopoly.
• Monopoly raises price from P1 to P2, therefore gains this rectangular area. This means that producer surplus (in the form of monopoly profit) increases at the expense of consumer surplus. There is a net loss of economic welfare caused by the fact that the amount bought and sold falls from Q1 to Q2.
• Welfare loss/deadweight loss is shown - depicts consumer surplus and producer surplus loss.

Question 6

Consumer sovereignty

Answer 6

Perfect competition = advantage of promoting consumer sovereignty. When consumer sovereignty exits… consumer is king.
HOWEVER
- the extent to which consumer choice would exist in a perfectly competitive world is extremely limited. All firms in a particular market would sell identical goods at an identical price (the ruling market price).

Firms that produce goods other than those for which consumers are prepared to pay, do not survive in perfect competition.

Question 7

Producer sovereignty

Answer 7

Goods and services available for consumers to buy are determined by the monopolist rather than by consumer preferences expressed in the market place.
Monopolist may still possess sufficient market power to manipulate consumer wants through marketing eg. persuasive advertising. Here, ‘producer is king’.

Question 8

What do economists regard more desirable…

Answer 8

Perfect competition (opposed to monopoly)

Question 9

Motivation economic theory assumes…

Answer 9

Everyone is motivated by self-interest and by self interest alone.

Question 10

Why firms like to become monopolies..

Answer 10

Entrepreneurs in competitive industries would very much like to become monopolists… to gain an easier life and to make bigger profits.
From a firms point of view, successful competition means eliminating competition and becoming a monopoly. But in perfect markets, market forces and the absence of barriers to entry and exit prevent this happening.

Question 11

Competition in perfect competition 1

Answer 11

• Price wars would not take place.
• All firms are passive price-takers, able to sell the output they produce at the ruling market price.
• Cannot gain sales or shares by price cutting.

Question 12

Forms of competition in perfect competition

Answer 12

• Use of advertising
• Packaging
• Brand imaging
• Provision of after sales service

Question 13

Cost cutting competition

Answer 13

• Likely in perfect competition because each firm has an incentive to reduce costs in order to make supernormal profit.
• In existence of cost cutting competition in a perfect can be questioned. Why should firms finance research into cost cutting technical progress when they know that other firms have instant access to all market information and that any supernormal profits resulting from successful cost-cutting can only be temporary?