8/14/2019 Rough Perfect Comp http://slidepdf.com/reader/full/rough-perfect-comp 1/22 9.1 INTRODUCTION What is Market structure Its classification : In ordinary language, the word market implies a particular place where the buyers and sellers assemble. In other words, an area, large or small, can be considered as a market where buyers and sellers are in easy contact with one another. The term thus indicates a geographical location. In economic jargon, however, market implies a contact either direct or indirect between buyers and sellers. Thus, market is a network of dealings between buy- ers and sellers. With the development of communications and banking, the markets have widened and deal- ings in some commodities are now world-wide. Therefore, the essential feature of a market is that buyers should be able to strike bargains with sellers. According to Wicksteed, “Thus market is the characteristic phenomenon of economic life and the constitution of markets and market prices is the central problem of Economics” . Quick Reference to Basic Market Structures Market Structure Seller Entry Barri- ers Seller Num- ber Buyer Entry Barri- ers Buyer Num- ber Perfect Competition No Many No Many Monopolistic competi- tion No Many No Many Oligopoly Yes Few No Many Oligopsony No Many Yes Few Monopoly Yes One No Many Monopsony No Many Yes One The correct sequence of the market structure from most to least competitive is perfect competition, imperfect competition,oligopoly, and pure monopoly. Broadly, markets may be classified on the basis of area as local, national and world markets. But, the classification relevant for our purpose is based on the extent of competition prevailing in the market. Accordingly, there are perfect markets and imperfect markets. The essential characteristic of perfect market is the prevalence of uniform price for the commodity. On the other hand, different prices prevail for the product in imperfect markets. Imperfect competition may have several forms, e.g. monopoly, duopoly, oligopoly and mono- polistic competition. Thus, markets are classified on the basis of number of sellers, nature of the product, degrees of competition etc. 9.2 PERFECT COMPETITION 1
What is Market structure Its classification : In ordinary language, the word market impliesa particular place where the buyers and sellers assemble. In other words, an area, large or small, canbe considered as a market where buyers and sellers are in easy contact with one another. The term
thus indicates a geographical location. In economic jargon, however, market implies a contact either direct or indirect between buyers and sellers. Thus, market is a network of dealings between buy-ers and sellers.
With the development of communications and banking, the markets have widened and deal-ings in some commodities are now world-wide. Therefore, the essential feature of a market is thatbuyers should be able to strike bargains with sellers. According to Wicksteed, “Thus market is thecharacteristic phenomenon of economic life and the constitution of markets and market pricesis the central problem of Economics” .
Quick Reference to Basic Market Structures
Market Structure Seller Entry Barri-ers
Seller Num-ber
Buyer Entry Barri-ers
Buyer Num-ber
Perfect Competition No Many No Many
Monopolistic compet i-tion
No Many No Many
Oligopoly Yes Few No Many
Oligopsony No Many Yes Few
Monopoly Yes One No Many
Monopsony No Many Yes One
The correct sequence of the market structure from most to least competitive is perfect competition,
imperfect competition,oligopoly, and pure monopoly.
Broadly, markets may be classified on the basis of area as local, national and world markets.But, the classification relevant for our purpose is based on the extent of competition prevailing in themarket. Accordingly, there are perfect markets and imperfect markets. The essential characteristicof perfect market is the prevalence of uniform price for the commodity. On the other hand, different
prices prevail for the product in imperfect markets.
Imperfect competition may have several forms, e.g. monopoly, duopoly, oligopoly and mono-polistic competition.
Thus, markets are classified on the basis of number of sellers, nature of the product, degreesof competition etc.
Perfect competition is said to exist when the market possesses following characteristics or ful-fils the conditions mentioned below:
a) A large Number of Buyers and Sellers : The fundamental condition of perfect competi-tion is that there must be a large number of sellers or firms. The total number of sellers is so large thatno individual seller is in a position to influence the price of the product in the market. In other words,
the individual seller’s decision to raise or lower the supply will have an insignificant effect on the mar-ket price, because each one is selling a small portion of the total output. Therefore, Each Seller is justa Price-taker and not a Price-Maker.
b) Homogeneous Commodity : This is the second fundamental condition of a perfect mar-ket. The products of all firms in the industry are homogeneous and identical. In other words, they areperfect substitutes for one another. There are no trade marks, patents etc. to distinguish the productof one seller from that of another. Under perfect competition, the control over price is completely elim-inated because all firms produce homogeneous commodities. This condition ensures that the sameprice prevails in the market for the same commodity.
