for A-plus writer

gregory velazco y trianosky

california state university, northridge

fall 2013

(taken from Manuel Vasquez, Business Ethics, 6th edition, and Wikipedia.

perfect competition versus monopoly

definitions

1. definition of a perfectly competitive free market

A perfectly competitive free market is one in which no buyer or seller has the power to significantly affect the prices at which goods are being exchanged.

Perfectly competitive free markets are characterized by the following seven features:

1. There are numerous buyers and sellers, none of whom has a substantial share of the market.

2. All buyers and sellers can freely and immediately enter or leave the market.

3. Every buyer and seller has full and perfect knowledge of what every other buyer and seller is doing, including knowledge of the prices, quantities, and quality of all goods being bought and sold.

4. The goods being sold in the market are so similar to each other that no one cares from whom each buys or sells.

5. The costs and benefits of producing or using the goods being exchanged are borne entirely by those buying or selling the goods and not by any other external parties.==

6. All buyers and sellers are utility maximizers: Each tries to get as much as possible for as little as possible.

7. No external parties ( such as the government) regulate the price, quantity, or quality of any of the goods being bought and sold in the market. (167)

2. A perfectly competitive market tends toward an equilibrium point.

In a perfectly competitive free market, the price buyers are willing to pay for goods rises when fewer goods are available, and these rising prices induce sellers to provide greater quantities of goods. Thus, as more goods are made available, prices tend to fall, and these falling prices lead sellers to decrease the quantities of goods they provide. These fluctuations produce a striking outcome: In a perfectly competitive market, prices and quantities always move toward what is called the equilibrium point. The equilibrium point is the point at which the amount of goods buyers want to buy exactly equals the amount of goods sellers want to sell and at which the highest price buyers are willing to pay exactly equals the lowest price sellers are willing to take. At the equilibrium point, every seller finds a willing buyer and every buyer finds a willing seller. (168)

i) E.g. selling strawberries at a farmer’s market: “When demand exceeds supply, suppliers tend to raise their prices, but when supply exceeds demand, suppliers will tend to decrease their prices in order to make sales. Consumers who can afford the higher prices may still buy, but others may forgo the purchase altogether, demand a better price, buy a similar item, or shop elsewhere. As the price rises, suppliers may also choose to increase production, or more suppliers may enter the business.”

ii) E.g. selling cell phone accessories on eBay: “ General equilibrium theory  has demonstrated, with varying degrees of mathematical rigor over time, that under certain conditions of  competition , the law of supply and demand  predominates in this ideal free and competitive market, influencing prices toward an  equilibrium  that balances the demands for the products against the supplies. [12]  At these equilibrium prices, the market distributes the products to the purchasers according to each purchaser's preference (or utility) for each product and within the relative limits of each buyer's  purchasing power .”

(“This equilibrating behavior of free markets requires certain assumptions about their agents, collectively known as  Perfect Competition , which therefore cannot be results of the market that they create. Among these assumptions are several which are impossible to fully achieve in a real market, such as complete information, interchangeable goods and services, and lack of market power.”

3. monopoly competition (176)

In a monopoly, two of the conditions [of perfect competition] are not present:

First, instead of numerous sellers, none of whom has a substantial share of the market, the monopoly market has only one seller, and that single seller has a substantial ( 100 percent) share of the market.

Second, instead of being a market that other sellers can freely and immediately enter or leave, the monopoly market is one that other sellers cannot enter. Instead, there are barriers to entry such as patent laws, which give only one seller the right to produce a commodity, or high entry costs, which make it too expensive for a new seller to start a business in that industry.

e.g. Alcoa ( the Aluminum Company of America) held the patents for the production of virgin aluminum in the United States until 1909, by which time it was firmly entrenched as the sole domestic producer of aluminum. Moreover, although its patents ran out in 1909, other manufacturers were never able to enter successfully into the production of aluminum because their start- up costs would have been too high and they lacked Alcoa’s experience, trade connections, and trained personnel. Alcoa remained the sole domestic producer of virgin aluminum until the 1940s, when it was successfully prosecuted under the Sherman Antitrust Act.

A. Factual consequences of monopoly

1) increased entrance barriers( interfere with competitive response to increased prices/decreased demand

e.g. a drug company operating under a patent [notice that it does not matter what overall share of the drug market the company has, provided only that it has a monopoly on the particular drug, or type of drug, in question] (178)

2) monopoly profits(increased costs to consumers

e.g. A policy of forced mergers during the closing decades of the 19th century enabled the American Tobacco Company to absorb all the major cigarette manufacturing companies in the United States so that by the turn of the century, the combine controlled the American cigarette market. In 1911, the company was ordered broken up into several smaller firms….At the turn of the century, for example, the American Tobacco Company, which earlier had managed to acquire a monopoly in the sale of cigarettes, was making profits equal to about 56 percent of its sales.

B. Moral consequences of monopoly

(i) In a monopoly market, prices for goods are set above the equilibrium level, and quantities are set at less than the equilibrium amount. As a result, the seller charges the buyer far more than the goods are worth ( from the average sellers point of view) because charges are far more than the costs of making those goods. Thus, the high prices the seller forces the buyer to pay are unjust, and these unjustly high prices are the source of [what we may then define as] the sellers excess profits.

(ii) A monopoly market also results in a decline in the efficiency with which it allocates and distributes goods.

(a) First, the monopoly market allows resources to be used in ways that will produce shortages of those things buyers want and cause them to be sold at higher prices than necessary. The high profits in a monopoly market indicate a shortage of goods. However, because other firms are blocked from entering the market, their resources cannot be used to make up the shortages indicated by the high profits. This means that the resources of these other firms are deflected into other non-monopoly markets that already have an adequate supply of goods. Shortages, therefore, continue to exist. Moreover, the monopoly market allows the monopoly firm to set its prices well above costs instead of forcing the firm to lower its prices to cost levels. The result is an inflated price for the consumer a price that the consumer is forced to accept because the absence of other sellers has limited the choices. These excess profits absorbed by the monopolist are resources that are not needed to supply the amounts of goods the consumer is getting. [notice how much at odds a business’s objectives are with the objectives (or “values”) of the free market itself]

(b) Second, monopoly markets do not encourage suppliers to use resources in ways that will minimize the resources consumed to produce a certain amount of a commodity. A monopoly firm is not encouraged to reduce its costs and is therefore not motivated to find less costly methods of production. Because profits are high anyway, there is little incentive for it to develop new technology that might reduce costs or that might give it a competitive edge over other firms, for there are no other competing firms.

(iii) Monopoly markets enable the monopoly firm to force on its buyers goods that they may not want in quantities they may not desire. The monopoly firm, for example, can force consumers to purchase product X only if they also purchase product Y from the firm. (Microsoft “browser wars”)