Perfect Competition and Market Characteristics

2704 words (11 pages) Essay in Finance

23/09/19 Finance Reference this

Disclaimer: This work has been submitted by a student. This is not an example of the work produced by our Essay Writing Service. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Perfect Competition

Perfect competition is a market structure where there are many buyers and sellers while firms are producing homogeneous products with free entry and exit of the market. In this market, there are no barriers to entry or exit. Therefore, there are very many producers who are producing goods of the same type and quality.  In the long run, these firms cannot make economic profits, but they break even. However, there is a time when there is a small number of producers and this renders firms to make a positive economic profit for a short time before other producers join the market.

Firms in the perfect competition experience the costs of input and output costs since these are not fixed. The figure below represents this situation on the firm and market perspective. On the market side, D1 and S1 present the equilibrium of the demand and supply in the short run. After a long run, the price change causes the equilibrium to shift due to either increased or reduced demand. Increase in demand will lead to a rise in prices from P1 to P2. Firms increase their output from X1 to X2 to meet the new demand in the market which has increased from Q1 to Q2. The firms are now enjoying economics profits presented in the shaded area after a short run. After a long run, many firms join in the production of that good and the price is restored to P1. Reduced prices increase demand to Q3 in the market and at this point, firms will be having negative Economic profits because of the low prices.  The real-life example of this market is agriculture. A farmer can decide to plant any crop and stop growing it without any barriers.

                                                                                                                                                                     

Profits and Losses are the exit and entry barriers in the perfect completion market. Losses will make the firm leave the market while profits will encourage firms to enter the market (Azevedo and Daniel 71).

Prices in this market structure are set by the market forces and not by firms. Increase in demand of goods in subsequently accompanied by increased supply. Price rises to P2 for the short run, but it goes back to P2 after a long run.

Goods in the perfect competition are completely inelastic. Sellers sell similar products and increase in price means customers will start consuming cheaper goods from competitors.

The government does not affect this market structure. Even when subsidies are provided, they reach all the producers since there is no selective allocation.

International trade does not affect this kind of market structure, this is because prices are purely set by the market forces. Price is at P=AC (Becker 41).

Monopolistic Competition

Monopolistic competition market is also referred to as imperfect competition and it’s a market where there is a lot of differentiation of products but they all serve as close substitutes. This market has a lot of sellers but they are all selling differentiated to their buyers. Differentiation here come in different forms like having an attractive packaging, having a fast service or having a celebrity as the face of your product.

There are no entry barriers in this market structure since a firm can enter the firm and start producing exact products being produced by the other players. This is because a firm must produce a differentiated product.  Many firms in this structure find a law by the government favoring them to go international markets to prevent the creation of a monopoly (Bertoletti and Federico 40). The real-life example of the firm in this market structure is the Restaurants industry. They sell similar products with other firms in the same industry, but their products are slightly differentiated.  Differentiation gives some firms edge in the market over the others. Profitability of the firms in this market structure is on the short run and the long run basis.

Short run profits.

Short run profits in the industry are first reflected in on elastic demand curves. These curves present the differentiation of products in the industry and they serve as close substitutes. On the P1 X1, the firm will maximize profits since the marginal cost is equal to marginal revenue. Since average cost C is less than marginal revenue P1, the firm will be enjoying economic profits equal to the shaded area.

Long run profits

After other firms see the profitability which the firm is making, they will enter the market and increase the competition by providing substitutes to the existing firm’s products. This reduces its economic profitability level to only normal profits.

Entry of many firms may also lead to losses of the firm when their increase does not correspond with increased demand. The loss will be equal to the shaded area in the following diagram. Loss part represents the competition pressure which will mean that some firms can exit the market at any time.

0

The price setting in the monopolistic competition is set by use product differentiation. However, prices are not set high above the market price. High prices on a certain product will lead to buyers consuming a competing good since they all serve as close substitutes. Price should always be equal to average cost (Nikaido 54)

 Goods sold in this market are highly elastic. They all serve as close substitutes of each other and increase of the price by one firm leads to increased consumption of the competitors’ product.

Government interaction in this market structure will be to reduce unnecessary competition. A point where the price is below the average cost means the firms are undergoing losses. The government comes in to protect all players by providing fairground and save the whole industry from collapsing.

Firms in the monopolistic competition are not affected by international trade since the goods are being sold at P=AC.

Oligopoly

Oligopoly is the market structure which consists of few firms compete which compete imperfectly. There are few buyers in this market and when a firm sets a price, it expects a certain reaction from its competitor. There is interdependent in the price setting since price change by one firm it affects all players in the industry. The real-life example of this market structure is the Jetline industry where Boeing and Airbus are the main players. Another example is the soft drinks industry which is controlled by Coca-Cola and Pepsi.

Entry into this market is free but new firms risk being cut out of the competition or being bought out by the large players. Pricing also makes the new firms difficult to gain market share since large firms can operate at a loss for the sole goal of eliminating competitor out of the market. The reason behind this is that these firms believe the players will destroy the market coordination which they enjoy (Nishimori and Hikaru 60). However, the market can also be having barriers which have been set by the government making market entry difficult. 

Oligopoly is the market structure which produces cartels when the competing firms decide to collide due to competitive pressure. When all the firms join hands, they have the power to set the prices high by controlling the supply thus always keeping the demand high. Firms under cartels always enjoy super profits in both short and long run periods. One real type of cartel is the Organization of the Petroleum Exporting Countries (OPEC). This is an organization which was formed by the oil producing countries to control petroleum prices in the world. Countries under this umbrella adhere to the rule of low production to create demand for oil in the world market thus keeping the price per barrel always high.