The two basic features, viz. large number of firms and homogeneous product make the de-mand perfectly elastic for an individual firm. As a result of this, the demand curve (i.e. AR curve) fa-cing an individual firm becomes a horizontal straight line and MR curve coincides with AR curve.(Refer Chapter 10.)
c) Free Entry and Free Exit : Under perfect competition, there is complete freedom of entryfor new firms and of exit for the existing firms. However, in short period, neither the new firms canenter nor the existing firms can leave the industry.
d) Perfect Knowledge : It is necessary to assume that the producers and consumers havefull knowledge of the prevailing price. Hence, there is no need for the sales promotion or to incur ex-penditure on advertisement in respect of their preferences for commodities.
e) Perfect Mobility : There is complete mobility of the factors of production from one firm toanother, or from one industry to another or from one occupation to another.
f) No transport costs : Another important condition of perfect competition is that producerswork sufficiently close to each other. In other words, the differences caused by transport costs do notexist.
Pure Competition and Perfect Competition
Economists like Chamberlin and others often make a distinction between pure competitionand perfect competition. The term Pure Competition is used in a restricted sense. It is also knownas atomistic competition. In order that competition be pure it requires the fulfillment of three condi-tions of perfect competition, namely, the existence of a large number of buyers and sellers, homogen-eity of the product, and freedom of exit and entry. These conditions together mean that no individualfirm can exert any influence over the market price.
But the term perfect competition is a wider concept, in the sense, that it includes the fea-tures of pure competition and some additional conditions, such as perfect knowledge on the part of buyers and sellers, perfect mobility of factors of production and absence of transport cost.
This means that, perfect competition requires that there should be no imperfections inthe market. Such imperfections arise due to imperfect knowledge or immobility of the factors of pro-duction.
In fact, pure competition is a part and parcel of perfect competition. American economistsprefer to use the term pure competition, while the English economists prefer the term perfect competi-tion. However, both the terms are used to analyse the features of perfect markets.
9.3 PRICE DETERMINATION UNDER PERFECT COMPETITION
The forces underlying the determination of price under Perfect Competition are Demand andSupply. The interaction of demand and supply determines the price of a commodity in the market.Marshall has compared the Process of price determination to the cutting of cloth with a pair of scis-sors. As two blades are required to cut the cloth; so the two blades – demand and supply – are re-quired to determine the price in the market, no matter one may be more active than the other andmore effective than the other, but the existence of both is indispensable.
Now, demand comes from the buyers and the supply from the sellers. The demand from thebuyers can be shown by the Market Demand Schedule and the supply from the sellers can be shownby the Market Supply Schedule.
Table 9.1Demand and Supply Schedules
Price per unit of commodity
Rs.
Quantity demand per weekUnits
Quantity supplied per weekUnits
50 80 530
40 120 480
30 200 400
20 300 300
10 500 180
5 650 70
From the above market demand and supply schedules, it is convenient to plot points on thegraph and derive the demand and supply curves respectively. (Fig. 9.1 ).
Fig 9.1 Price Determination under Perfect Competition
DD represents the demand curve and SS the supply curve. The two curves intersect at pointE. This point of intersection is called the point of equilibrium – because it is at point E that quantitydemanded equals quantity supplied, viz. 300 units. The possible level of price at which QD=QS isRs. 20/-. It is also called the equilibrium price or the market price, because it is at this price that
quantity demanded and quantity supplied are in equilibrium.
At pt E, Qd x= Qs x. E is the point of equilibrium between qd x and qs x and OP is the Equilibri-
um Price because for OP as the price Qd x = Qsx. Thus, the price of commodity X in the market
under perfect competition is fixed at the point of intersection of demand and supply curves
.
