First of all, according to John Wiley and Sons (1995), perfect competition is kind of market structure that processed the following factors: each firm is so small compared to the market and the influence on price is elastic; the product is homogeneous; there are freedom changes of all resources which includes free entry and exits of firms in and out of the markets and there is perfect knowledge between the buyers and the sellers so buyers know what prices are all firms charging. A firm that is perfectly competitive usually operates at an output level where profit is maximized.
As for monopolistic competition, it has some features in common with perfect competition and monopoly. Three key factors can be described as monopolistic competition which is each firm has a little amount of market power because the firms are extremely competitive; firms can enter and exit freely of the industry if the level of profits is tempting and the profit is maximized. However, compare to monopoly, each of the firms is facing a downward sloping demand curve.
The contrast between perfect competition and monopolistic competition.
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There are many similar features between perfect and monopolistic competition. Both perfect competition and monopolistic competition has large number of firms which are compete each other. They both have the freedom of entry and exit of firm since they are selling almost similar products to the consumers. The breakeven point is formed where marginal cost is equal to marginal revenue. In the both market conditions, firms can earn abnormal or super profits and also can incurred short run lose. As for long run production, firms only can earn normal profits.
Furthermore, both perfect and monopolistic competition can benefits the customer by pricing which is very competitive. Consumers are freely to compare the prices of the similar products and choose the best among of the all. Consumers are usually like to buy the product which is good in quality and affordable.
Comparison between perfect competition and monopolistic competition.
For instance perfect competition does not have the ability to affect the market price as they are price takers because price is determined by the demand and supply of the consumers or suppliers. It cannot affect the price by only performance. As for monopolistic competition, each of the firm has a very small degree of market price control. In addition, all firms have its own price policy which set by the government and they must follow the price of the goods that they got to sell to the consumers.
In the perfect competition, each firm produces and sells homogeneous products so that buyer does not have the chance of choosing for the commodity of any seller over others. Other than that, there is product differentiation in monopolistic competition. The products may be similar but they are more to non-identical to each other or they can say to be close substitutes.
Perfectly and monopolistically competitive firms are free to enter and exit of the industry but for monopolistically competitive firms might have few restrictions but they are greatly unrestricted in terms of government rules and regulation, barriers to entry or even start-up cost. As for the perfectly competitive firms, they also not restricted but some case like firms that incurred high cost, they will need to get the permission from the government to enter the industry. The monopolistically competitive firms are not perfectly mobile as compared to perfectly competitive firms.
In monopolistic competition, buyers have perfect knowledge about the prices that set by the sellers. One firms cannot sells higher price of goods than others if not the consumers will change to other sellers as they are price elastic. All perfectly competitive firms must have the same production techniques or technology and they cannot produce goods better or faster with special knowledge. As for monopolistic competition, buyers do not know everything about the prices, but they have close information about alternative prices of other firms.
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As shown in the figure 1 above, the demand curve AR, average revenue of a perfectly competitive firm is perfectly elastic and MR, the marginal revenue curve occupy same place with it. As for monopolistic competition, the demand curve of a firm is elastic and downward slopping and its corresponding MR, marginal revenue curve locates below it. It define that a firm will have to increase its sales by reducing the price of its product to attract some consumers from others competitors, provided the price is not reduced later.
Though the equilibrium states that the two market conditions are the same but yet there are differences in the relationships of price marginal cost between the two competitions. Under perfect competition MC equal to MR, price also equals among them because price is AR equal MR. This also explain that the AR curve is horizontal to the X axis which means the price remain the same all the time. As for monopolistic competition, the AR curve was downward slopping to the left, the MR curve was below of it. So price can be state as AR bigger MR equal MC.
Dissimilarities among the two market situations correspond to their dimensions. In the long run competitive firms which are in the size of optimum and they will produce their products in full capacity for the reason of AR equal LMC equal LAC at its minimum level. But for monopolistic competition firms are likely to be less than the optimum size and process in surplus capacity since the AR curve is downward slopping and cannot be aligned on the LAC curve at its minimum point. So, the price is AR equal LAC bigger LMC equal MR.
Examples of firms in each market structure
The perfectly competitive firms are likely to be grocery stores those selling necessity goods such as tissue, breads, drinks and more. This grocery store could be like Carrefour, Tesco and Giant.
As for monopolistic competition firms, the best example will come from retail trade, including restaurants, clothing stores, and convenience stores. Retail store such as Al-ikhsan is one of the examples. This store sells different of the products but they are not identical such as Nike and Adidas. Coca cola and Pepsi also are the examples of monopolistic competition since they are close substitutes.
In conclusion, perfect competition and monopolistic competition have their own advantages and disadvantages. Usually people will choose monopolistic industry rather competitive one because it is much lesser competition compare to perfectly competition.
