In a free market economy, firms and households act in self-interest to determine how resources get allocated, what goods get produced and who buys the goods. This is opposite to how a planned economy works, where the central government gets to keep the profits.
There is no government intervention in a pure market economy. However, in real there is no exactly free market economy. For example, while America is a capitalist nation,nevertheless government still attempts to control fair trade, government programs, honest business, monopolies, etc.
In this type of economy, there is a division of the government and the market. This division doesn`t allow the government have too more power and keeps their interests according with that of the markets. Hong Kong has been seen as an example of a free market society.
Consumers pay the highest price they want to, and businesses only produce profitable goods and services. There is a lot of stimulus for entrepreneurship.
This leads to the most effective use of the factors of production since businesses are very competitive.
Moreover, Businesses invest heavily in research and development. There is an incentive for constant innovation as companies compete to provide better products for consumers.
Nevertheless, market structure have own disadvantages. Like firms will only supply products to consumers who are able to pay for them.
In addition, market based only in self interest, economics needs have priority in social and human needs: like providing healthcare for people. Also there no government regulation.
The main market structures are perfect competition, monopolistic competition, oligopoly and monopoly, each with a different outcome to the market which leads economists to consider some market structures to be more desirable for the society such as perfect competition while others are less desirable such as Monopoly. So, monopoly is a single firm or small groups of firms acting together that has sufficient market power to restrict competition and determine market price.A pure monopoly controls half of the supply of production no a market. Pure monopoly is a single large supplier. The monopoly firm can determine market plan.
In reality it is hard to find a market in which will not be a form of substitutes of firm or product. Therefore, the Competition Commission in the UK defines a market as a monopoly if there is a firm possessing over a 25% market share.
So, to what extent monopoly is undesirable form of market structure?
In order to evaluate monopoly and to determine whether it should be allowed or not, it is vital to understand the characteristics of monopoly and to apply various efficiency concepts such as productive efficiency, allocative efficiency and X-efficiency to both extremes of the market structure, perfect competition and monopoly, to understand their effect on both consumer and producer surplus in the form of households and firms which consequently affect the general economic welfare.
A monopolist is a ‘price taker’ and is often considered to be an undesirable form of market structure due to the fact:
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– Restricts competition due to structural and statute barriers to entry
– Leads to a lower output and increased costs.
Allocative and productive inefficiency
Monopolies are both allocatively and productively inefficient, in comparison to a situation under perfect competition, since the firm is not operating at its lowest point on the ATC curve nor where MC=P.
– Allocative efficiency occurs where MC=P
– Productive efficiency occurs where MC=ATC
This hence means that the firm is not making optimal use of its resources, this therefore means that monopolies are undesirable since they are not statically efficient.
Too much monopoly power may be considered to be undesirable since it can ‘kill the goose which lay the golden egg’ and prevent new innovative ideas surviving due to firms operating with high research and development costs alongside dominant advertising.
Allocative efficiency
Activation efficiency means that managers throughout the economy use the most effective resources to match customer preferences. the allocative efficiency represents the benefit decided from the consuming of a good or a service with relationships to a definite level of price. Therefore, both producers and consumers benefit., Price must equal marginal cost in every market.
For the whole economy to be allocatively efficient, price must equal marginal cost in every market. However, it is unlikely that a monopoly seeking profit maximisation would be allocatively efficient. A monopoly tends to restrict output below the market equilibrium to force up the prices.
This represents the allocated efficiency, which suggests that the availability of cars is based on the limited resources of car retailers, who know what will sell the most. So, they provide what consumers need to sell more cars and realize a higher profit.
Productive efficiency
Productive efficiency is associated with the production of goods and services with the optimal combination of inputs to maximize productivity output for minimum costs.
This can be achieved only if the firm uses available methods and factors of production at the lowest possible cost per unit of output. As Lipsey (1992) argues that, in the context of the industry, the interpretation of production efficiency is that firms operate in such a way that costs are minimized.
Under monopoly conditions, unlike perfect competition, there are no competitive forces that could make a firm hold costs down to a minimum.
X-efficiency
In addition, a monopoly may have less incentive to reduce costs due to lack of competition. Consequently, it will also be X-inefficient, that the monopoly cost curves will be higher than they would be if there were more competitive pressures. Similarly, a monopoly, creating super-profitable profits, in fact may not have incentives for innovation and the provision of quality services due to the inelasticity of demand for the consumer. So, a monopoly cannot be considered desirable, since economist Harvey Leibenstein suggested that a nationalized monopoly could take more care of the political consequences of a reduction in the number of people, rather than get rid of its surpluses in order to minimize costs.
This means that the LRAC monopoly is above what would be technically possible, so the resources are wasted.