9.4 TENDENCY TOWARDS ONLY ONE PRICE
We may further note that there exits the tendency towards prevalence of only one pricefor the commodity in the market under perfect competition. (Fig. 9.2). Let us assume that theprice instead of being Rs. 20/- is Rs. 30/-. Then when the price is Rs. 30/-, the sellers are prepared tosell more. At Rs. 30/- as the price, supply is likely to expand to 400 units but at the same time, de-mand will contract to only 200 units. Thus, supply is in excess of demand when the price is Rs. 30/-.Sellers will compete with each other to dispose of their stock, and this will result in lowering of theprice. Therefore, when supply is in the excess of demand, the price will start falling from Rs. 30/- to
Rs. 20/- at which point the quantity demanded will equal quantity supplied and the original equilibriumpoint will be restored.
Y
60 D
S
50 • •
40 • •
S Exceeds D
30 • •
P E
20 •
10 • •
S • D Exceeds S • D
O 100 200 300 400 500 600 700 X
Quantity of X Demanded and Supplied
Fig 9.2 Prevalence of Only One price
If the price were now to go below the original price, assuming the price to be Rs. 10/-, then atthis price the buyers will demand more units of commodity X; the new demand at price of Rs. 10/- willgo up to 500 units, but the sellers will be less prepared to sell commodity X at this low price. The sup-ply will shrink to only 180 units. Hence when the price falls to Rs. 10/- demand will exceed supply andthere will be competition among the buyer to buy readily the units of commodity X because it is goingcheap in the market. This competition will lead to the pushing up of the price. Now, the price will startrising till it becomes Rs. 20/-; and where quantity demanded and supplied of commodity X once againbecome equal. This tendency towards the prevalence of only one price is the acid test of perfectcompetition.
9.5 EFFECTS OF SHIFTS IN DEMAND AND SUPPLY ON THE PRICE LEVEL
Why does the price rise ? The price rises in the market because of two theoretical conditions:
i) When demand increases i.e., when the demand curve shifts to the right (Fig. 9.3). Let usassumed that the original equilibrium point is E
and OP is the original market price. Now when the demand increases, the demand curves shifts to theright and new demand curve is D1D2. This curve intersects the supply curve at point E’. Thus E’ is thenew equilibrium point and the new price is now OP i , which is higher than the original price OP, therebyshowing that price rises when demand increases. (Fig. 9.3)
ii) When supply decreases, i.e. when the supply curve shifts to the left. (Fig. 9.4) Let us as-sume that E is the original point of equilibrium and OP is the original price level. Now when supply de-creases, the supply curve shifts to the left and the new supply curve is S 1S2. The new equilibriumpoints now becomes E’ and the new price is OP’, which is higher than the original price OP; thus whensupply decreases, the price rises.
When will price fall?
The price will decline when :
i) The demand decreases, i.e. when the demand curve shifts to the left. (Fig. 9.5)
Y SD
D1
E P
P’
DS
D2
O M’ M X
Quantity Demanded and Supplied
Fig 9.5 When demand curve shifts to the left.
Let us assume that E is the original point of equilibrium and OP is the original price level. Nowwhen demand decreases the demand curve will shift to the left and D1D2 will be the new demandcurve. E’ will be the new equilibrium point and the new price will be OP’ which is lower than the origin-al price OP. Thus, when demand decreases, the price will decline.
ii) The supply increases, i.e. when SS curve shifts to the right. (Fig. 9.6)
Y D S
S1
EP
E’P’
D
O M M’ X
Quantity Demanded and Supplied
Fig 9.6 When Supply Curve shifts to the right
Let us assume that E is the original point of equilibrium and OP is the original price level. Now,when the supply increases, the supply curve will shift to the right. The new supply curve will be S1S2.and the new point of equilibrium will be E’. The new price will now be OP’ which is lower than the pre-vious price OP. Thus, the price will decline when supply increases. Thus shifts in demand and supplycurve will influence the price.
Perfect CompetitionPerfect competition is an economic model that describes a hypothetical market form in which no
producer or consumer has the market power to influence prices. According to the standard economicaldefinition of efficiency (Pareto efficiency), perfect competition would lead to a completely efficient
outcome. The analysis of perfectly competitive markets provides the foundation of the theory of supply
and demand.
