Economics – The allocation of resources - The role of markets in allocating resources | e-Consult

Perfect Competition: This market structure is characterized by several key features:

• Many Buyers and Sellers: There are numerous small firms and consumers, none of whom have significant market power.
• Homogeneous Products: The products offered by all firms are identical.
• Free Entry and Exit: Firms can easily enter or leave the market without significant obstacles.
• Perfect Information: All buyers and sellers have complete and accurate information about prices and products.

Because of these features, firms in a perfectly competitive market are price takers. They must accept the prevailing market price. The market price is determined by the forces of supply and demand. Firms maximize profit by producing at the quantity where marginal cost equals marginal revenue (MC = MR). As a result, output is generally high and prices are low.

Monopoly: A monopoly is characterized by:

• Single Seller: There is only one firm in the market.
• Unique Product: The product offered by the monopolist has no close substitutes.
• High Barriers to Entry: Significant obstacles prevent other firms from entering the market. These barriers can be legal (e.g., patents), economic (e.g., high startup costs), or natural (e.g., control of a scarce resource).

Because the monopolist is the sole seller, it has significant market power and can influence the market price. The monopolist is a price maker and chooses its output level to maximize profit. It will produce where marginal revenue equals marginal cost (MR = MC) and then set the price based on the demand curve. As a result, output is generally lower and prices are higher than in a perfectly competitive market. This leads to a deadweight loss for society.

Key Differences Summarized: