Perfect competition and monopoly EV - Efficiency

Question 1

Is perfect competition preferable to monopoly?

Answer 1

Apply:

• efficiency concepts (productive efficiency, X-efficiency, allocative efficiency, and static and dynamic efficiency)
• how perfect competition and monopoly affect the consumer surplus and producer surplus that households and firms respectively enjoy.

Question 2

Fundamental purpose of economic system

Answer 2

Achieve highest possible state of human happiness or welfare.
Judge Perfect Competition & Monopoly on the extent to which they improve human well-being.
Must consider efficiency in order to judge the contribution of a market structure to human welfare.

Question 3

Economic efficiency

Answer 3

Economic efficiency minimises costs incurred, with minimum undesired side effects eg. social costs.

Question 4

Technical efficiency

Answer 4

Maximises output from the available inputs.

Question 5

Productive efficiency

Answer 5

Involves minimising the average costs of production.
Long run concept.
MC =AC
(for economy as a whole defined as producing on PPF)

Question 6

X-efficiency

Answer 6

All points on cost curve are X-efficient.

Question 7

X-inefficiency

Answer 7

Due to organisational slack resulting from absence of competitive pressures, monopolies are always likely to be technically and productively inefficient.
X-inefficiency = organisational slack.
Factors of production are combined in a technically inefficient way.
At the level of output it is producing, the firm incurs unnecessary production costs, i.e.. if the firm wished, it could reduce its costs.

Question 8

Causes of X-inefficiency

Answer 8

1: Technically inefficient eg. employing too many workers
2: Firm paying works unnecessarily high prices.

Question 9

Allocative efficiency

Answer 9

Occurs when it is impossible to improve overall economic welfare by reallocating resources between industries or markets (assuming an initial distribution of income and wealth).
For resource allocation in the whole economy to be allocatively efficient, price must equal marginal cost in each and every market in the economy.

Question 10

Allocative efficiency occurs when…

Answer 10

P = MC in all industries and markets in the economy.

Question 11

Price (P)

Answer 11

Measure of the value in consumption placed by buyers on the last unit consumed.
Indicates welfare obtained at the margin in consumption. This is the good’s opportunity cost in consumption.

Question 12

MC

Answer 12

Measures the good’s opportunity cost in production.

Question 13

P > MC (allocative inefficiency)

Answer 13

High price discourages consumption, so at this price the good is under-produced and under-consumed.

Question 14

P

Answer 14

Price is too low, encouraging too much consumption of the good, thus at this price the good is over-produced and over-consumed.

Question 15

Reallocation

Answer 15

Reallocation of resources from markets where P MC total consumer welfare will increase.
Prices adjust and P = MC in all markets, no further reallocation of resources between markets can improve consumer welfare (assuming that all other factors which influence welfare eg. distribution of income, remain unchanged). The outcome in which P = MC in all markets is allocatively efficient.

Question 16

How can total consumer welfare be increased?

Answer 16

… if resources are reallocated from markets where P

Question 17

Allocative inefficiency define

Answer 17

Occurs when it is possible to improve overall economic welfare by reallocating resources between industries or markets.
Resource allocation is allocatively inefficient when price is less than or greater than marginal cost in each and every market in the economy.

Question 18

Monopoly power…

Answer 18

The greater the gap between price and marginal cost of production and price – the greater the monopoly power.
Prices exceed marginal costs, economic inefficiency and resource misallocation occur.

Question 19

Static efficiency

Answer 19

Measures technical, productive, X and allocative efficiency at a particular point in time.

Question 20

Dynamic efficiency

Answer 20

Measures the extent to which various forms of static efficiency improve over time.

Question 21

Improvements in dynamic efficiency

Answer 21

Results from introduction of better methods of producing existing product, including firms’ ability to benefit to a greater extent from economies of scale and also from developing marketing completely new products.

Invention, innovation, and R&D improve dynamic efficiency.

Question 22

Perfect competition vs. monopoly

Answer 22

Perfect competition is productively and allocatively efficient whereas monopoly is neither.
This depends on the assumption that there are no economies of scale. When substantial economies of scale are possible in an industry, monopoly may be more productively efficient then competition.

Question 23

Justification of monopoly when economies of scale are possible

Answer 23

A monopoly may be producing above the lowest point on the SRATCn, therefore displaying some degree of productive inefficiency. However, at all points on SRATCn incur lower unit costs and are productively more efficient than any point on SRATC1, which is the relevant cost curve for each firm if the monopoly is broken down into a number of smaller competitive enterprises.

Question 24

Dynamic efficiency in monopoly

Answer 24

1: Monopolies may be more dynamically efficient than a perfectly competitive firm.
2: Protected by barriers to entry, a monopoly earns a monopoly profit without facing the threat of new firms entering the market and taking the profit.
3: This allows an innovating monopoly invest in R&D and product development.
4: Pertly competitive firms have no incentive to innovate as other firms can free ride and gain costless access to the results of any successful research. This justifies patent legislation.
COUNTER
5: Monopoly reduces rather than promotes innovation and dynamic efficiency. As protected from competitive pressure, a monopoly may profit-satisfice rather than profit-maxisie, content with satisfactory profits and an easy life.

Question 25

Patent legislation

Answer 25

Grants a firm the right to exploit the monopoly position created by innovation for a number of years before the patent expires.