The Filipino entrepreneur’s psyche is a unique one. If an enterprising individual notices that a neighbor is doing well with their chosen line of business, trust that he/she would try to replicate its success by trying it out for themselves.

In Dumaguete, for example, we see the occurrence of this phenomenon. While a few years ago, only a number of stalls selling lechon manok dot certain places in the city, today practically every street corner has a lechon manok stall trying to get a fair share of the market in Dumaguete. As a result, they compete for a place in a crowded market. While new stalls enter and try their luck, those that are not able to withstand the competition are squeezed out of the business.

This brings us to asking the following questions: How does competition affect prices and profit? What causes some business firms to enter an industry and others to leave it? What are the effects on profits and prices of new businesses entering and old businesses leaving an industry?

If the good involved is a private good, perfect competition results in an efficient outcome because it results in “the best deal” for all buyers and sellers combined. An efficient outcome is one where we have exploited all possible gains from trade between buyers and sellers. The “best deal” is measured as the maximum welfare defined as the aggregation of consumer surplus and producer surplus.

Market failure is what we have when the usual working of the market does not result in an efficient outcome. How can this happen? Generally it arises because of a) market structure – the market is not perfectly competitive, but instead is characterized by something else, like a monopoly, or b) “externalities,” as in the case of pollution which a producer does not take into account when he calculates his costs. By definition, there is an externality when not all costs and benefits of a product are fully taken into account by either the producer or consumer, respectively.

On the one hand, monopoly is an instance of market failure. Imagine the perfect competition model, but this time, allow one big capitalist to buy up all his competitors. What you have happening is what is called monopoly.

Once you can control the sources of supply, you can control the price. In perfect competition, an individual firm sees a price-elastic demand curve, which means that the firm has no control over the price. The firm is called a “price taker” because it “takes the price as given.” If the firm tries to quote a higher price, there is no sale, and if it quotes a lower price, it would violate the assumption of profit-maximization – it could have sold all it wanted at the higher price, and also made more profit.

But when there is no longer perfect competition, the seller can see that he can charge a particular price, and it is not an “all or nothing” outcome in terms of how much he can sell. The extreme departure from the perfect competition model is when there is only one seller, or, even more extreme, when there is at the same time one seller and also only one buyer. The former is called a monopoly, while the latter is called bilateral monopoly.            However, a monopoly is socially wasteful because quantity produced is too low relative to what would result from perfect competition. There is a reduction in consumer and producer surplus. A monopoly decides the quantity sold at the point where marginal revenue equals marginal cost. 

There is justification for monopoly only when necessary to make the product come into existence, i.e., the monopoly from patents given to inventors. 

Between perfect competition and monopoly are the situations of monopolistic competition, oligopoly (few sellers), cartel (few sellers behaving like a monopoly), and price leadership (where one seller is so large that it dominates the market, but there are many small competitors who take the price “dictated” by the price leader).

Firms vary in size as well as in their internal organization, but they take inputs and transform them into outputs through a process called production.

Because firms naturally compete with each other, no single firm has any control over prices or the cost they have to undertake with their production.

To make decisions, firms need to know three things: 1) the market price of their output; 2) the techniques of production that are available; and, 3) the price of inputs.

Production is a social, as well as a technical, phenomenon. In the Philippine economic setting, the concept of team spirit comes in when we talk of production. This is also where “diseconomies of scale” occur because as a firm gets bigger and bigger, higher average costs of production are likewise experienced.

Consequently, the role of the entrepreneur in production and cost analysis is crucial as he/she translates costs of production to supply, as well as the implications of using cost analysis in the real world.

Essentially, an excellent entrepreneur is one who sees an opportunity to sell an item at a price higher than the average cost of producing it.

It is said that an economically efficient production process must be technically efficient, but a technically efficient process need not be economically efficient.

Economies of scale initially cause average total cost to decrease; diseconomies eventually cause average total cost to increase.

Costs in the real world are affected by economies of scope, learning by doing and technological change, the many dimensions to output, and unmeasured costs such as opportunity costs.

This only shows that if a single firm raises its price above the market price, it will sell nothing. Because it can sell all it produces at the market price, a firm has no incentive to reduce prices.

However, there is enough differentiation, usually by brand name, so that each producer can control the price and see itself as a monopoly. The demand curve faced by each producer is highly elastic, but not perfectly so.

In oligopoly, a few compete with each other, and do not attempt to collude. They watch how each other behaves and adjust as best they can. The state of knowledge here is very imperfect.

What are the sources of monopoly? First, there is law, as in patents for drugs and inventions; or exclusive franchise (as in the case of PAGCOR in gambling, or PLDT for a very long time in telephones); or restricted access to a natural resource (when the government establishes a corporation as the sole entity that could exploit the natural resource, as in the case of PNOC and oil and natural gas reserves).

Second, there is cost structure, where a declining cost industry results in “natural” monopoly. As one firm gets bigger, its cost gets smaller. Pretty soon, it can undercut the price of any competing firm, and it then becomes a monopoly. It is “natural” because it arises without the aid of legislation.

And, third, is network or location preference, which results in what is known as “contestable” monopolies. A monopoly is said to be contestable when the status of the monopoly is uncertain because another firm can easily invade the monopolist’s market.

Most economists see monopolistic competition as a “necessary evil” because the scenario of perfect competition, often idealized as the best means of maximizing economic welfare, is not feasible. The welfare costs of monopolistic competition are said to be small enough, since on balance it also results in a drive for product innovation that ultimately benefits the consumer. The justification for monopolistic competition is to some extent similar to that for the grant of monopoly to inventors.

Be that as it may, there are benefits as well as disadvantages of a monopolistic setup, just as in any undertaking for that matter. The key is to be aware of how we can make full use of it to our greatest advantage.