EKN 310
Chapter 4 – Allocative E7iciency, Imperfect
Competition and Regulation
Introduction
This chapter will be focusing on imperfect competition and monopolies.
Imperfect competition:
• Is also called non-competitive markets
• It occurs when markets are dominated by monopolies or oligopolies
• We will be examining the economic e?ects of monopolies, using electricity
supply as a case study.
Monopolies:
• We must distinguish between 2 types of monopolies…
1. Statutory/ Artificial Monopoly
• Perfect competition in this market is technically possible but it is
restricted by legal or institutional barriers
• Barriers may include government regulations or incumbent firm
actions
• For example, controlling suppliers or temporarily lowering prices.
2. Natural Monopoly
• This is when technical factors prevent there from being competition.
• Due to the cost structure of the industry, it is only e?icient for there
to be ONE producer rather than multiple competition firms.
• In these industries, average costs decrease as output increases
(economies of scale) and
• These industries also have large capital outlays (they require huge
initial investments to set up infrastructure)
,Social Costs of Statutory Monopolies
The figure below shows the distinction between perfect competition and
imperfect competition (monopoly) :
- Here we assume the demand function (D) and marginal cost (MC)
are the same for the 2 market forms.
Perfect Competition:
- MC represents the sum of marginal cost curves of individual firms
making up the market.
- Equilibrium occurs at point E where demand = supply.
- 0QC is produced at a price of 0PC.
Monopoly:
- MC represents the marginal cost of the monopoly only.
- Equilibrium occurs at point F where MR = MC
- The market produces a smaller quantity 0Qm , at a higher price 0Pm.
- The loss in consumer surplus under monopoly is given by the
rectangle PmGEPC.
- Of that PmGHPC is the straight transfer from consumers to
producers while the remaining triangle GEH is the deadweight loss.
- The value represented by HEQCQm represents the social cost of
monopoly because the resources contributing to this value (labour/
capital equipment) may remain unemployed for long periods of time
until they find alternative employment.
, E"iciency Implications of a Monopoly:
• Remember from chapter 2 that for there to be pareto-e?iciency the
condition is:
• MRPT (how much Y must be sacrificed to produce on more X) must equal
marginal cost ratio and price ratio
• In perfect competition P=MC so this condition is satisfied
• And therefore the production mix is e?icient
Introducing monopoly…
• Assume that industry Y = monopoly and industry X = perfectly competitive
• This means Py > MCy
(because monopolies charge a higher price than marginal cost)
• And that PX = MCX
(because perf competitive firms charge price equal to their marginal cost).
• This means that for a monopoly
• So, when there is a monopoly, the e?iciency condition for pareto optimum
is broken
• And the economy produces the wrong combination of goods
Let’s see the economic consequence of this graphically…
Chapter 4 – Allocative E7iciency, Imperfect
Competition and Regulation
Introduction
This chapter will be focusing on imperfect competition and monopolies.
Imperfect competition:
• Is also called non-competitive markets
• It occurs when markets are dominated by monopolies or oligopolies
• We will be examining the economic e?ects of monopolies, using electricity
supply as a case study.
Monopolies:
• We must distinguish between 2 types of monopolies…
1. Statutory/ Artificial Monopoly
• Perfect competition in this market is technically possible but it is
restricted by legal or institutional barriers
• Barriers may include government regulations or incumbent firm
actions
• For example, controlling suppliers or temporarily lowering prices.
2. Natural Monopoly
• This is when technical factors prevent there from being competition.
• Due to the cost structure of the industry, it is only e?icient for there
to be ONE producer rather than multiple competition firms.
• In these industries, average costs decrease as output increases
(economies of scale) and
• These industries also have large capital outlays (they require huge
initial investments to set up infrastructure)
,Social Costs of Statutory Monopolies
The figure below shows the distinction between perfect competition and
imperfect competition (monopoly) :
- Here we assume the demand function (D) and marginal cost (MC)
are the same for the 2 market forms.
Perfect Competition:
- MC represents the sum of marginal cost curves of individual firms
making up the market.
- Equilibrium occurs at point E where demand = supply.
- 0QC is produced at a price of 0PC.
Monopoly:
- MC represents the marginal cost of the monopoly only.
- Equilibrium occurs at point F where MR = MC
- The market produces a smaller quantity 0Qm , at a higher price 0Pm.
- The loss in consumer surplus under monopoly is given by the
rectangle PmGEPC.
- Of that PmGHPC is the straight transfer from consumers to
producers while the remaining triangle GEH is the deadweight loss.
- The value represented by HEQCQm represents the social cost of
monopoly because the resources contributing to this value (labour/
capital equipment) may remain unemployed for long periods of time
until they find alternative employment.
, E"iciency Implications of a Monopoly:
• Remember from chapter 2 that for there to be pareto-e?iciency the
condition is:
• MRPT (how much Y must be sacrificed to produce on more X) must equal
marginal cost ratio and price ratio
• In perfect competition P=MC so this condition is satisfied
• And therefore the production mix is e?icient
Introducing monopoly…
• Assume that industry Y = monopoly and industry X = perfectly competitive
• This means Py > MCy
(because monopolies charge a higher price than marginal cost)
• And that PX = MCX
(because perf competitive firms charge price equal to their marginal cost).
• This means that for a monopoly
• So, when there is a monopoly, the e?iciency condition for pareto optimum
is broken
• And the economy produces the wrong combination of goods
Let’s see the economic consequence of this graphically…
