Perfect Competition

6 Key excerpts on "Perfect Competition"

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  eBook - ePub

  Microeconomics

  A Global Text

  • Judy Whitehead(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  9 The Perfectly Competitive Market

  Equilibrium of the Firm and Industry in Short-run and Long-run ; Perfect Competition and Economic Efficiency ; Industry Dynamics: Changes in Demand, Costs and Taxes .

  The market structure of Perfect Competition is often considered a highly desirable one particularly from the point of view of economic efficiency in a static, distributive sense. This is in consonance with the view that trading in increasingly competitive markets is, in theory, beneficial to economic welfare because of the greater efficiency in the use of economic resources. While this may or may not hold true in reality, it is nevertheless of importance to understand the intricacies and mechanics of this model which has received so much attention.

  Perfect Competition is the centrepiece of the traditional theory of the firm. It is one of the four basic models of market structure that make up the traditional theory of the firm. The others are Monopoly, Monopolistic Competition and Oligopoly. As a model of market structure, it is used to explain and predict the behaviour of firms which are part of this industry. Furthermore, as one of the so-called ‘marginalist’ models of the firm, the firm is theorized to maximize profits by following the ‘marginalist’ rule of equating marginal revenue with marginal cost.

  These marginalist models are later contrasted with the more modern alternative models of the firm which are included in the study of market structure. Newer models have proliferated since the 1930 and particularly since the 1950s and include the Managerial, Behavioural, Average-cost/Mark-up Pricing and Entry-Prevention models.

  9.1 Assumptions and Fundamentals of the Model

  9.1.1 Basic assumptions

  The basic assumptions of the model of Perfect Competition are as follows:

  • There are many buyers and sellers (firms) in the industry. There are so many buyers and sellers that no single buyer or seller can influence price or output sufficiently to alter the equilibrium of the industry.

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  Business Economics

  • Rob Dransfield(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  In most markets firms compete with each other through the prices they charge. However, in monopoly markets the monopolist is able to set prices. In some instances the government also sets price controls in the form of maximum prices that sellers can charge.

  5.4  Perfect Competition

  As a way of analysing how businesses compete with each other, economists have developed a theory of Perfect Competition. Perfect Competition does not exist in pure form in the real world because there are always differences between sellers. For example, one street vendor of plain colour t-shirts might be more friendly than another vendor of identical items.

  The idea of Perfect Competition that economists have modelled is based on the following assumptions:

  • There would be lots of firms competing with each other;
  • Each firm would produce an identical product;
  • Each producer would know exactly what the others were producing and the prices they were charging;
  • There would be no barriers to new firms entering the market and no barriers to exit, so firms enter or leave the market easily;
  • Each firm would produce only a small percentage of the overall production in the market; and
  • There would be lots of buyers, each of whom would know the prices charged by all the sellers.

  Given these conditions, economists believe that:

  • Businesses would all charge the same price;
  • This price would be the minimum that a business could charge without going out of business;
  • The price would just enable each business to cover its costs and to make the minimum (normal) profit required to keep operating in the market; and
  • No firm would risk charging more than the market price, because they would make no sales if they did so.

  Key Terms

  Normal profit – the profit that a business needs to make to stay in a market. The normal profit that an entrepreneur will need to make is equivalent to what they could make from using their capital and their talent in its next best use – that is, the opportunity cost of remaining in an industry.

  Abnormal profit

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  Foundations of Real-World Economics

  What Every Economics Student Needs to Know

  • John Komlos(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  6    Firms and ImPerfect Competition Wealth, as Mr. Hobbes says, is power.

  Adam Smith1

  We next examine aspects of the microeconomic theory of the firm that are usually glossed over in Econ 101. Standard economic theory focuses on the perfectly competitive model. This assumes that there are innumerable firms which produce a homogenous product. There are no brands since everyone produces the same generic product. So, there is no product differentiation, no differences in quality, and hence no advertisements. There is not much sense in advertising for generic cereal because one firm’s cereal is the same as all the others. These are important features of perfectly competitive markets. However, there are obviously not too many products like that.

  The price of a product in such a market is determined by aggregate supply and demand; consequently, no single firm has the power to influence the price. In such a case every firm is a price taker. Hence, the demand for the product of each firm is given by the market price. Firms will produce as long as they can at least break even at the given price. Consequently, firms are producing efficiently at the minimum unit cost and have just enough revenue to stay in business. In such an equilibrium, price equals both marginal and average cost and the consumer is “king”: firms produce what consumers want (see Figure 3.1 in Chapter 3 ).

