Answers may include:

Definitions

1. Perfect Competition: A market structure with a large number of small firms that have no control over output prices. All firms sell an undifferentiated product and there are no barriers to entry.
2. Allocative Efficiency: State of the economy in which the combination and quantity of goods and services produced is aligned with the preferences of consumers and producers, maximising social surplus.

Economic Theory

• Characteristics of Perfect Competition:

  • Large number of small firms, each unable to influence market price.
  • Homogeneous products, leading to no consumer preference for one firm's product over another.
  • Free entry and exit, ensuring no long-term economic profits.
  • Perfect information, allowing consumers and producers to make informed decisions.

• Efficiency in Perfect Competition:

  • Allocative Efficiency: Achieved in the long run as firms produce at the point where P=MC, ensuring resources are allocated according to consumer preferences.
  • Productive Efficiency: Firms produce at the lowest point on their average cost curve in the long run, minimizing waste.
  • Dynamic Efficiency: Limited due to lack of supernormal profits, which restricts investment in innovation.

• Diagram:

  • Short-run and Long-run Equilibrium: Illustrate with a diagram showing a firm's cost curves (MC, ATC) and the market price line. In the long run, the firm's ATC curve is tangent to the price line, indicating normal profits and allocative efficiency.

Evaluation (SLAP)

• Stakeholders:

  • Consumers: Benefit from lower prices and greater choice due to competition, as seen in agricultural markets like wheat or corn.
  • Producers: Face pressure to minimize costs and may struggle with low profits, limiting their ability to invest in R&D.
  • Government: May favor perfect competition for its efficiency but must consider the lack of innovation.

• Long-run vs. Short-run:

  • In the short run, firms can make supernormal profits, but in the long run, these are eroded by new entrants, leading to normal profits.
  • Example: The dairy industry in New Zealand operates under conditions close to perfect competition, with numerous small producers and minimal barriers to entry.

• Advantages vs. Disadvantages:

  • Advantages: Allocative and productive efficiency, consumer sovereignty.
  • Disadvantages: Lack of dynamic efficiency, potential for market failure if externalities are present.

• Prioritize:

  • While perfect competition is efficient, it may not always be the most socially desirable due to its limitations in innovation and addressing externalities. In some cases, a monopolistic or oligopolistic market might better support R&D and technological advancement.

Conclusion

1. Perfect competition offers significant benefits in terms of efficiency and consumer welfare.
2. However, its limitations in innovation and addressing externalities may make it less socially desirable in certain contexts.
3. The most socially desirable market structure may vary depending on the specific needs and goals of the economy, such as innovation or environmental sustainability.

Answers may include:

Definitions

1. Monopoly: A market structure with one single dominant firm that has substantial control over output prices. The firm sells a unique product and is protected by high barriers to entry.
2. Market Power: The degree to which a firm in a market is able to control its output price.
3. Market Failure: Occurs when firms fail to efficiently allocate the resources within an economy.

Diagram

• Diagram: A monopoly diagram showing the demand curve (AR), marginal revenue curve (MR), marginal cost curve (MC), and average total cost curve (ATC).
• Indications:
  • The diagram should illustrate the profit-maximizing output where MR = MC.
  • Show the price set above marginal cost (P > MC), indicating allocative inefficiency.
  • Highlight the area of deadweight loss, representing the loss of social welfare.

Explanation

• Market Power and Pricing:

  • A monopoly can set prices above marginal cost due to lack of competition, leading to allocative inefficiency.
  • This results in a higher price and lower output compared to a perfectly competitive market, where P = MC.

• Allocative Inefficiency:

  • In a monopoly, the price (P) is greater than the marginal cost (MC), meaning that the value consumers place on the last unit is greater than the cost of producing it.
  • This leads to underproduction and a misallocation of resources, contributing to market failure.

• Deadweight Loss:

  • The area between the demand curve and the MC curve, from the monopoly quantity to the socially optimal quantity, represents deadweight loss.
  • This loss indicates the reduction in total welfare, as potential gains from trade are not realized.

• Barriers to Entry:

  • High barriers to entry prevent other firms from entering the market, sustaining the monopoly's market power and perpetuating inefficiency.
  • Examples include economies of scale, legal barriers, and control over essential resources.

• Productive Inefficiency:

  • Monopolies may lack the incentive to minimize costs due to the absence of competitive pressure, leading to productive inefficiency.
  • This can result in higher average costs and further welfare loss.

• Additional Explanation:

  • X-Inefficiency: Monopolies may also suffer from X-inefficiency, where they operate at higher costs than necessary due to lack of competitive pressure.
  • Dynamic Efficiency: While monopolies might invest in research and development due to higher profits, this potential benefit does not outweigh the immediate welfare loss from allocative and productive inefficiencies.