Features of Perfectly Competitive Market - Essay Example

In a market where there are various industries that have diverse characteristics and qualities, a firm has to be in a proper environment and in a proper setting and venue for it to prosper. The capitalist economy offers different environments that will maximize the productivity and growth of the firms included in it. To achieve this goal, a firm should locate the appropriate market structure wherein it can effectively transact with its customers and sell its product. Knowing this would boost its performance and competitiveness. A market is a "social arrangement that allows buyers and sellers to discover information and carry out a voluntary exchange of goods and services (Market)." In an economy, there are different kinds of market structures that a firm should operate in, depending on what industry the firm is affiliated and what goods and services it sells. The market has various structures under which firms operate. A market structure is the method or system wherein "the suppliers and demanders in an industry interact to determine price and quantity (Deardorff, 2001)." There are four main market structures: perfect competition, monopoly, oligopoly, and monopolistic competition. The categorization is based on the extent and characteristics of competition in the market that affects the behavior of both the buyers and sellers (Fischer). One consideration in analyzing market structures is how the price of a particular product affects the quantity demanded of the product. The relationship between the price of a product and the quantity demanded is measured by the price elasticity of demand (PED). Perfect competition A perfect (pure) competition is a market wherein potential and actual buyers and sellers are so many that both market players have very limited individual influence in the market. Because of the huge number of participants in this market structure, individual producers and consumers are heaviliy dependent on the market forces and mechanisms. A perfect competion has different assumed characteristics. Primary of these is that all the firms in this market structure are selling an homogenous, identical, or standardized product. They are perfect substitutes for one another. This means that when one firm failed to produce a product that buyers expect, the product of other firms can immediately replace it. The second character of a perfectly competitive market is that firms are price takers. This means that no single firm can affect the price. Because of the numerous firms that produce and sell an identical product. Their number makes their influence insignificant. Buyers of this product are also many. Consumers have the information regarding the prices that all sellers in the market charge. This makes consumers sensitive to the changes in price. If one firm raised the price of its product, buyers can easily switch to another firm's product, which is, as mentioned above, a perfect substitute. All firms are assumed to have equal access to resources and improvements in production technologies achieved by one firm can spill-over to all the other suppliers in the market. No one is assumed to be privileged when it comes to acess to technology and other factor inputs. Another notable quality of perfect competition is its freedom of its firms to enter in and exit from the market in the long run. This means that the market is open to competition from new suppliers. The existence and the absence of an individual firm does not affect the overall market. Price Elasticity of Demand in Perfect Competition In a perfect competition, the demand curve is perfectly elastic. This means that a change in price of a good in this market structure will greatly affect the quantity that consumers demand. As mentioned above, any increase in price will cause the demand for the product to fall. If one internet service provider raises its price, customers will find another firms that provide the same, standard product. Features of Perfectly competitive market With the mentioned qualities above, a product in a perfectly competitive market has lower prices. This is because of the huge number of competing firms, which are cautious of the imminent negative effect if they increase the price. Because a single firm are just price-taker, any attempt to increase the product's price could make the consumers is to find another identical product, which is very easily achieved because of the abundance of perfect substitutes. Due to the ease in entry in the market of new players, competition makes the profits of the firms lower. Since the market is too crowded with firms, price would fall down. This would, in turn, generate just meager profit for producers. Industries with a fewer players enable producers to influence the price of their product. A by-product of competition is efficiency of the industry. Because of the cautiousness of individual firms to be outrivaled by their competitors. Thus they will try to minimize cost to maximize their profit. They also aim to move towards productive efficiency. The fear of being eliminated from the fierce competition would force them to come up with technological innovation and improvement. Improved technology will likely improve the quality of the product and productive capacity of the firm and the industry as a whole (Perfect Competition - Introduction). Monopoly As a direct contrast of perfect competition, a monopoly is an industry that has only a single seller of a good and service, which has no close substitute. In a capitalist society where perfectly competition is heavily favored by economists, monopoly was not favored by most economists. However, some economists regard this market structure an "exceptional case in a modern economy (Causes of Monopoly). " There are reasons why monopoly is existent in an economy. The first reason is the protection that an inventor enjoys temporarily after receiving a patent from the government. This is done by governments to encourage inventors and innovators in coming up with technologies that will improve human condition. Polaroid, for instance, was temporarily given the exclusive right to produce instant cameras. (Patents). The second reason is the control of input resource. (e.g. monopoly of aluminum in US). Another reason is the government grant of monopoly for the benefit of the public. Public goods and utilities, such as water and electricity are monopolized by the government to come up with a price that will be affordable to everyone. Characteristics of a pure monopoly Aside from being a single producer, the product of a monopoly has no close substitute. The product is either rare or the method or technology of producing the product has just been recently discovered or invented. This attribute gives the monopoly power over the price and the quantity of goods it supplies. The presence of barriers of entry of competitors is another characteristic of the monopoly market structure. Primarily because of the product's uniqueness or the