Perfect Markets in Relation to Consumer Demand and Other Markets - 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) This means that economists rely on the behavior of buyers and sellers in the market and then decide 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, while monopolistic competition and oligopoly are the structures that are to the moderate side. In this paper, our focus will be largely on perfect markets, how they react to consumer demand and to one 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 and Brue, 2004) This means that a perfect market is that market structure in which there are numerous amounts of buyers and sellers, selling the same kinds of products. Besides this, there are many other characteristics of a perfect market listed below: All the products in a perfectly competitive market are homogenous or the same. There are many buyers and sellers in a perfect market structure because of which the size of the firms in a perfect market structure are small. There is perfect freedom of entry and exit in the firm which is why there are a large number of firms in the market. This is also called ‘perfect resource mobility’ in economic terms. Another characteristic of perfect markets are that they are price-takers and do not have any control on the prices of the goods and services that they trade. Lastly, there is perfect information about prices and technology among both the sellers and buyers. 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.” (Edmond Quek, 2011) This is because of the several amounts of small firms in the market which are unable to influence the price of the good or service that they provide in any way. This leads to inflexibility in the prices and thus, there is a perfectly elastic demand curve. The demand curve is illustrated in the diagram below. Figure 1: Chart showing perfectly elastic demand in a perfect market (Source: Google Images) This demand curve in a perfectly competitive firm is also its marginal revenue curve. Marginal revenue refers to the revenue earned by the sale of one extra unit of production. Both the demand curve and marginal revenue curve are equal in perfect competition because the price of all goods and services are exactly the same in a perfect market. The demand curve is also equal to the average revenue in a perfectly competitive market because each product has 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.” (Irvin B. Tucker, 2010) This is because the perfectly competitive firm produces at a profit, which is at the point where Price meets the marginal cost curve. This is also the point where the marginal revenue curve meets the marginal cost curve. The firm 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.” (Tonu Puu, 2011) 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 allocative system under oligopoly are almost similar to perfect competition,” the same cannot be said about the qualitative factors. (R. Lipsey, A.Chrystal, 2011) There are many vast differences between an oligopoly and a perfectly competitive market among which the major ones are listed below: A perfectly competitive firm has numerous numbers of small firms while an oligopoly consists of larger firms which are also few in number. Besides this, producers in a perfectly competitive firm produce homogenous products while there is variety in the product range produced by an oligopolistic producer. “A firm that produces exclusively differentiated products is known as a pure oligopoly” (Ghai and Gupta, 2002) There is no concept of advertising in a perfectly competitive market but in an oligopoly, there is fierce competition on the basis of advertising and “the only way open to an oligopolistic firm to promote his sales is by advertising his products.” (Jain and Khanna, 2010) 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.” (Christian Michael 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, William J. 1961. "What Can Economic Theory Contribute to Managerial Economics" American Economic Review 51(2)(May): 142-146 Demand Curve (Figure 1): Amos web Edmond Quek, Chapter 3, Elasticity of Demand and Supply, Perfectly elastic Demand, Economics Café, 2011, page no. 2. Figure 3: Chantel McCain, Ross McFarlan, Iz Altman, 2012, Econ by Dummies Irvin B. Tucker, Chapter 8, Perfect Competition, Microeconomics for Today, Page no. 235, 2011. McConnell, C. and Brue, S. (2004), Economics: principles, problems and policies, 16 ed. McGraw-Hill Companies Pankaj Ghai and Anuj Gupta, Chapter 2, Non-collusive oligopoly, Microeconomics Theories and Applications. Page no. 40, 2002. Richard Lipsey and Alec Chrystal, Chapter 9, Imperfect Competition, Economics Twelfth Edition, Page no 178, 2011. Short-run equilibrium (Figure 2): S-cool.co T.R.Jain and O.P.Khanna, Chapter 7, Price Determination under Oligopoly. Business Economics, page no. 111, 2010. Tonu Puu, Chapter 1, Introduction. Oligopoly: Old ends, new means, 2011, page no.2 URL: Christian Michael Mansueto, 2012. Determinants of market structures Read More