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RISK NEUTRAL: A person who values a certain income the same as an equal amount of income that involves risk or uncertainty. Let's say that you're given two options--(A) a guaranteed $1,000 or (b) a 50-50 chance of getting either $500 or $1,500. If you don't really care which option you chose, because both options have the same "expected" values, then you're risk neutral.

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MONOPOLY AND PERFECT COMPETITION:

Monopoly and perfect competition represent two extremes along a continuum of market structures. At the one extreme is perfect competition, representing the ultimate of efficiency achieved by an industry that has extensive competition and no market control. Monopoly, at the other extreme, represents the ultimate of inefficiency brought about by the total lack of competition and extensive market control.
Monopoly is a market structure with complete market control. As the only seller in the market, a monopoly controls the supply-side of the market. Perfect competition, in contrast, is a market structure in which each firm has absolutely no market control. No firm in perfect competition can influence the market price in any way.

The best way to compare monopoly and perfect competition is the four characteristics of perfect competition: (1) large number of relatively small firms, (2) identical product, (3) freedom of entry and exit, and (4) perfect knowledge.

  • Number of Firms: Perfect competition is an industry comprised of a large number of small firms, each of which is a price taker with no market control. Monopoly is an industry comprised of a single firm, which is a price maker with total market control. Phil the zucchini grower is one of gadzillions of zucchini growers. Feet-First Pharmaceutical is the only firm that sells Amblathan-Plus, a drug that cures the deadly (but hypothetical) foot ailment known as amblathanitis.

  • Available Substitutes: Every firm in a perfectly competitive industry produces exactly the same product as every other firm. An infinite number of perfect substitutes are available. A monopoly firm produces a unique product that has no close substitutes and is unlike any other product. Gadzillions of firms grow zucchinis, each of which is a perfect substitute for the zucchinis grown by Phil the zucchini grower. There are no substitutes for Amblathan-Plus. Feet-First Pharmaceutical is the only supplier.

  • Resource Mobility: Perfectly competitive firms have complete freedom to enter the industry or exit the industry. There are no barriers. A monopoly firm often achieves monopoly status because the entry of potential competitors is prevented. Anyone can grow zucchinis. All they need is a plot of land and a few seeds. Feet-First Pharmaceutical holds the patents on Amblathan-Plus. No other firm can enter the market.

  • Information: Each firm in a perfectly competitive industry possesses the same information about prices and production techniques as every other firm. A monopoly firm, in contrast, often has information unknown to others. Everyone knows how to grow zucchinis (or can easily find out how). Feet-First Pharmaceutical has a secret formula used in the production of Amblathan-Plus. This information is not available to anyone else.
The consequence of these differences include:
  • First, the demand curve for a perfectly competitive firm is perfectly elastic and the demand curve for a monopoly firm is THE market demand, which is negatively-sloped according to the law of demand. A perfectly competitive firm is thus a price taker and a monopoly is a price maker. Phil must sell his zucchinis at the going market price. It he does not like the price, then he does not sell zucchinis. Feet-First Pharmaceutical can adjust the price of Amblathan-Plus, either higher or lower, and so doing it can control the quantity sold.

  • Second, the monopoly firm charges a higher price and produces less output than would be achieved with a perfectly competitive market. In particular, the monopoly price is not equal to marginal cost, which means a monopoly does not efficiently allocate resources. Although Feet-First Pharmaceutical charges several dollars per ounce of Amblathan-Plus, the cost of producing each ounce is substantially less. Phil, in contrast, just about breaks even on each zucchini sold.

  • Third, while an economic profit is NOT guaranteed for any firm, a monopoly is more likely to receive economic profit than a perfectly competitive firm. In fact, a perfectly competitive firm IS guaranteed to earn nothing but a normal profit in the long run. The same cannot be said for monopoly. The price of zucchinis is so close to the cost of production, Phil never earns much profit. If the price is relatively high, other zucchini producers quickly flood the market, eliminating any profit. In contrast, Feet-First Pharmaceutical has been able to maintain a price above production cost for several years, with a handsome profit perpetually paid to the company shareholders year after year.

  • Fourth, the positively-sloped marginal cost curve for each perfectly competitive firm is its supply curve. This ensures that the supply curve for a perfectly competitive market is also positively sloped. The marginal cost curve for a monopoly is NOT, repeat NOT, the firm's supply curve. There is NO positively-sloped supply curve for a market controlled by a monopoly. A monopoly might produce a larger quantity if the price is higher, in accordance with the law of supply, or it might not. If the price of zucchinis rises, then Phil can afford to grow more. If the price falls, then he is forced to grow less. Marginal cost dictates what Phil can produce and supply. Feet-First Pharmaceutical, in comparison, often sells a larger quantity of Amblathan-Plus as the price falls, because they face decreasing average cost with larger scale production.

<= MONOPOLYMONOPOLY, CHARACTERISTICS =>


Recommended Citation:

MONOPOLY AND PERFECT COMPETITION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: November 26, 2014].


Check Out These Related Terms...

     | monopoly, demand | monopoly, efficiency | monopoly, realism | monopoly, problems |


Or For A Little Background...

     | monopoly | perfect competition | monopoly | perfect competition, characteristics | economic profit | short-run production analysis | profit maximization | market structures | market control | marginal cost | total cost | average cost | supply | efficiency |


And For Further Study...

     | monopoly, short-run production analysis | total revenue | average revenue | marginal revenue | price discrimination | perfect competition | oligopoly | monopolistic competition | monopoly, marginal revenue and demand elasticity | barriers to entry |


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