Sub: Economics Topic: Micro Economics

Question:

Assume all firms produce in a perfect competitive market. What will happen to
short run & long run equilibrium , if market demand decreases. Explain with an
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aid of a diagram, why monopoly is inefficient but perfect competition is

efficient.
Explain with aid of a diagram why monopoly is inefficient but perfect competition is efficient. Is
it valid to say that monopoly is no good and hence the government should break up all the
monopolists and convert them into perfect competition?

Solution:

The above diagram shows the comparison between the perfect competition and the monopoly.
In perfect competition the price is less and the output is more on the other hand the monopoly

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 Sub: Economics Topic: Micro Economics

is price is more than the perfect competition. Both the allocative efficiency (P=MC) and the
productive efficiency (min ATC) are achieved in perfect competition. As both allocative
efficiency and productive efficiency can be achieved in perfect competition there is no
deadweight loss. But in monopoly no efficiency can be obtained. The red shaded area shows
the deadweight loss due to monopoly in the above diagram. Thus monopoly is inefficient
compare to perfect competition.

No, government should not break all the monopolies. Many monopolies are considered as the
natural monopolies. A natural monopoly exists when there is great scope for economies of
scale to be exploited over a very large range of output. Indeed the scale of production that
achieves productive efficiency may be a high percentage of the total market demand for the
product in the industry. Natural monopolies tend to be associated with industries where there
is a high ratio of fixed to variable costs. For example public utilities like railways and water
provision can be considered as the natural monopoly. Too many firms will not come to the
industry due to high set up cost. In that case it will be very difficult to have the perfectly
competitive market for that particular product or service. Ultimately if governments plan to
break all the monopolies the consumers will affect adversely.

** End of the Solution **

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