Comparisons between (perfectly) competitive and monopolistic industry structures

Question

Comparisons between (perfectly) competitive and monopolistic industry structures suggests that there might be important differences between the two in term of their performance along the three dimensions of: allocative efficiency; productive efficiency efficiency); and progressiveness (or dynamic efficiency). What are these different forms of efficiency? What are the potential tradeoffs confronting society as a result of the different performance of competitive and monopolistic markets along these three dimensions? An interesting explanation for the sudden rise in oil prices that occurred in the 1970s, and the subsequent precipitous decline during the early 1980s, focuses on the government budgetary needs of the oil exporting countries, and specifically on their target revenues. Using the relevant diagram, explain bow output choices would respond to changes m the price of oil. Describe the implications of this model for the demand-supply analysis of the crude oil market Explain how this model can help us understand the determinant reasons for the rapid rise and decline m crude oil prices The chart below indicates that even at the regional level indices of output concentration in the refining industry are rather modest in spite of the existence of substantial scale economies. Identify the main determinants of the capital costs of oil refiners, and analyze their implications for the presence of scale economies Identify any other sources of scale economies. . Why does the existence of scale economics not lead to greater industry concentration?

Explanation / Answer

1. Different forms of efficiency:

a) Allocative efficiency: Allocative efficiency results at the allocation where equilibrium price equals the marginal cost of production, and the market surplus is maximized. The state of allocative efficiency is referred to as Pareto optimal because when allocative efficiency occurs, no one can be made better off without making at least one person worse off.

b) Productive efficiency (or X efficiency): Productive efficiency is the efficiency that results when output is produced at the least cost possible.

c) Dynamic efficiency: An economy is said to be characterized by dynamic efficiency when the economy has a tendency to innovate its products and technologically improve its production process over time.

2.

A perfectly competitive market results in allocative efficiency, but it also results in productive efficiency, which often leads to changes that are not Pareto optimal. For example, when more efficient producers replace less efficient producers, not everyone is made better off.

Perfectly competitive markets lack in dynamic efficiency as compared to markets that are monopolistically competitive. This is because, in perfect competition, there is perfect flow of information and firms do not have any market power, such that any technological progress made by any firm is equally distributed as knowledge in the market. That is, all producers benefit from the hard work of one producer. Therefore, perfectly competitive firms do not have much incentive to innovate. But innovate undertaken by a monopolistically firm yields that firm some market power. Therefore, monopolistically competitive markets are more dynamically efficient as compared to perfectly competitive firms.

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