Perfect Competition/Microeconomics - Essay Example

? Microeconomics: Perfect Competition Microeconomics: Perfect Competition Introduction Economics is a social science concerned with the production, distribution and consumption of goods and services (Dilts, 2004). It is mainly divided into microeconomics and macroeconomics. Microeconomics basically focuses on the supply and demand theories while macroeconomics is concerned with the national economy. Microeconomics identifies areas where a market fails to give efficient results and describes the conditions required for perfect competition. The law of demand and supply assumes that markets are perfectly competitive and none of them can influence the prices of goods and services. Although economics is divided into two categories, this article is mainly going to cover microeconomics and how it affects businesses, with a bias on perfect competition. Characteristics of Perfect Competition Microeconomics deals with how individuals, households and firms come up with decisions to allocate scarce resources in markets (Dilts, 2004). It examines how these decisions which determine prices influence the supply and demand of goods or services. Perfect competition is a tool used in the business world and especially in microeconomics to determine the price of goods and services. According to Dilts (2004), perfect competition is a situation in the market whereby the number of buyers and sellers of homogenous commodity is very large or very small to have any degree of individual control over prices. Therefore, firms that are operating under perfect competition are price takers and not price makers According to Hub pages (2011), a perfectly competitive market will only exist when all participants are price takers and none of them influence the price of the product it sells or buys. The main characteristics of perfect competition include: Homogeneous Product All sellers sell homogeneous products hence buyers cannot prefer the product of one seller over the other. The products of one firm are substitutes for another firm’s. Therefore, incase one firm increases the price of its products above the market price then it is likely to lose all its sales to other firms that sell their products at the market price. Free Entry and Exit of Firms A business can easily enter or leave a perfectly competitive market as there are no legal barriers that control the entry and exit of firms from any industry. This means that any new firm can easily enter a market if it stands to gain. Also, existing firms may leave the market incase they are experiencing losses. Absence of Transaction/Transport Costs In perfect competition buyers and sellers do not incur any costs in making any exchange since it is assumed that every firm posses equal access to the market. In other words, no sing firm has greater privileges over other participating firms in the competitive market environment. Large Number of Sellers and Buyers A perfectly competitive market is composed of a large or infinite number of small firms in which no single firm is too large compared to the whole market that it can influence the price of the product it sells. This implies that the quantity of products sold by an individual firm is so small that even if it withdraws from the market the total supply would not fall to an extent that the price of the product would increase. Perfect knowledge The quality and prices of products in the market should be known by all consumers and producers. This means that buyers cannot pay a price higher than the prevailing price in the market. Similarly, sellers also cannot sell their products at a price below the one dictated by the market. Perfect Competition Examples One example of perfect competition is farming. In the agricultural sector, several farmers in some cases produce farm outputs and sell it at fixed prices to the government. There is no possibility of one particular farmer hiking prices of his/her produce while all other suppliers are selling the same product at a fixed price. Yet another example of perfect competition is in regard to internet service providers (ISPs). There are numerous other companies that sell their products under perfect market situations. One main characteristics of this kind of market in practice is that prices generally get lowered or raised by all participating companies at more or less the same time. Advantages and Disadvantages of Perfect Competition Like every other kind of market, the perfect market is often associated with numerous advantages and disadvantages. Fogiel (2000) gives the following advantages and disadvantages of perfect competition. Advantages of Perfect Competition In a perfectly competitive market there is optimal allocation of resources because the price of the products equals the marginal cost. The competition between firms also encourages efficiency because the firms produce at the very lowest point of the average cost. In addition, there is no wastage of resources through advertisements since products are homogeneous. Perfect competition is also very responsive to consumer wishes since any change in demand leads to extra supply. Disadvantages of Perfect Competition In perfect competition there is lack of economies of scale because the many small firms produce relatively small quantity. Therefore, this implies that firms with highly fixed costs would be unsuitable to perfect competition. There is also lack of product variety hence consumers are denied the freedom of choice. Perfect knowledge discourages development of new technologies because they would be used with other companies. Externalities such as pollution in production and consumption may also lead to market failure without the intervention of the government. Conclusion Perfect competition in the business world and especially in microeconomics is a market situation in which no supplier or company has power to solely impact the prices of a homogeneous product. Such a market condition has a number of special characteristics, and is associated with unique advantages and disadvantages. According to Fogiel (2000), perfect competition does not actually exist but it is merely theoretical, not practical. This is because the rules that apply in such a market are very strict and may therefore not be met by existing situations in real life. However, in practice, there exists a competitive market that does not rely on the strict criteria of a perfect competition. References Dilts, D. A. (2004) Introduction to Microeconomics E201, Department of Economics, School of Business and Management Sciences, Indiana - Purdue University - Fort Wayne http://www.ipfw.edu/econ/courseschedule/Books/E201book.pdf Fogiel, M (2000) Microeconomics: Super Reviews; All You Need to Know Series Research & Education Assoc. http://books.google.co.ke/books?id=-ldygVZ4Q1wC&pg=PP10&dq=Advantages+and+Disadvantages+of+Perfect+Competition&hl=en&ei=URZqTfL5Bc2p8QPp0ODyBw&sa=X&oi=book_result&ct=result&resnum=5&ved=0CD4Q6AEwBA#v=onepage&q=Advantages%20and%20Disadvantages%20of%20Perfect%20Competition&f=false Hub pages (2011) Characteristics of a Perfect Competition in business http://hubpages.com/hub/Characteristics-of-a-Perfect-Competition-in-business Read More