Question

How is monopoly different from perfect competition?

Short answer

Monopoly and perfect competition differ in several key aspects. In perfect competition, there are a large number of small firms producing identical products with no market power, whereas a monopoly has only one firm with significant market power and the ability to set prices. Perfect competition has no barriers to entry, while a monopoly involves high barriers to entry. Efficiency is higher in perfect competition, as it leads to the optimal allocation of resources and lower prices, while monopolies may restrict output, charge higher prices, and allocate resources less efficiently, resulting in deadweight loss.

Step-by-step solution

Define Perfect Competition

Perfect competition is a market structure characterized by a large number of small firms producing identical (homogeneous) products or services. These firms have no market power, as each firm is a price taker and must accept the market price determined by supply and demand. In perfect competition, there are no barriers to entry or exit, allowing firms to freely enter or exit the market. Additionally, there is perfect information available to all participants in the market.

Define Monopoly

A monopoly, on the other hand, is a market structure in which there is only one firm that provides a unique product or service, with no close substitutes available. This single firm has significant market power, allowing it to set the price for its product. High barriers to entry prevent other firms from entering the market and competing with the monopolist. Information may not be perfect in this market structure.

Compare the number of firms

One of the most significant differences between perfect competition and monopoly is the number of firms operating in the market. In perfect competition, there are a large number of small firms, while in a monopoly, there is only one firm dominating the market.

Analyze market power

In perfect competition, firms have no market power as they are price takers. This means they cannot influence the market price and must accept the price determined by market forces. However, in a monopoly, the single firm has substantial market power and can set the price for its product, since there are no close substitutes available to consumers.

Discuss price setting

In a perfectly competitive market, the price is determined by the equilibrium between supply and demand. Firms in perfect competition have no control over the price; they can only adjust their production levels to maximize profit. On the other hand, a monopolist has price-setting power and can choose the price that maximizes its profit, which is typically higher than the competitive market price.

Consider barriers to entry

Perfect competition is characterized by the absence of barriers to entry, allowing new firms to enter or existing firms to exit the market freely. In a monopoly, significant barriers to entry prevent other firms from entering the market and competing with the monopolist. These barriers could include legal barriers such as patents, economies of scale, or exclusive access to essential resources.

Evaluate efficiency

Perfect competition is considered to be the most efficient market structure, as it leads to the production of goods and services at the lowest possible cost and the optimal allocation of resources. Monopolies, on the other hand, tend to be less efficient as they can restrict output, charge higher prices, and may not allocate resources efficiently. This results in a deadweight loss, which represents the lost welfare to society due to the monopolist's market power.