Perfect Markets in Relation to Consumer Demand - Essay Example

? MARKET STRUCTURES Perfect Markets in relation to consumer demand and other markets BY: PRESENTED [Institute /State] [Date] INTRODUCTION: When it comes to economics and marketing, market structures play quite an important role in defining both. A market structure is the type of market that an economy chooses in order to assist in its decision-making. “The extent and characteristics of competition in the market affect choice behavior among the actors.” (Baumol, 1961, p.142) This means that economists are more concern on the attitude of buyers and sellers in the market and then conclude which market structure would be best for a certain economy. With every market structure, however, comes advantages and disadvantages of adopting that particular choice. There are mainly four types of market structures with “perfect competition”on one extreme and “monopoly”on the other (Baumol, 1961, p.142. Furthermore, “monopolistic competition”and “oligopoly” are those salient structures that are counted asthe moderate ones. In this paper, we will be focusing primarily on the Perfect markets. It will incorporate an analysis ontheir relation to consumer demand and the comparison to any other market structure in the economy. PERFECT COMPETITION AND MARKET DEMAND Perfect Market: Perfect competition is “a very large number of firms producing a standardized product.” (McConnel&Brue, 2004) This means that a perfect market is that structure which entails numerous extents of “buyers and sellers” for selling the same kinds of product. Besides this, there are several other noticeable characteristics of a perfect market that are being listed below: In competition oriented perfect market, there are groups of buyers and sellers who are involved. In fact “the number of buyers and sellers is so large that no individual decision maker can significantly affect the price of the product by changing the quantity it buys or sells.”(Hall &Leiberman, 2009, p.251) There is an ideal autonomy of entry and exit in the firm which is why there are a huge number of firms in the market. This means that “firms and resources are freely mobile.” (McEachern, 2011, p. 174) Another distinctive of perfect markets is that they do not have any control on the prices of the commodities in which they trade. Lastly, there is perfect information about prices and technology among both the sellers and buyers. (Besanko&Brauetigam, 2010, p.330) The Perfect Market and the Demand Curve: The demand curve of a perfect market is perfectly elastic which means that it is a horizontal line. “The price elasticity of demand (PED) for a good is a measure of the degree of responsiveness of the quantity demanded to a change in the price, ceteris paribus.” (Quek, 2011, p.2). It happens so because of the fact that the presence of small firms in the market makes it difficult for them to influence the pricing fluctuations of the goods and services that they offer. This leads to an inflexible proposition of prices of products to the consumers and thus, a perfectly elastic demand curve is achieved in this context. The figure below illustrates the demand curve: Figure 1: Chart showing perfectly elastic demand in a perfect market (Source: Google Images) Quek propagates that“demand curve in a perfectly competitive firm is also its marginal revenue curve” (2011, p.2). “Marginal revenue”can be understood as the revenue received by selling one extra unit of production. The demand curve and marginal revenue curve are equivalent in a perfect market competition since the price of goods and services are preciselythe same. The demand curve is identical to the average revenue as well in a perfect market because each product is sold at the same price i.e. the average of the total production. An increase in the price of products in a perfect market leads to the quantity demanded of that product to rise to infinity while a decrease in price leads to the quantity demanded of the product to fall to zero. This is also because there are many substitutes in the market of each product, which is why each product can be easily replaced. Short-run Equilibrium in Perfect Markets: An equilibrium condition is where the demand and supply curve of an economy intersect. At this point, the equilibrium price and equilibrium quantity of a particular product is determined so producers know how much to supply at the price on which consumers will demand the most quantity. The demand curve in perfect competition has already been discussed above. The supply curve in a perfect market “produces along its marginal cost curve above its intersection with the average variable cost curve.” (Tucker, 2010, p.235) This is because in the competition-based perfect market, companies produceprofit, which is achieved at a point where Price encounters the marginal cost curve. This also happens to be the point where the marginal revenue curve and the marginal cost curve intertwine. The company, thus, produces according to the marginal cost curve of a firm which it does by moving along the same curve. Where equilibrium is concerned, the equilibrium condition of a perfectly competitive firm occurs where marginal revenue equals the marginal cost of a product. This is illustrated in the figure below. Figure 2: 3 cases of short-run equilibrium in Perfect Markets (Source: s-cool.edu.co) In the conditions above, when price is at D1, it shows abnormal profits from the point where D1 intersects MC to the SRAC curve below. At D2, there are only normal profits because it is the point where the SRAC curve touches the MR or