Perfect competition. (1995). In Dictionary of Economics, Wiley. Available at: http://www.credoreference.com/entry/wileyecon/perfect_competition (Accessed: 4th March 2012)
Perfect competition. Available at: file:///E:/Introduction%20to%20Economics/Amos
WEB%20is%20Economics%20%20Encyclonomic%20WEB%20pedia.htm (Accessed: 14th April 2012)
Monopolistic competition: Available at: file:///E:/Introduction%20to%20Economics
Monopolistic competition. (2003). In The New Penguin Business Dictionary. Available at http://www.credoreference.com/entry/penguinbus/monopolistic_compe
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Similarities and Dissimilarities between Monopoly Competition and Perfect Competition Homework Help, Tutoring (2009) Available at: file:///E:/Introduction%20to%20Economics/Similarities%20%20%20Dissimilarities%20%20%20Monopoly%20Competition%20%20%20Perfect%20Competition%20%20%20Assignment%20Help%20%20%20Homework%20Help%20%20%20Online%20Tutoring.htm. ( Accessed 11th April)
Taylor John,B. Frost,L. (2006) Micro economics.3thedn. United Kingdom and Australia: Stanford University and Monash University.
Explain the principal characteristics of a free market economy. Sometimes, government fixes or controls the prices of certain goods and services. Explain what is meant by price control and discuss the advantages and disadvantages of such actions. The effects of both ceiling price and floor price should be discussed.
The principal characteristics of a free a market economy
A free market economy is a type of economic system where control by demand and supply, rather than intervention from the government. A true free market economy is a kind of economy that individuals owned all resources. The allocation of those resources is made by individuals rather than government. The producer gets the chance to decide what to produce, how many to produce, what is the price to charge consumers for those goods, and how much to pay to workers. These decisions are usually affected by the demand, supply and competitors.
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Free market economy also can call as free enterprise economy which also know as the role of a limited government. A competitive free market economy provides the use of resources efficiently. It is a self-doing economy. Capital and natural resources like buildings and equipment are free hold which does not belong to government. The products that services produced in the economy are owned privately.
Price controls can be defined as the prices that restricted by government on the prices that are going to be charge for the products and goods in the market. There are two primary types of price control, which are a price ceiling, the maximum price that can be charged to consumers and a price floor, the minimum price that can be charged to consumers
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The diagram above shows the maximum price which is price ceiling.
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The diagram above shows minimum price which is floor price.
Advantages and Disadvantages of Price Control
Firstly, the practice of price control should be done by all country to reduce the pressure of consumers. The advantage of implementing such price controls is to maintain affordability of consumers for foods and goods, to prevent price rising tremendously during shortages of resources, and to reduce the speed of inflation.
As for disadvantages of price control which will cause low supply of products. There will also be a scarcity where unlimited wants but limited resources which will then lead to demand will exceed supply. This may causes long waiting lists and cases of black markets likely to be happened because people try to overcome the shortage of the resources. For example, during the Second World War, price of goods was fixed. However, people are encouraged to sell the goods with inflated prices on the black market.
The effects of both ceiling price and floor price
For instance, price ceilings help to prevent suppliers from charging tremendously high prices for limited goods or services easily just because they can do that. Price ceilings are also helps those people that are poor by ensuring the cost of living is affordable for them during recession. Inflation describes the rises of prices for goods and services gradually over time. During recession periods which also known as high inflation, prices increase faster than wages which lead to decease of the purchasing power. So, practicing price ceilings is necessary for consumers as they need to maintain their standard of living.
Price ceilings can bring negative impacts to the marketplace also. Suppliers are not interested in producing more of goods when they cannot earn more profits by setting their own prices, therefore, supply of resources will decreases, thus reduced the availability of products to the market. Price ceilings also reduce the quality of products that can be produced, as suppliers have difficulty in financial to reinvest in their business.
Floor price is useful for the government as they can use it to prevent people from buying unhealthy goods such as alcohol and cigarettes. They can have control on the market and set a price on the item that must be sold at the price or above of it. The result of doing this is then suppliers are forced to raise their prices up and cause the quantity demanded from the consumers to be decreases. The floor price must be set above the market only then it will be effective.
Sometimes a false market can be formed where the seller sell their good at the original market price. They should not to do that because that is illegal, only company with permission from governments can do that. For example, in the United Kingdom nowadays it is very common to find small dealers that import large stocks of alcohols or cigarettes illegally and then sell to consumers at a cheaper price of cigarettes and it much cheaper that in shops.
For suppliers, there are not many advantages. They cannot set the price anymore or depending on the elasticity of the good as their profit will commonly decrease. Also, they will often facing problem of surplus of supply at higher price.
For consumers it is all bad. There are no good advantages; however, if for example a floor price was used on Cigarettes, people will smoke less because the cigarettes are too expensive. Lesser third parties will get affected negatively by second hand smoke especially children and therefore negative externalities can be prevented.
Price control can bring a lot benefits to consumers as well as troubles. So the government will have the biggest responsibility to control the price to ensure that everything is going smoothly and accordingly.