The oligopolistic market has the price setting being determined by the competitor’s behavior but not the market forces. It is mostly explained by the use of the prisoner’s dilemma theory where survival of one prisoner depends on the outcomes of the other prisoner (McManus 47).

Goods in this market can be elastic or inelastic. Firms which are homogeneous products are called pure oligopoly. Firms producing differentiated products are called to be in differentiated oligopoly.

Government interaction in this market maybe mode of saving its citizens from the exploitation of cartels when competing firms collude to set a common price. Legal action can be taken against colluding firms if they are found guilty. Government intervention may also be in the form of saving small industries who are suffering under the big firms.

International trade does not affect this kind of market structure when the prices were set by the market forces. Foreign players find it difficult to enter such a market because the cartels always set a lot of barriers.

Monopoly

Monopoly market structure is the type of market where there are only one seller and very many buyers. Goods sold in this market have no close substitutes and the firm is the price setter.

Entry into this market is not free because there exist natural and artificial barriers. Natural barriers lead to the creation of natural monopolies. Some of the monopolies in this sector include firms in the electric provision companies, telephone companies and train companies. The government chatters these companies as monopolies in its laws and they are liable to control the price and output levels of these goods. Artificial barriers are the ones which have been created by the firms themselves and they lead to the formation of the artificial monopolies. Artificial barriers can be a use of violence and also exclusive ownership of the raw materials or holding the knowledge and the patent rights of the production of certain goods. Monopolies in any single time enjoy super profits because they are the price setters (Askar 83).

Monopolists also use price discriminations in setting prices in the market. This is the method where a good will be sold with two different prices for two markets. Since the consumer doesn’t have similar information about the goods in the two markets, monopolists use this chance to charge two prices. The move is one of the profit expansion methods which works by reaping on the consumer surplus as shown on the figure below (Andersen and Henrik 53).

Price changes do not always come from increased demand in monopolistic market structure.  The demand for the goods may rise, but it will not be accompanied by a subsequent increase in prices. This leads to a situation like the one presented in the graphs below wherein the first graph there are output X1 is sold at two different prices P1 and P2. A situation like this does not present the supply which was supposed to increase after demand increased but there I subsequent increase in price. In the second graph, the monopolist is selling two outputs of X1 and X2 with price P1. Increased demand for the goods was subsequently followed by an increase in the supply but the price remained at P1.

Government intervention does not affect this market structure since many of the monopolists are created by the government. However, the government makes sure the price setting is favourable for the buyers (Andersen and Henrik 44).

Products sold in the monopoly market are inelastic. They do not have close substitutes and this is the main reason why it is difficult to win a competition against a monopolist. The price change is not a result of competition or increase in demand.

The monopolist market is affected a lot by international trade. Since they do not have local competition, entry of the Multinational Corporation dilutes their monopoly status and they start experiencing the threat of the market forces. However, the government protects monopolies which have been chartered by introducing high duties to foreign corporations and sometimes offer incentives to its firms. i.e Tax holidays.

Section 2

The market structure I would prefer to buy products from is a perfect competition. There is symmetric information about the goods in the market and this makes the market forces to be the price setters. Prices on the goods reflect the total cost for their production and there will be no overpricing which harms consumers.

Characteristics of a perfect competition market.

  1. Perfect competition has many sellers and buyers.
  2. There are homogeneous products. Goods sold in this market do not have close substitutes.
  3. Resources in perfect competition move freely. This means there are no transport costs imposed on goods.
  4. There is free entry and exit in this market since there are no barriers.
  5. All buyers have perfect knowledge of the products. Sellers cannot impose price discrimination in this market.

The market which I would prefer to sell is the oligopoly market structure. This is because even if the price setting depends on the behavior of the competitor, the price is still above the average cost. Firms in this market always enjoy profits and they are not affected by market threats.

Characteristics of the oligopoly market.

  1. There are few sellers who are selling homogeneous products or differentiated product to many buyers.
  2. Interdependence in the price setting leads to communication among the players which results in market coordination and possible collusion.
  3. Firms also form a cartel to determine pricing and output in the industry.
  4. Firms are involved in the non-price competition like advertising and better service delivery. It eventually leads to product differentiation.

Works Cited

  • Andersen, Per, and Henrik Vetter. “Pricing as a risky choice: Uncertainty and survival in a monopoly market.” Economics: The Open-Access, Open-Assessment E-Journal 9.2015-29 (2015): 1-22.
  • Askar, S. S. “On complex dynamics of monopoly market.” Economic Modelling 31 (2013): 586-589.
  • Azevedo, Eduardo M., and Daniel Gottlieb. “Perfect competition in markets with adverse selection.” Econometrica 85.1 (2017): 67-105.
  • Becker, Gilbert. “Perfect Competition.” Wiley Encyclopedia of Management (2015): 1-1.
  • Bertoletti, Paolo, and Federico Etro. “Monopolistic competition when income matters.” The Economic Journal 127.603 (2017): 1217-1243.
  • McManus, Brian. “Nonlinear pricing in an oligopoly market: The case of specialty coffee.” The RAND Journal of Economics 38.2 (2007): 512-532.
  • Nikaido, Hukukane. Monopolistic Competition and Effective Demand.(PSME-6). Vol. 1391. Princeton University Press, 2015.
  • Nishimori, Akira, and Hikaru Ogawa. “Public monopoly, mixed oligopoly and productive efficiency.” Australian Economic Papers 41.2 (2002): 185-190.

Cite This Work

To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Related Services

View all

DMCA / Removal Request

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please: