Perfect Competition and Long-run Equilibrium - Term Paper Example

Perfect Competition and Long-run Equilibrium” Objectives: This paper aims to explain perfect competition in detail and the effects of such a marketin the long run. It also explains the conditions that cause marginal social benefits to be equal to the marginal social costs. For a better understanding a few examples are used within the paper. Moreover, definitions and key concepts are clarified within the text. Introduction: It has been a matter of debate if the concept of perfect competition is valid or not. Criticizers believe that markets are always competitive to some extent but mostly they are under such a competition that they must be called as imperfectly competitive. They have strong criticisms against such an assumption as they believe that in the globalized world, firms have the option of using cheap labor, technology and new approaches to improve their quality and hence prices. However, the assumption is absurd to some extent as these advantages may be availed by all the firms and hence a remarkable decrease in the market price can be seen. Regardless of the criticisms, it has been observed that there are certain commodities which sell identical items and their prices depend on the market conditions. Such commodities include those associated with agriculture, basic food, shoes etc. Nowadays with the advent of different economies many types of systems have arrived too. These systems usually indicate the amount of competition that is currently happening in these economies. The competition in the market has widely increased with the rise of the business world and different systems for the competitions have arisen. One such type of competition is perfect competition. In perfect competition many firms are taking part in the manufacturing of similar products i.e. many firms produce one kind of a product. This means that if one firm is manufacturing soap many others are manufacturing the similar kind of soap too. In such a competition the market should be for a long term so as to be successful. This is because in short term, the businesses may not get huge profits as the marginal cost of producing a new product would nearly be the same as the average cost. This means that the whole cost of producing the new unit would be nearly the cost of the investment. Perfect Competition and Long-run Equilibrium: Basically in a market of perfect competition does not give monopoly to a single company. A single firm or company does not rule over the whole market as many firms are producing the same products. Thus one single firm is not able to determine the prices of products. A market with perfect competition would have many suppliers, producers and consumers because of the different firms involved in such a market. Perfect competition involves many sellers or firms and thus it cannot be found to be very common in this world. In perfect competition it is not difficult for the new firms to enter, thus it is seen that many sellers are involved in this type of competition. The reason for this is that the firms do not have to have a huge capital to enter this competition and they can seek help from many individuals when entering in this sector. Moreover not only is it easy to enter the perfect competitive market but also it is easy to exit such a market. The transactions which are made in this type of competition do not cost anything to the buyers or sellers. In such a type of competition it is aimed that the firms maximize their profits by selling their products where the marginal costs and marginal revenue are in equilibrium. The most important characteristic of such a competition is that the products which are being sold are usually manufactured by many companies thus strong competition is felt in this type of competition. An example of perfect competition is of a group of fruit vendors who are selling the same fruits. In such a market the buyers can easily switch from one fruit vendor to the other. And a single seller cannot affect the prices of goods for the whole market. Another example of perfect competition can be of apparels in the modern world. Many brands are found all over the world which are selling apparels thus the consumers have different options while selecting their apparels. Similarly many firms also produce shoes which give the market for shoes a perfect competition. In an industry which shows to have perfect competition, the market price is determined by the supply and demand that prevail in the industry. No individual firm is allowed to set prices for its, own benefits. Once the price is determined and regulated in the industry, all the firms in the industry have to follow it. The profits or losses that price generates are irrelevant and cannot be considered in order to increase or decrease that particular price, called as equilibrium price. The presence of economic profits and losses indicate that the industry is in the short-run. If the firms in an industry are generating economic profits, more firms will be motivated to enter in the market. This event will gradually increase the supply in that particular industry and will start reducing the price. After a certain time period, the economic profits would disappear and firms will reach the breakeven point where all firms produce normal profits. On the other hand, if there is an economic loss faced by firms in the industry, the firms will start exiting from the industry reducing the supply and increasing the prices. The presence of both allocative and productive efficiency of the firm in long run equilibrium under perfect competition seems beneficial for the society as