The nature of perfectly competitive markets - Essay Example

?Project on Introduction to Economics By (please place all data on the page) This paper deals with understanding the nature of perfectly competitive markets. Perfect competition means pure competition in a perfect market. A full market competition is an idealized form. In perfectly competitive markets, short-run profits are possible. However after the entry and exit of firms, a situation of long-run equilibrium results in zero profits. The aim of this paper is to understand and analyze this adjustment process and how it affects the typical firm and the market. There are two ways of observing at what the perfect competition mean in terms of neoclassical economics. The very first focus should be on the lack of ability of one agent for affecting prices. This matter can be justified by the fact that one consumer or firm is very small if compared with the entire market and the presence or absence of the firm or consumer does not affect the equilibrium price. The hypothesis of impact of each and every agent on the equilibrium price was done by Aumann in the year of 1964. There are some differences between the approach of Aumann and the normal textbooks (Robert, 1966). The firms or consumers have their own power to decide the prices of their own products but the thing is it does not affect the market. Secondly, the consumers and agents consider the price as their parameters. The results of both the approaches are almost same. Another approach of perfect competition can be achieved in terms of the consumers taking advantage by eliminating the some exchange opportunities that are profitable. The competition in market increases when the arbitrage takes place in market faster. The average market price can be adjusted if the market is more competitive. It also depends on the supply and demand of the products. According to this approach, the meaning of perfect competition is the adjustments occur instantly in perfect ways. Firstly, the notion of the perfect competition needs to be understood. The following properties must be ensured so that a "perfect competition" is possible: many buyers and sellers homogeneous goods full market transparency prevails all market participants are "price taker" market participants have no influence on the price of the goods No transaction costs No taxes free market access In a perfect market, supply equals demand. Thus, there is only one price where the market is cleared. This is called the equilibrium price. On the basis of market transparency, it is not possible to achieve excess profits. This means no profits on the pay related factors (rent, interest, and wages) beyond production. The provider cannot rate any higher price because they would find no buyers and the buyer can not demand a lower price because no company in the market would offer a lower rate. A market consists of potential buyers, who determine what amount of a commodity should be brought into the market (O'Sullivan, 2003). The demand from retailers determines the supply of goods. The market is not tied to a particular place but can be seen as abstract. There are different considerations which are provided in a perfect competition market. The problem with perfect competition markets is that after the companies have entered or left the market, equilibrium sets in. This does not let profits to increase and all the companies involved are stuck in a situation with no improvement. A demand curve can be used to explain this. The following demand curve D shows the relationship between commodity prices and the quantity demanded by the consumer. The demand is determined by the price of the goods. Price is on the Y axis and quantity is on the x axis. Law of demand curve states that other things being equal; the demand decreases if the price rises and if the price drops. Thus, the negative demand depends on price. Demand curve refers to a single company, and measures the correlation between output and market price. The demand curve is not only dependent on the consumer behavior, based on the product of the individual operator, but is in direct competition with other market participants. On the other hand, market demand curve refers to the relationship between the output and the total amount of goods traded on the market. The market demand curve is thus dependent only on the consumer demand. Reasons for the shift in demand curve: Factors affecting demand Income Preferences / taste Expectations Number of buyers Changes in these factors may shift the demand curve. It can lead to an increase in demand or demand reduction (Wells, 2005). The market economy in theory leads to a performance-based distribution of income because the income is influenced by things such as education, professional qualifications, as well as motivation and personal performance. It follows naturally that less qualified people are inferior to the more qualified on income levels. In practice, the income distribution is also influenced by different initial conditions, which can be subsumed under the concept of market power. Due to state regulations, such as redistribution, income inequality can be reduced. This is where a perfect competition scenario comes in. Here there is a danger that particular case-by-state intervention into the market economy often leads to side effects, for which intention may partially be reversed. When companies enter the perfect market, initially, they can make short term profits. But after some time, due to the equilibrium, the profits of the companies get controlled and limited. There are a lot of rival companies involved all of whom offer the same products or services. Thus, in order to survive, a common price is fixed. The entire market is transparent and no company can increase or decrease the stipulated price in order to make bigger profits. Thus, the return of each company involved gets fixed. The profit percentage cannot change. If new companies enter the market or some companies leave the market, the equilibrium breaks for some time and short term profits can be made. But as soon as the adjustment process is over and the equilibrium resets, the old scenario returns. Supply curve is meant to sell the quantity that sellers offer at a certain price. The supply curve S refers to the relationship between the amount of the goods offered by the seller and the price of commodities. The offer of a commodity is determined by the price. Set of the offer: The offer is positively dependent on the price when other things are equal. This means that the price raises when supply increases and price will decrease when supply decrease. Supply Curve and Market supply curve: Supply curve: this is the single offer of a commodity at a specified price by a single company, which competes with other companies on the market. Market supply curve: this is the sum of all providers in the market, which is a homogeneous product on the market to offer a certain price. Reasons for the shift in supply curve are factors that influence the supply of seller: Input prices Technologies Number of sellers Change in these factors can shift the supply curve. In market equilibrium, the demand and supply determine the quantity produced and the market price of a good. It is a balanced market emerged when one speaks of a cleared market. Cleared market means the intentions of the buyer and the seller of the sale plans. The intersection of the supply curve and demand curve is the market equilibrium. When the price in the two curves intersects is called the equilibrium price or market clearing price P*, i.e. when buyer wants to buy the quantity or the demand is equal to the amount the providers want to sell. The amount is the equilibrium quantity. When the demand on the market is greater than the supply, it should be assumed that a small price to P depends on the market, there is no equilibrium price that reflects: P ' Read More