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O level, Igcse and Gcse revision notes

LESSON 22- Perfect Competition and Monopolies

Main Lecture:-

1. Intro to Perfect Competition

Perfect competition suggests that the perfect or best use of resources is being made by
firms in markets where they face many competing firms. The firms providing the best-
quality goods and services at the lowest prices will be the most successful.

Competition between firms encourages them to make a good use of scarce resources,
because in order to make profits these firms must produce products that give the best
value for money for consumers. The greatest competition between firms in a market is a
situation of perfect competition.

2. The characteristics of a perfectly competitive market

(i) Homogenous Products - All firms produce the same product

(ii) Price takers - There are a very large number of buyers and sellers of the product, none
of whom can buy or sell enough to be able to influence the price of the product. Because
the buyers and sellers cannot affect the market price of the product, and have to accept
that price, they are known as price takers.

(iii) Perfect information - It is assumed that all buyers will have perfect knowledge of the
products at sale and similarly the sellers will have all the information on the latest
production techniques.

(iv) Freedom of entry and exit - Firms can freely enter or leave the industry if they wish.
That is, there are no barriers to entry or exit.

Because of these unrealistic characteristics there are no perfectly competitive industries

in the world. No industry has all of the four features listed above, although certain
industries have some of them. For example, in the manufacture of clothes there are a
large number of small firms producing products which have the same basic designs. In
agriculture, for example, wheat production, there are lots of small farms acting as price
takers, where no single farmer can produce enough to be able to charge price s/he would
like.

3. Intro to monopolies

A monopoly can be referred to as the complete opposite of perfect competition. A firm is

pure monopoly if it is the only supplier of a particular good or service. For example,

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O level, Igcse and Gcse revision notes

Railtrack is the sole supplier of rail network in Great Britain. However, there are very
few pure monopolies but many firms have significant market power.

Where a handful of large companies are able to control the supply of a commodity to a
market they are known as oligopolies. These type of firms can be found to exist in many
markets, for example, oil companies, the banks, soap and detergents.

4. Features of a Monopoly

(i) No competition - Since well, it is the only supplier in the market!

(ii) Abnormal Profits - Because there is no competition, the monopolist is able to

permanently earn high profits.

(iii) Price makers - A monopolist is not a price taker. Because it is the only supplier, it
can vary its supply to change the market price.

(iv) Barriers to entry - Monopolists can keep their large profits by preventing new firms
from entering their market and taking some of their abnormal profits. Monopolists do this
by creating barriers to entry.

(v) Non-homogenous products - Monopolists will usually produce different varieties of

their products in order to make it difficult for other firms to copy them.

5. How monopolies can prevent competition?

There are to main types of barriers to entry that monopolies make use of: natural barriers
and artificial barriers

(a) Natural barriers to entry:-

(i) Control of Supply - A firm may own most or all of the supply of a raw material. Thus
they are the sole owners and controllers of supply.

(ii) Economies of Scale - In some industries there are very large economies of scale or
cost savings to be gained from increasing production. If one large firm can produce and
sell all of a particular product required in the market at a lower average cost per product
than a number of smaller firms put together then this large firm would be a natural
monopoly.

(iii) Expense - Some industries, for example, the Nuclear Power Industry, need many
millions of pounds worth equipment. This helps keep the nuclear power industry a
monopoly, because most firms could not afford to start up in the nuclear power industry.

(iv) Legal considerations - Some firms can stay as monopolies because laws have been
passed to make it illegal for other firms to start up in the same industry.

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(b) Artificial barriers to entry:-

Companies can create artificial barriers to entry by following methods:

(i) Restricting the availability of supplies

(ii) Predatory pricing - such pricing occurs when a large firms cuts its prices, even if this
means losing money in the short run, in order to force new and smaller competing firms
out of the business. Once the smaller firm has been removed, the larger firm can raise its
prices again.

(iii) Exclusive dealing - Businesses that sell the products made by a monopolist rely
heavily upon the monopolist for supplies. If the monopolist produces a well-known and
popular good or service it gives them the power to threaten firms selling its products. (So
that those firms sell ONLY their products.)

6. Adv/ Dis Adv of monopolies

Advantages:-

(i) Economies of scale resulting in low cost bulk production

(ii) Research and Development readily takes place as monopolies continue to find new
ways of stamping their authority
(iii) Lower prices result because of mass production
(iv) Monopolies can compete at a global level, which is healthy for a country and to its
Balance of Payments.

Disadvantages:-

(i) Poor levels of service - Monopolies face little competition so there is a tendency for
them to slack of a bit because of which the quality of their service suffers.

(ii) Low output and high prices - They control the supply, so by restricting output they
can voluntarily increase prices to boost profits.

(iii) Producer sovereignty - When the producer has control over the use of scarce
resources there is said to be producer sovereignty. This arises because monopolies
prevent consumers from obtaining a wide range of goods and services by using barriers to
entry and prevent competition.

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QUESTION/ANSWER SESSION:-

Q. Why does perfect competition make the best use of scarce resources?

Ans. Firstly because of low prices. Competition b/w forms to make profits means that
prices to consumers are as low as possible to attract their customers. Secondly because of
efficiency, since only the best firm making the best value-for-money products will
survive. Firms using scarce resources to make poor-quality products will be forced out of
business. Thirdly because of consumer sovereignty. Under perfect competition there is
consumer sovereignty, that is, the consumer gets what s/he wants.

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