Monopoly and Perfect Competition: A Comparison

When comparing any two market structures, one has to analyse the following aspects: A.   Goals of the firm

B.   Assumptions

C.   Behavioral rules of the firm

D.   Comparison of long run equilibrium

E.   Comparison of predictions

Comparison of perfect competition and monopoly in the light of above method is summarised below.

A.   Goals of the firm

In both market  structures,  the firm has a single goal, that of profit maximisation.  The firm is rational when its behavior aims at the maximisation of profit.

B.   Assumptions

The product is homogeneous  in perfect competition.  In monopoly, the product may or may  not  be  homogeneous.  The  main  feature  of monopoly  is that  the  total  supply  of the product is concentrated in a single firm. In perfect competition, there are a large number of sellers, so that each one cannot affect the market price by changing the supply. In monopoly, there is a single seller in the market.  In perfect competition,  entry and exit is free in the sense that there are no barriers to entry. In monopoly, entry is blockaded by definition. In both markets, cost conditions are such as to give rise to U shaped cost curves, both in the short run and in the long run. Perfect knowledge is assumed in both the markets.

C.   Behavioral rules of the firm

The demand curve in perfect competition is perfectly elastic, showing that the firm is a price taker. In monopoly,  the demand of the firm is also the demand of the industry and hence  is  negatively  sloping.  The  only  decision  and  policy  variable  of  the  firm  in perfect competition is the determination of its output. There is no room for selling activities, since the firm can sell any amount it can produce. The monopolist can determine either his output or his price, but not both, since once one of these policy variables is decided, the other is simultaneously  determined.  The  monopolist  may  change  the  style  of his product  and/or indulge  in  research  and  development  activities.  In  both  the  market,  the  firm  takes  its decisions which will maximize its profit, applying the marginalistic rule MC=MR.

D.   Comparison of long run equilibrium

Given the cost conditions, in monopoly, the level of output will be generally be lower and price higher as compared  with perfect competition.  This is due to the fact that in perfect competition,  the firm  produces  at the minimum  cost (minimum  point  of LAC curve)  and earns just normal profit, while the monopolist  usually earns abnormal  profits even in the long run. Under such conditions, price will be higher in monopoly as compared with perfect competition. In monopoly abnormal profits are usually earned both in the short run and in the long run.

E.   Comparison of Predictions

In perfect competition,  an increase in market demand will lead to an increase in price and in output in the short run. In the long run, the output will be larger, but price may return to the initial level, remains above the original level or fall below the original level. A shift in demand above the original level in monopoly will result in an increase in output, which may be sold at the same or a higher or lower price, depending on the extent of the shift in the demand and the change in elasticity. The imposition of lump sum tax in perfect competition will not lead to a change in output and price in long run, but output will decline and price will rise in the long run. In monopoly a lump sum tax will not affect the market equilibrium in  the  short  run  or  in  the  long  run,  so  long  as  the  monopolist  continues  to  earn  some abnormal profit. The effects of a profit tax are the same in both the markets as in the case of the imposition of the lump sum tax.