Ryan Gardner

ECON-2010
Professor: Pook Carson
Date: 10-27-16
Monopolistic Competition, Pure Monopoly, and Oligopoly
This years presidential election has brought to the forefront concerns about monopolies
and oligopolies, which is why it is especially important to understand the concepts behind their
creation and their effect on the economy. One of the misconceptions about monopolies was
addressed in chapter 12; monopolies are able to charge any price that they please, and can
produce unlimited profits just by increasing the price of their product. The actual reality is that an
unregulated monopoly is able to produce in the elastic range of the demand curve, allowing them
to take an economic profit. Oligopolies and competitive monopolies have some of the same
shortcomings as a pure monopoly in relation to the productive and allocative efficiencies
achieved by the business model. I will first discuss an ideal market system which will most
efficiently allocate resources, and using this as a baseline, identify the shortcomings of
monopolies and oligopolies. I will then discuss the reasons these market systems exist, and
outline possible solutions to limit the advantages of monopolies and oligopolies.
The ideal market system is one that most effectively allocates our limited resources. Pure
competition achieves this task with a very large number of producers making the same product.
These producers are price takers, meaning they cannot manipulate the market price by changing
their output. This business model forces each producer to maximize efficiency in their firms; this
happens due to competition. Productive efficiency occurs when price is equal to minimum
average total cost. Pure competition also allocates societies optimum amount of resources to
production of the particular good. Allocative efficiency occurs when price equals marginal cost.
Now that we have discussed what makes an ideal market, we are able to identify the
reasons that oligopolies and monopolies do not achieve productive and allocative efficiency. The
main reason they do not achieve the optimum allocation of resources for society, is they have a
small number of producing firms. Entry of new firms is barred by the necessity of an economy of
scale, meaning that a small firm would not be able to achieve the low production costs of the
large firm, and would be immediately priced out of the market. Monopolies are price makers,
meaning that when they are unregulated they will produce where marginal revenue of the last
unit produced equals marginal cost of that good. This will maximize their profits, allowing them
to take an economic profit. This economic profit causes a reallocation of money from the buyer
to the owner of the monopoly. This is negative for society, because producing in this range will
cause an under allocation of resources to the good being produced. Oligopolies are able to
achieve similar results through collusion with the few competitors in their industry. The negative
effects on the economy caused by monopolies and oligopolies have caused policy makers to take
action.

Antitrust laws have been used to bring production of monopolies and oligopolies closer
to the socially optimum level. In respect to oligopolies, collusion is restricted. Non-collusive
oligopolies keep each others prices in check. In respect to pure monopoly, pricing is regulated.
Antitrust laws bring both business models closer to optimum, but even with regulation they will
not achieve productive or allocative efficiency. Inefficiency is built into the business model, and
regulation has consequences to productive efficiency. For instance, the monopoly utility
company may have a board who determines what the fair market price of their electricity is. This
fair market price limits their profit, but it does nothing to limit costs of production. The utility
can simply request a price that allows them to continue to produce with operational
inefficiencies.
In summary, pure competition allows for the optimum allocation of societies resources,
and all other market models have built in inefficiencies. Antitrust laws can limit these
inefficiencies, but can have unanticipated side effects, such as increased operational expenses of
utility providers. The different market models have varying degrees of inefficiency, and some
inefficiencies also provide benefits. One benefit to consumers provided by monopolistic
competition is differentiated products. This gives consumers a selection of goods to choose from.
Ultimately, consumers will provide the signals to regulators and policy makers when societys
goods are not being allocated satisfactorily.

Reflection
The effects of monopolies and oligopolies is important for economists to study because
we must have accurate data in order to determine the proper action for policy makers to take. The
general misconception that monopolies can charge any price they want, and will always make a
profit underlines the need for economists to analyze the specifics of each firm so that a balanced
solution can be found. It has been made clear that a collusive oligopoly and pure monopoly have
the potential to transfer a large amount of wealth from us, the consumer, when they are allowed
to produce at MR=MC. Equally important is allowing these firms to collect a fair return because
they provide a necessary service for society. The role of the unbiased economist is to determine
what the fair return for the firm should be, protecting my budget personally from exorbitant
profit.