Amount of profit for any firm or organization make is determined by the structure of the market where they operate. Market structure also determines whether the firm profit will be large, or just enough for it to survive, or so low that it will be forced out of business, or the price charged to it’s customer will be high or low and further more will the consumer benefit from the decision the firm make (Slomon, 2013). In this essay Perfect competition and Monopoly market structures are analysed to understand the nature of a business.
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Perfect Competition: “A market Structure where there are many firms; where there is freedom of entry into the industry; where all firms produce an identical product; and where all firms are price takers” (Slomon, 2013).
Monopoly: “A market structure where there is only one firm in the industry, and hence no competition from within the industry” (Slomon, 2013)
The major factors deciding the market structure are the number of seller in the market, product differentiation and entry & exit barriers. Perfect competition and Monopoly market structures are considered as extreme market structures as compared to the other ones like, oligopoly and monopolistic competition (Kwasnicki, 2000).
In a perfect competition, the number of sellers is many as compared to a monopoly, which consists of a single seller. One of the major differentiating factors between the two structures is the entry and exit barriers. In a Perfect competition, it is easy to enter the business and exit since there are no barriers to either entry or exit. This implies that, only if businesses or firms can notice the chances of incurring a substantial profit in a particular business, they would make an entry into it. But for a monopoly there are very high entry and exit barriers which prevent other firms to enter. The barriers can be like patents, technical know-how etc. created by existing firms (Sloman, 2013).
In a perfect competition, the similar products are sold by a lot of firms. Hence these products are perfect substitutes. The consumers are aware of the differences in the product if any and the pricing in the various firms. A good example can be Coke or Pepsi. But, in Monopoly the products sold are not perfect substitutes and rather are unique.
In a perfect competition the firms have no control over the price. The price is determined by the market. If a firm increases the price of a product it will lose out to its competitors who are selling at a comparatively lower price. Hence, the perfect competition firms are called as price takers. On the other hand, monopoly firms are called as price makers because they decide on what prices are their products to be sold. This is because they are the single sellers in the market (Mankiw, 2011).
In a perfect competition, there are chances to earn abnormal profits in the short run. This would not be possible in the long run because with the occurrences of abnormal profits new firms will be entering the market and hence would reduce or shrink the profits, resulting in the profits going down. But for monopoly structure, abnormal profits are possible even in the long run because of they are only one of their kind and the entry to their market is very difficult (Makowski & Ostroy, 2001).
Source: (Mankiw, 2011)
In a perfect competition, the industry is the price maker and the firm has to take that price and behave as price taker. This industry consists of all the firms selling homogenous products and the price is where the market demand is equal to market supply. Every firm has to charge the price decided by the industry (Sloman, 2013).
Perfect Competition in the Short RunPC-short-run.png
Source: (Mankiw, 2011)
In the short run, the firm can make super normal profits because there will be lesser firms competing in the market.
Perfect Competition in the Long Run
Source: (Morton & Goodman, 2003)
In the long run, when the firms are having abnormal profits, other firms would also get lured to make an entry into the market and in the lack of entry and exit barriers, itââ‚¬â„¢s easier for firms to enter the markets. This would reduce the selling price and shrink the profits. The supply curve of the industry would get pushed or shifted to the right hand side and this will go down to the point where all the abnormal profits will be exhausted (Arnold, 2008).
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If any firm is making losses, it will leave the market since there are no exit barriers and would shift the curve to the left which shall increase the price and result in normal profits for the firms that are working.
Source: (Mankiw, 2011)
Monopolies will have supernormal profits both in the long as well as short run, since there is no competition or substitutes.
A monopolist is price maker and the demand curve is downward sloping in such a scenario. The profit will be maximum when MC = MR. If the AR is above ATC at the profit maximising output, there shall be supernormal profits. The demand curve of a monopoly is inelastic, the price will be higher and this will increase the super normal profits (Morton & Goodman, 2003).
[Where, AC = Average Cost; AR = Average Revenue; ATC = Average Total Cost; MC = Marginal Cost and MR = Marginal Revenue]
It is worth studying the above two extreme cases as they provide frame work within which to understand the real world. Some industries tend more competitive to the extreme, thus their performance more towards perfect competition and their products have more substitutes, like cabbage and carrots. On the other hand in monopoly, there is one dominant firm and a few much smaller firms. So, the firm has considerable control over price, like prescription drugs and local water supply company.