demand curve of the industry. There is a loss at point D3 because the revenue that the firm is making is below the SRAC curve. The firm will finally shut down at D4 because it is even below the short run average cost curve. Long-run Equilibrium in Perfect Market: The perfect market does not make any profits in the long-run because of there being no barriers of entry and exit in the industry. This means that in a case of profits in the short-run, new firms will enter in the long-run and the profits will be divided among them. On the other hand, a loss would mean existing firms exiting the market which would bridge the gap created by the loss. This is why there are normal profits in the long-run which is a condition of no profits and no losses. DIFFERENCE BETWEEN A PERFECT MARKET AND AN OLIGOPOLY “Oligopoly, competition among few sellers, is placed between monopoly, one seller and perfect competition.” (Puu, 2011, p.2) In an oligopoly, unlike perfect competition, there are large firms that have control of the entire market. An oligopoly is that market structure which is closest to the one followed in the real world. There can be many examples that can be found relating to this market structure. The airlines in Britain could be a good example of oligopoly because a few airlines have the entire control over the market. “Even though in quantitative terms, the workings of the allocated system under oligopoly are almost similar to perfect competition,” the same cannot be said about the qualitative factors. (Lipsey& Chrystal, 2011, p.178) There are many significant and wide-ranged differences between oligopoly and a perfect market. Some major ones are being listed here: In a perfect market, companies involve large number of small firms whereas in an oligopoly scenario,only few large firms are involved. Homogenous products are produced by firms in a perfectly competitive market, while in oligopolistic market, producers focus on providing a wide range and huge array of products to the consumers. Ghai and Gupta believe that “a firm that produces exclusively differentiated products is known as a pure oligopoly” (2002, p.40) Advertising is non-prevalent in perfectly competitive market. However, in an oligopoly based market structure, advertising is the central focus and enhance the fierce competitive standards. Jain and Khanna stated that “the only way open to an oligopolistic firm to promote his sales is by advertising his products.” (2008, p.111) There is a concept of interdependence when it comes to oligopolies because firms can create cartels and divide the supernormal profits made by the industry amongst them. This collaboration is not possible in a perfect market. There is also a difference between the short-run and long-run equilibrium curves of an oligopoly and a perfect market. As shown in the first figure below, there is a concept of a kinked demand curve under an oligopoly while the demand curve in perfect competition is straight, which is not possible in the real world. The Marginal Revenue curve also has a gap in the oligopolistic individual firm, unlike a perfectly competitive firm. Figure 3: Short-run equilibrium in Oligopoly (Source: chantel721.tripod.com) CONCLUSION: Oligopoly is one of those market structures that are closest to the market structures that are followed in the real world. The other market structures exist in order to depict the extremes that the market structures can reach. While the perfect competitive market is socially and productively efficient, the oligopolistic market can only try to achieve that level but cannot because of the extra costs that it has to bear due to fierce competition. An economy should ideally choose that market structure which suits the general environment of the country. “The government controls the degree of competition in the interest of the economy and the consumers.” (Mansueto, 2012) This is one of the key consideration points in some industries and the market structure is chosen purely based on the government choice. The choice of market structures, thus, should be made in a wise and unbiased way through which maximum efficiency and economical welfare is ensured. REFERENCE LIST Baumol, W., J. (1961). "What Can Economic Theory Contribute to Managerial Economics" American Economic Review, 51(2), pp. 142-146. Besanko, D., &Breautigam, R., (2010). MicroEconomics (CH-9), John Wiley & Sons, pp.330. Demand Curve (Figure 1): Amos web, 9th March, 2013. Retrieved From: Ghai P., & Gupta, A., (2002). Microeconomics Theories and Applications, Sarup& Sons, pp. 40. Hall, R., E., &Leiberman, M. (2009).Microeconomics: Principles and Applications, Cengage Learning, pp.251. Jain, T., R., &Khanna, O., P. (2008).Business Economics, FK Publications, pp.111. Lipsey, R., & Chrystal, A., (2011). Economics, ed. 12th, Oxford University Press, pp. 178. McConnell, C., & Brue, S. (2004), Economics: Principles, Problems and Policies, ed.16th. McGraw-Hill Company. McEachern, W., A. (2011).Economics: A contemporary Introduction, Cengage Learning, pp.174. Oligopoly (Figure 3): McCain, C., McFarlan, R., & Altman, I., (2012), Econ by Dummies Retrieved from: Puu, T., (2011). Oligopoly: Old Ends, New Means, Springer, pp.2 Quek, E. (2011). Economics Cafe (CH-3), pp. 2. Available at < http://www.economicscafe.com.sg/wp-content/uploads/2011/04/CHAPTER-3-ELASTICITY-OF-DEMAND-AND-SUPPLY.pdf > Short-run equilibrium (Figure 2): S-cool.co, 10th March, 2013. Retrieved From: Tucker, I., B., (2010) Microeconomics for Today, Cengage Learning, pp. 235. Mansueto, C., M., (2012).Determinants of Market Structures. Available at: Read More