Competition Leads to a More Efficient Use of Resources Essay Example

total consumer and producer’s surplus are maximized.Alternatively, productive efficiency is about how to produce a good or service. To achieve productive efficiency, a firm must use all available methods to produce a certain level of output at the lowest possible costs. To start with, a profit-maximizing firm under perfect competition has, first of all, too small the proportion of total industry supply to make any influence on the market price of the identical product.

It is therefore a price-taker. As nobody has the power to control the industry, there is complete freedom or no barrier for new firms to enter the industry competing with the existing firms.In this case, the individual firm faces a horizontal demand curve and its AR and MR coincide with the demand curve (shown in figure 1). The firm now is gaining supernormal profit (the shaded area ABPSRPLR) in a short run; as a result, there will be more firms rushing into the industry due to the existence of the supernormal profit. In the long run, the pressure of increasing supply in the industry will push the price at PSR down to the price at PLR where it just equals the lowest level of LRAC, where firms can only get a normal profit for continuing running the business.

From the graph, it is easy to see that in the perfectly competitive market, the market price in the long run must be equal to both the firms’ marginal cost and the lowest level of the their long-run average cost. According to the definitions, it is both allocatively and productively efficient. Hence, economic efficiency is achieved. That is, the economy operates at some point

on the production possibility frontier—a situation that no one can make itself better off without making others worse off.In other words, “an economy composed entirely by price takers—a competitive economy—automatically allocates resources efficiently, without any need for centralized direction, and it is the power of Adam Smith’s ‘invisible hand’.

”(Katz, p410) This is the function of competition, just as Richard pointed out: “Competition works because people are always trying to get away from it. If its effect is everywhere and always erode away profits, the only way left to avoid subsistence rations is to find some special advantage through innovation so that one can at least for a time earn more than a normal profit. ” (Low, p54)However, monopoly is another kind of extreme market structure where there is only one firm in the industry. The firm therefore has the power to decide the market price in relation to its amount of output and the firm’s average revenue is the market downward-sloping demand curve. This is shown in figure 2. The profit-maximizing monopolist will produce an output of Qm and charge the price at Pm, where MC=MR (point A).

Yet, only price equals marginal cost which is at Q3 and P3 (point E), can allocative efficiency be achieved and only MC equals AC which is at Q2 and P2, can productive efficiency be achieved.So a monopolist would produce less and charge higher than firms under perfect competition. A monopolistic economy, in this way, would be much more inefficient than a perfectly competitive economy. Just like Adam Smith noted: “The monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their

commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate. (Resource: Smith The Wealth of Nations.

Book 1 Chapter 7 p60) Furthermore, if the economic activity will bring maximized total utility which is the sum of consumer and producer’s surplus, it is also said to be efficient. Welfare will be maximized at the equilibrium point where price is equal to marginal cost. According to Katz, “…total surplus is lower whenever industry output is either less than or greater than competitive equilibrium level. ”(Katz, p380) Again, perfect competition leads to a more efficient use of allocating society’s resources.As it has shown in figure 3, the total welfare in the perfectly competitive market is the area of ABPPC and ACPPC, whereas the total utility under monopoly is the same area less the area of ADE. By setting a higher price and less amount of output, the monopolist may have gained more benefits from the loss of consumers, but the deadweight welfare loss representing total societal loss has also occurred which is a social waste made by the monopolist.

Therefore, competition as the example given in perfect competition would lead to a more efficient use of society’s resources.Although perfect competition would bring us the maximized economic efficiency, monopoly in certain industries such as water supply industry may seen to be more beneficial due to the nature of the industries. The reason for this is that in some industries which require scale economies, there is an absolute advantage of a monopolist over small firms in perfect competition—economies of scale—that the monopolist is able to produce its goods and

services at a lower cost level because of larger scale of production, more efficient use of large machines, more specialized division of labour or even more efficient management.If we take scale economies into account, perfect competition leading to efficiency is not that preferable: shown in figure 4, the curve MC1 is no longer relevant to the monopoly price and output, which is now determined by MC2.

Therefore the monopoly price P2 is lower and output Q2 higher than those under perfect competition. “It is possible that the benefits which result from economies of scale may exceed the productive and allocative efficiency losses which occur in monopoly. (Powell, p43) Moreover, a monopolist has the ability to invest in research and development because of the supernormal profit it gains and the excess capacity resulting from the limited output, whereas firms in the perfectly competitive market are only able to struggle to survive. Being a profit-maximizing firm, the monopolist is certainly willing to invest to enlarge its abnormal profit as long as the benefits derived from innovation are greater than the costs of R&D. … in the modern industry shared by a few large firms, size and the rewards accruing to market power combine to insure that resources for research and technical development will be available… In this way market power protects the incentive to technical development. ” (Shepherd, p203) By whatever process innovation or product innovation, the monopolist has not only enhanced its own surplus but also increased consumer’s surplus by setting a lower price and a higher output, as we can see the enlarged darker areas showing the increase in both producer’s and consumer’s surplus in

figure 5.

Therefore, in these circumstances, although competition would lead to efficiency, monopoly may be viewed as being preferable to perfect competition because of the efficiency gained in forms of scale economies and the incentives of research and development. To sum up, firms under perfect competition produce at the price of the lowest cost and optimal output which would lead to both allocative and productive efficiency and maximize social utility. However, as the competitive firms are too small to make any impact on the market, they are not able to produce goods and services at a even lower level, whereas monopoly who has the full ontrol over the market is big enough that it will lead to scale economies which can push the cost to a lower level—even lower than that in perfect competition in certain industries, even though it is not efficient at its own production level because it still can get supernormal profit by setting a higher price and a lower output compared with its own optimal output. Bibliography Griffiths, A.

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, Homewood, Illinois. Powell, R. : (1988) Economics. A-Level Course Companion (3rd ed). Charles Letts & Co Ltd, London, Edinburgh and New York. Shepherd, W.

G. : (1970) Market Power and Economic Welfare. Dewey, D. J. , Random House, Inc. , New York.

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