Requirmen for perfect compitition:
Perfect competition requires that the following six parameters be fulfilled. In such a market,
prices would normally move instantaneously to economic equilibrium.
i. Atomicity
An atomistic market is one in which there are a large number of small producers andconsumers on a given market, each so small that its actions have no significant impact on
others. Firms are price takers, meaning that the market sets the price that they must choose.
ii. Homogeneity
Goods and services are perfect substitutes; that is, there is no product differentiation. (All
firms sell an identical product)
iii. Perfect and complete information
All firms and consumers know the prices set by all firms (perfect information and complete
information).
iv. Equal access
All firms have access to production technologies, and resources are perfectly mobile.
v. Free entry
Any firm may enter or exit the market as it wishes ( barriers to entry).
vi. Individual buyers and sellers act independently
The market is such that there is no scope for groups of buyers and/or sellers to come together
with a view to changing the market price (collusion and cartels are not possible under this
market structure)
Behavioral assumptions of perfect competition are that:
Results:The model is a description of one type of market structure, most closely approximating only a few
markets, such as agriculture. In real-world markets, any of its assumptions may be violated. For example, firms will never have perfect information about each other. Its usefulness as a scientific
construct may be judged by the range of market behavior explained by it and as a standard for
comparison with other market structures.
In a perfectly competitive market, there will be allocative efficiency and productive efficiency.
Allocative efficiency occurs when price (P) is equal to marginal cost (MC), at which point the
good is available to the consumer at the lowest possible price.
Productive efficiency occurs when the firm produces at the lowest point on the average cost curve(AC), implying it cannot produce the goods any more cheaply. This would be achieved in perfect
competition, since if a firm was not doing it another firm would be able to undercut it by selling
In contrast to a monopoly or oligopoly, it is impossible for a firm in perfect competition to earnabnormal profit in the long run, which is to say that a firm cannot make any more money than is
necessary to cover its economic costs. If a firm is earning abnormal profit in the short term, this will act
as a trigger for other firms to enter the market. They will compete with the first firm, driving the market price down until all firms are earning normal profit, it could be said that abnormal profit is 'competed
away'. On the other hand, if firms are making a loss, then some firms will leave the industry, reduce the
supply and increase the price. Therefore, all firms can only make normal profit in the long run.
It is important to note that perfect competition is a sufficient condition for allocative and productive
efficiency, but it is not a necessary condition. Laboratory experiments in which participants have
significant price setting power and little or no information about their counterparts consistently produceefficient results given the proper trading institutions
(Smith, 1987, p. 245).
Shutdown Point:
When a firm is making loss, it will have to decide whether to continue production or not. This
decision will, in fact, depend on the different total costs levels and whether the firm is operating in the
short run or in the long run.
If the firm is in the short run, and is making a loss whereby:
Total costs (TC) is greater than total revenue (TR)
and whereby total revenue is equal to total variable cost (TVC)
It is advisable for the firm to continue production. If it fails to achieve these conditions, it is advised to
close down so that the only costs the firm will have to pay will be the fixed costs.
Even if the firm stop producing, it will have to continue to meet the level of fixed costs. Since whether
the firm produces or not, it will have to pay fixed costs, it is better for it to continue production in an
attempt to decrease total costs and increase total revenue, thus making profits. This can be done by:
Increasing productivity. The most obvious methods involve automation and computerization
which minimize the tasks that must be performed by employees. All else constant, it benefits a
business to improve productivity, which over time lowers cost and (hopefully) improves abilityto compete and make profit.
Adopting new methods of production like Just In Time or lean manufacturing in an attempt to
reduce costs and wastages.
In the long run, the condition to continue producing requires the price P to be higher than the ATC, i.e.the line representing market price should be above the minimum point of the ATC curve.