  This is fundamentally poor pedagogy, because it emphasizes a market structure that is essentially irrelevant in today’s economy except for homogeneous raw materials in wholesale markets. In our time, practically no consumer good is produced under the above conditions. Rather, the dominant market structure is called imPerfect Competition. The concentration of production implies that firms are not price takers but retain the power to determine prices, wages, and to manipulate consumer wants (Figure 3.2

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  Principles of Agricultural Economics

  • Andrew Barkley, Paul W. Barkley(Authors)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  12The competitive firm

  Plate 12.1 The competitive firm

  Synopsis

  This chapter examines market structure. Emphasis is placed on the four characteristics of Perfect Competition: (1) numerous buyers and sellers, (2) a homogeneous product, (3) freedom of entry and exit, and (4) perfect information. Special attention is given to the desirable property of firms in perfectly competitive industries: efficiency. The chapter uses timely and relevant examples from agriculture and agribusiness to describe strategies for perfectly competitive firms. Since competitive firms cannot influence the prices of the commodities they sell, their best strategy is to continuously attempt to lower production costs by being early adopters of new technologies.

  12.1 Market structure

  Chapter 11 described how the interaction of buyers and sellers determines the market price and quantity of a good or service in a market economy. Here, attention turns to Market Structure , or how an industry is organized.

  • Market Structure = the organization of an industry, typically defined by the number of firms in an industry.

  Market structure, sometimes referred to as “industrial organization,” has a major influence on the prices and quantities of goods and services sold in a market. In general, the number of sellers in an industry is an important indicator of market structure. If there are only a few firms, their behavior and business strategies will be quite different than the behavior and strategies of firms in an industry with numerous competitors.

  The number of firms in an industry varies considerably in a free market economy, especially an economy as large and complex as that of the United States. In the US, residents in a given town or city often purchase electricity from a single firm with no option to purchase power from an alternative source. Similarly, software for the nation’s computers is provided primarily by Microsoft, with a few other options such as Linux. Fast food is available from numerous sources, including McDonald’s, Burger King, KFC, Taco Bell, Wendy’s, and many others. Clothing purchases come from huge chain stores (Macy’s), small locally owned stores, catalogs, used clothing stores (often operated by churches and charities), and the Internet.

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  Economics versus Reality

  How to be Effective in the Real World in Spite of Economic Theory

  • John M Legge(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Nineteenth-century mechanical engineers designing steam engines knew that real steam would not pass instantaneously from the boiler to the cylinder as soon as the valves were opened; even an ideal gas would have some inertia and consequent “Newtonian” viscosity, which would limit the speed at which it could travel. At the piston speed typical of late-nineteenth-century engines, the discrepancy was minor, although neglecting or miscalculating these effects often led to designs for engines that failed to meet their specifications. Engineers soon learned the risks involved in assuming perfection while dealing with the real world. These lessons were slow to pass to economists.

  Perfect Competition is a theoretical state in which an economy, or part of an economy, may exist on the assumption that consumers and producers behave like a frictionless, weightless ideal gas: if producer A offers a lower price than producer B, every consumer will instantaneously transfer their business from A to B, no matter how small the price differential. This is known to economists as the Law of One Price, and as such is part of the dogmatic core of the theory of Perfect Competition. Industrial Organization (IO) economists, as discussed further below, do not consider that Perfect Competition exists in reality, although they tread fairly carefully around the Law of One Price.

  Orwell, in his book 1984, suggested that control of language could become control of thought. The economic concept of Perfect Competition is an example of this: if there is such a thing as perfection, why should anything else be tolerated? Some economists may believe that Perfect Competition is a practical possibility; others realize that the preconditions for Perfect Competition are so stringent as to render it impossible to actually exist as a practical matter of commerce.

  The best that can be hoped for is “nearly perfect” competition, whatever that may be. J. M. Clark introduced the idea of “workable competition” in 1940.3 “Workable” competition is defined as the closest practical approach to “perfect” competition, recognizing that there aren’t an infinite number of firms or consumers and that all products are not fully interchangeable. Clark’s proposal does not seem to have satisfied the generality of economists. S. H. Sosnick published a critique of workable competition in 1958,4

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  eBook - ePub

  Microeconomics For Dummies

  • Lynne Pepall, Peter Antonioni, Manzur Rashid(Authors)
  • 2016(Publication Date)
  • For Dummies

    (Publisher)

  Part IV

  Delving into Markets, Market Failure, and Welfare Economics

  Find free articles on hundreds of topics at www.dummies.com .

  In this part …

  Find out why consumers love Perfect Competition but firms may not.

  Get to grips with what welfare means in economics.

  Discover why monopolies produce less for a higher price.

  Understand how things change when one side of a market knows more than the other.

  Passage contains an image Chapter 11

  Stepping into the Real World: Oligopoly and ImPerfect Competition

  In This Chapter

  Considering the criteria for an oligopoly

  Modeling firms’ strategic behavior in oligopoly

  Differentiating products to soften competition

  Oligopoly is the name economists give to a type of market with only a few firms (it comes from the Greek word oligos meaning few). The classic example of an oligopoly is the airline industry, where a few airlines compete among themselves for customers, and the bulk of the domestic market is locked up among the four largest competitors: American, Delta, United Airlines, and Northwest. But oligopoly is visible everywhere, in industries as different as cable television services, computer and software industries, cellular phone services, and automobiles.

  One of the ways in which economists analyze oligopoly is by comparing it with other market structures. Compared to Perfect Competition, described in Chapter 10 , consumers don’t get as good a deal. But compared to monopoly (which has no competition, see Chapter 13

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