very huge cost that a possible competitor can face once he will produce the same product, prospective producers would likely be discouraged to compete with a monopoly. In a pure monopoly, the firm is the sole price maker. Since it controls the supply of the whole industry, it can set the price of the product. It has the capacity to control the market by setting the price and the quantitily of products being suppiled by the firm (Monopoly). Unlike in perfectly competitive market structure, a monopoly has the sole right to control the price and quantity of the product it supplies to the market. Underneath this also lies the exclusive responsibility to improve the efficiency and quality of its production. Price Elasticity of Demand in Monopoly In contrast to perfect competition, the demand curve of a monopoly is highly inelastic. Any change in price produces less effect on the number of the demanded quantity of the product. Since a monopoly, like electric company, is a sole seller of the product, consumers will bear the price the producer sets. However, if the electric company raise the price to a level that the majority of consumers can no longer afford, they may resort to other near substitute aside from that which the monopoly solely offers. Oligopoly Oligopoly is a market structure that has a few sellers. There has been no single theory to explain how firms determine the price and output. However based on experience, an oligopoly ordinarily shows certain features. Features of a Oligopoly Product differentiation and brands are evident in an oligopoly. Automobile manufacturers, for example, produce different brands to cater different social classes. Like monopoly, an oligopoly has significant entry barriers that discourages new entrants from proceeding. Establishing a company under this market structure is very costly. Oil refineries needs huge amount of money that no ordinary investor can set up. Decisions under oligopoly are being made interdependent of other players in the industry. This means that the probable reactions that a firm's rivals in an oligopolistic setting is very important. Since they are only few compared to a perfect compitition, any change in their competitors significantly affect individual companies. Another noticeable quality that an oligopoly has is the presence of non-price competition. While in perfect competition, additional services that will influence consumers to buy products is unimportant, it matters greatly in oligopolies. The existence of extended operation hours of supermarkets and gas stations can significantly improve the chances of obtaining increased sales (Riley). Advertising and other marketing campaigns are very important in introducing the product to the consumers in this kind of market. It is also a strategy that would create a more attractive and appealing image to the market. Price Elasticity of Demand in Oligopoly The demand curve of an oligopoly is kinked. Above the kink, demand is relatively elastic. This is because all other players in the oligopoly haven't changed their price. When the price falls below the kink, however, demand will become relatively inelastic since other firms will set the same price cut. This will eventually result into a price war. The kink point serves as the equilibrium point, the best price that a producer in an oligopoly can set. Monopolistic Competition The most striking feature of monopolistic competition market structure is its quality of being a hybrid of the qualities of perfect competition and a monopoly. A firm in this market structure has the freedom of entry enjoyed by perfect competition while, at the same time, producing imperfectly substitutable products of monopolies. Features of a Monopolistic Competition There are many firms in a monopolistic competition, identical to perfect competition. The difference between the two is that in the former produces differentiated products while the latter produces standardized ones. A producer of a toothpaste, for example, may produce a wide array of flavors from spearmint to wintergreen. Free entry and exit of firms in response to profits in the industry is also evident in a monopolistic competition. This means that once firms gained positive economic profits, it will serve as a signal to others to open up similar firms producing the same products. On the other hand, if firms lose money, thus making negative economic profits, then, gradually, firms will exit out of the industry. Another quality of monopolistic competition is that these differentiated products are imperfectly substitutable in consumption. Meaning if the price of one product rises, a fraction of their customers would switch their purchases to another product within the industry. On the part of the customers, their demand for differentiated products is sometimes described by using these two distinct approaches the love of variety approach and the ideal variety approach. The love of variety approach has an assumption that each consumer has a demand for many product variants over time. On eating in a restaurant, most consumers frequently switch from one kind of delicacy to another. One day a consumer prefer to eat at an Italian restaurant, the next day at a German restaurant and so on. On the other hand, the ideal variety approach assumes that each product is made up of a collection of different characteristics. In the case of an automobile, it has different color, engine features, etc. Each customer is assumed to have his own distinct preferences, his ideal choice from the rest of the automobile's attributes. These two attitudes of customers shows the feasibility of the existence of monopolistic competition in the market. By having the love of variety, buyers select a product suited for his own personal preference. Knowing the various needs and wants of consumers, a firm in a monopolistic competition continually finds ways to seize the opportunity that love for variety of its customers bring. This can give them the edge over their competitors in increasing their profits.(Suranovic). Price Elasticity of Demand in Monopolistic Competition The demand in monopolistic competition is highly elastic. This means that change in price can affect the quantity demanded of the product. However, unlike perfect competition, it is not perfectly elastic. The reason for such is that products are imperfect substitutes. Brand and product loyalty still restricts consumers to freely shift to other variants. Works Cited "Causes of Monopoly" 2006. 20 Mar. 2007. Deardorff, Alan V. "Market structure." 2007. Deardorff's Glossary of International Economics. 20 Mar. 2007. "Perfect Competition - Introduction" 2007 Tutor2u Limited 20 Mar. 2007. . Riley, Geoff. "Oligopoly - Overview" Sep. 2006. Tutor2u Limited. 20 Mar. 2007. Stigler, George J. "Monopoly." 2002. The Concise Encyclopedia of Economics The Library of Economics and Liberty. 20 Mar. 2007. Suranovic, Steven M. "Model Assumptions - Monopolistic Competition" 2007. International Trade Theory and Policy. 20 Mar. 2007. Read More