If P is equal to ATC, the firm is indifferent between shutting down and continuing to produce. This caseis different from the short run shut down case because in long run there's no longer a fixed cost
endeavors patent – exclusive government-granted right to sell or use any new art, machine, item of
manufacture, or compositioncopyright – exclusive right given to an author or artist to sell, publish, or reproduce hisor her work for their lifetime plus 50 years
2) Producers and consumers are reasonably well-informed about conditions and opportunities
3) Resources are free to move from one industry to another
4) Prices reasonably reflect the costs of production, including rewards to entrepreneurs
If any of these four conditions are altered significantly, a market failure occurs
Inadequate competition
Collusion in oligopolies
Dangers of monopoliesDenies consumers the benefits of competition
Production is restricted
Least efficient form for resource allocation
Influence politics by wielding its economic might
Restricted number of buyers (demand side) dictating terms to many different suppliers vying for busi-ness (buyers of skyscrapers or commercial airliners)
Inadequate information
If resources are to be allocated efficiently, consumers, producers, and government officials must have
adequate information about market conditions.
Where can the best use be made?Where can the best profit be made?
What products do consumers want?Which company should we invest in?
Resource immobility
Land, labor, capital and entrepreneurs need to be free to move to markets where returns are the highest.
In reality this is difficult to achieve in the real world such as with the closing of a factory in a small
A market structure in which, several or many sellers each pro-duce similar, but slightly differentiated products. Each produ-
cer can set its price and quantity of its productions without af-fecting the marketplace as a whole.( Adapted from http://www.investorwords.com/3111/monopolistic_competition.html)
CHARACTERISTICS:
• Many Producers and Consumers in an industry.
• Consumers have clearly defined preferences – indicating that each has his or her
own ‘ideal’ needs, wants and expectation of a product.
• Producers attempt to differentiate their products from their competitors –
indicating the need for innovations; hence goods and services are dissimilar.
• Few/ Low barriers to entry and exit.
Examples of industry in Monopolistic Competition includes automobiles, toothpaste, furnaces, restaur-ant meals, motion pictures, romance novels, wine, beer, cheese, shaving cream and many more due to
economies of scale in production and for product differentiation.
NATURE :
Monopolistically competitive firms are inefficient. (E.g. costs of regulating prices for every productthat is sold in monopolistic competition by far exceed the benefits. Basically, in MonopolisticCompetition model, firms are free to set price and quantity)
Monopolistic competition fosters advertising and the creation of brand names. (These
advertising induce customers into spending more particularly the consumers products because
of the name associated with them rather than because of rational factors.
Such nature of the industry leads to a competitive environment
It also allows increasing returns to scale in production, and presence of differentiated
INTRA-INDUSTRY TRADEIntra-industry trade refers to the exchange of products belonging to the SAME
INDUSTRY, or broad product group. The term is usually applied to international
trade, where the same kinds of products and services are both imported and
exported.CHARACTERISTICS:
• Involves the exchange of differentiated products
• Take advantage of important economies of scale in production and product
differentiation. (which leads to International economies of scale – sharp increase in in-
ternational trade in products and components, setting up of facilities abroad etc)
• Enjoys internal economies of scale present in industries.
E.g. Internal economies of scale is where the cost per unit depends on the size of an individual firm but not necessarily on that of the industry which leads to imperfect competition.
• Stimulates innovation and benefits consumers because of the wider range of
choices available at lower prices.(E.g. the average cost per unit lowers as the number of goods produced increases).
NATURE :
Cost efficiency & Product Quality BenefitsEconomies of Scales, consumer needs and wants differs as well as differences in
consumer behaviours (in terms of expectations)
Examples on Intra Industry trade:-
1. Entrepot trade
An entrepôt - a trading centre, or simply a warehouse, where merchandise can be imported and
exported without paying import duties, often at a profit. (E.g. Instead of having the ships to travel the
entire length of a long trading route, it can chose to sell to the entrepôt – a form of imported goods(whereby in domestic country could also be producing relatively similar product), however, this
entrepôt has the benefit of re-selling(export) its buys at a higher price.
2. Seasonality
For example, in agricultural products, apples, which may be exported all around the world during its
growing season, but imported during its poor growing seasons in order to meet its domestic needs.
3. Transport costs
Intra-industry trade may occur when transportation cost can be saved. Take for instance, both country A
and B are producing the same goods. Both decides to sell to Country C. Country B is assumed to be
located further away from country C as compared to Country A. To save transport cost, Country A and
B may decided to engage in an Intra-industry trade activity whereby, Country B sell its productions as alesser profit margin to A and A in turn may export it at a much higher profit margin.