the firm then produces at the lowest point of its Average Total Cost curve (i.e. P=MC=ATC). There are certain conditions that indicate that either the firms are employed in a long-rum equilibrium position or not. The conditions are discussed in this part of the paper. In the long run, firms produce zero profits. The productions of all firms are carried out where marginal cost is the price. (i.e. MC=P). All firms in the industry produce where price equals the min. of short run average cost i.e. P= minimum SRAC. This indicates towards zero economic profits. In long-run equilibrium firms produce where [rice also equals min. of the long run average cost (i.e. P= min LRAC). This indicates towards the fact that neither of the firms in the industry are motivated to enter or exit. Summarizing all these findings it can be evaluated that an industry is in long run equilibrium under perfect competition when, P=MC=min SRAC=min LRAC Marginal social benefit can be said to be the benefit which is usually relating to the goods. This means that marginal social benefit is the benefit that a good provides to the user and the external benefits that the good provides. An example can be cited here of a redevelopment package for polluted areas near the cities. These polluted areas usually if redeveloped can provide space to the city authorities for new developments. This space provided to the city authorities can be termed as the external benefits and the removal of pollution is the private benefit. Thus marginal social benefit is achieved in this way. Marginal social cost is said to be the cost which the society succumbs for producing an extra unit. This cost of the extra unit does not include only the cost directly to the concerned authorities of the product but also the people who are getting affected externally by the product. Marginal social cost can be said to be calculated by adding up the values of marginal private cost and marginal external cost. The marginal private cost and marginal private benefit are equal at the market equilibrium. Externalities have a direct link with both marginal social cost and marginal social benefit. Externalities refer to the affect of the buyer or seller to a third party. In other words it refers to the perks and costs borne by the third party because of the first two parties. An externality is termed to be positive if it gives benefits to the third party where as it is termed to be negative if the third party has to pay for the actions of the other people. The marginal social benefit and marginal social cost are equal at a place where the externalities are absent. This usually happens because the externalities do not cause other individuals to bear the cost of the first two parties. First two parties here refer to the seller and the buyer. Marginal social cost and marginal social benefit includes the costs and benefits or losses to the third parties whereas if the externalities are absent no third party would be involved in the costs or benefits. An example can be cited here in which an individual is buying a cold drink for himself. The individual is buying a cold drink and this does not involve a third party as he is having the cold drink himself. And thus it does not involve any third party. The buyer and seller are involved in a one way process in which no one else is provided with benefits or given losses thus providing equilibrium to both marginal social cost and marginal social benefit. Conclusion: Perfect competition refers to a competitive system where a huge crowd of firms aim to produce a homogenous product for the consumers. All firms have equal knowledge and information to produce and sell the particular product. The market runs in such a stable way that it becomes impossible for the competitors to enjoy additional benefits by increasing their prices. There are no complex restrictions on the entry and exit of firms under such market conditions. The firms, under perfect competition, are price takers and cannot set a price different from its competitors as the consumers may switch the supplier in case of higher prices and lower prices for a comparable product may not generate any profits for the firm. Hence, firms have to adopt the price prevailing in the market and sell as much quantity of product as possible to keep the business running. In addition, under such market state, the production is planned where marginal cost equals marginal revenues. We can also conclude that in the long run under such market conditions the average revenue equals marginal cost and firms enjoy only normal profits. The concept of perfect competition in my opinion does exist. The market of a wide range of commodities can be included under such market conditions. In order to continue the research, a number of case studies may be analyzed to completely understand this concept. Moreover, the shut-down rules in perfect competitions can be a good direction for further research. Perfect competition in the short run may also be a helpful topic to continue the research and get a better understanding of this type of market competition. The following books may be helpful for further research: Economics - by Walter J. Wessels (2000) First principles of economics‎ - by Richard G. Lipsey, Colin Harbury (1992) Economics for South African students‎ - Philip Mohr, Louis Fourie - Business & Economics (2004) References: Mankiw, N. Gregory. Principles of Microeconomics. Mason, Ohio: Thomson/South-Western, 2004. Parkin, Michael. Economics. Boston, Mass. [u.a.]: Pearson/Addison-Wesley, 2008. Lipsey, Richard G., and Colin Harbury. First Principles of Economics. Oxford: Oxford University Press, 1992. Read More