Example of intra-industry trade: US trade with Mexico
The table below lists the top 7 exports and imports to and from Mexico for 1998. The top 3 imports from Mexicoto US are Electrical machinery and equipment, vehicles, nuclear reactors, boilers, and related items. Interest-ingly, the US’ top 3 exports to Mexico are also these 3 categories. The similarity of exports and imports between
US and Mexico represent intra-industry trade, giving consumers variety of choice of available products. Out of these imports and exports, about 80% represent intra-industry trade
http://www.washburn.edu/sobu/dnizovtsev/200P10ans.htmlc. …allocation of resources in both market
structures is inefficient.TRUE. The long-run equilibrium in a monopolistically competitive market corresponds to the case
when the demand curve each firm is facing is tangent to its ATC curve. Due to the negative slope of the
demand curve, such tangency never occurs at the minimum of ATC. Hence allocation is inefficient. (It
would be if the demand curve was horizontal.)A monopolist is concerned only about profit maximization (MR=MC), and cost minimization is not ne-
cessary. The quantity where MR=MC can be anywhere on the ATC curve.
2. In the long run, firms in monopolistic competition
a. produce at the point where the average total cost curve is tangent to the demand curve.
b. earn positive economic profits.c. produce at the minimum point of their average total cost curves.
d. face steeper demand curves than in the short run.
e. produce at a point where MC>MR.
> Compared to H-O model which is based on comparative advantage or differences in factor endow-ments (labor, capital, natural resources and technology) among nations, intra-industry trade is likely to
be larger among industrial economies of similar size and factor proportions (when factors of productionare broadly defined)
> Socially, intra-industry trade is more readily accepted as all the nation’s factor endowments benefit
from this as compared to the strong opposition to inter-industry trade that usually involve lower realwages and massive reallocations of labor to other industries in industrial nations.
What are the differences between perfect competitve market an monopoly market?
his is a rather common question within the Market Structure topic in Economics. In Market Structure,
the Perfect Competition (PC) and the monopoly are considered extreme market structures, while other
market structures also exist, like the oligolpoly and the monopolistic competition(MC). Before under-standing the differences of these 2 market structure. It's important to realize that the PC market struc-
ture consists of many firms or sellers in an area or industry. The monopoly on the other hand, consists
of a single seller. A good example, would be someone selling things on an island. The differences between the PC and the monopoly market structure are (1) Ease of entry and exit for firms (2) Type of product sold (3) Type of firm (4) Profit in short run and long run. First of all, is (1) ease of entry and
exit for firms. For the PC market structure, new firms can easily enter the market structure, as there are
no barriers of entry. This means that new firms who knows that there is a profit to be made in somearea, location or industry can easily set up a new shop there. For the monopoly, there is substantial or
high barriers of entry preventing new firms from entering the market structure. These barriers of entry
are created by existing or dominant firms in a monopoly to prevent new firms or competitiors to enter the market structure. The second difference is (2) the type of product sold. For a PC market structure,
the product sold is similar. This means that what one seller is selling, is what another seller is selling.
Hence products in the PC market structure are perfect substitutes. We also assume that in PC market
structure, the consumers have perfect knowledge of the product. This means that the consumers areaware of the price sold in another shop. For the monopoly, the product sold are not perfect substitutes,
and can be rather unique. The third difference is the (3) type of firm. Since the PC market structure
faces the above 2 characteristics, this means that the firm in this market structure are powerless to influ-ence the price. This means they have no control to increase the price of the product. This is because if
they increase the price of the product, and there are perfect competition, firms who increase the price,
will lose out to other firms. Hence firms in PC market structure are considered to be Price Takers. Firmsin monopoly market structure on the other hand, are Price Makers. This means that they can influence
the price of their product sold to consumers. The monopoly is able to do that, as the monopolist is the
single seller in a market. The last difference is the (4) existence of profit. For the PC firm, there is a possibility to earn abnormal profit in the short run, but not possible in the long run. This is because, in a
PC market structure, when existing firms earn profit, new firms will enter the market structure, shrink-ing the profit. For the monopoly, there is a possibility to earn abnormal profit in short run and long run,
as there is the existence of barriers of entry to prevent new firms to enter the market. Hope this helps.
