Perfect Competition Model - Research Proposal Example

Introduction It is believed that Perfect Competition model is merely a theoretical model that rarely exists in the world. It may be applicable mostlyin agricultural products; or in other products but only at a micro-level, i.e. for other products the perfect competition may be limited to a small geographical location (e.g. a small town or a village). However, in the real world which is much more complex it is nearly impossible to find any such market which contains all the characteristics of a perfectly competitive market. There are other types of market structures or imperfect competition that is more dominant in the world viz. monopoly, oligopoly or monopolistic competition. Why might the world steel market be described as perfectly competitive Markets become perfectly competitive when they contain all of the following features and fail to be termed as perfectly competitive due to the absence of one or more requirements of the perfect competition model. The steel market may be termed as perfectly competitive as it has all of the following features: There are many buyers and sellers in the market. Firms are price takers, no buyer or seller alone has the power to influence the price of a commodity. There are no restrictions on the entry or exit of firms from the market, i.e. there are no barriers to entry and exit. The products are homogeneous, i.e. the products are not differentiated from each other in any aspect such as color, scent, packaging etc. Buyers cannot distinguish between products of different producers, that is why there is little or no incentive for firms to spend on advertising or marketing. Producers can only decide on the quantity they wish to sell, they can sell any amount of output at the given market price. In a perfectly competitive market, the demand curve is perfectly elastic and AR=MR=P, that is, the Average Revenue, Marginal Revenue and the Price curve are the same in this market structure. There is the existence of "Omniscience", i.e. all the buyers, sellers, workers etc. have perfect knowledge of market conditions, whether it be the price charged by all the producers or the wages offered to labor etc. Firms cannot earn supernormal profits in the long run. As there are no barriers to entry, any supernormal profits (earned in the short-run) attracts more suppliers into the industry causing the supply to increase until the point the profit is completely driven off and the industry comes to its equilibrium position. Similarly, in the case of subnormal profits or loss (in the short-run) some firms will leave the industry, shifting the industry's supply curve to the left, raising prices and helps the firm earn normal profits in the long-run. FIGURE 1 The likely impact on the profits of steel producers of the rise in the world price of steel from 2002-2004 The likely impact on the steel producers of the rise in the world price of steel is that there was a rise in the revenue earned by steel manufacturers. Since, the steel market may be termed as perfectly competitive, there is little that the manufacturers can do to differentiate their product (i.e. steel), however they can sell there entire output or whatever output they wish to sell at the current market price. As shown in Figure 1, the demand for a company is perfectly elastic, it has to sell whatever output it wants at the current market price only, if the company decides to increase its price its demand may fall tenfold or even to zero. Between the period 2002-2004 there was a sharp increase in the demand for steel, at the same time there was also a noticeable increase in the production of steel with China emerging prominently as a large manufacturer and with a high demand as well. The diagram (Figure 1) for the perfectly competitive models depicts clearly that the although the company has a perfectly elastic demand curve, the industry has a normal demand curve. The increase in the prices of steel may be linked to an increase in the demand of steel, i.e. a shift in the demand curve of steel, causing its supply to extend and its prices to increase. The increased prices yielded greater profits for the manufacturers and acted as an attraction to the investors. Why chinese steel producers expanded their production capacity in 2004 and 2005. The driving force behind the expansion in production by Chinese steel producers in 2004 and 2005 appears to be the sharp increase in demand for steel and for goods linked with the steel industry such as automobiles etc. China became the world's largest exporter as well as the world's largest consumer of steel. It also had the highest growth rate and highest increase in the demand for steel. The increase in the prices of steel during that period may also have provided an incentive to steel manufacturers to produce more. As shown in FIGURE 1, the industry has a normal demand curve; the increase in demand (shift in the demand curve) caused the prices of steel to increase and the supply to extend. The increased prices meant higher revenues and profit margins and this also provided an incentive to urge the steel manufacturers to increase their production and expand their capacity. There has also been an increase in demand of other industries which consume steel in their manufacturing, this also affected demand for steel (some goods are in joint demand or complementary goods for steel) and caused its production to rise to match the increase in demand for steel and steel-related products. Why non-chinese steel producers are likely to cut back their production when steel prices fell in 2005 and 2006 There are several reasons which may have caused non-chinese steel producers to cut back their production when steel prices fell in 2005-2006. The main reason behind the cut-back in production by non-Chinese manufacturers was the sharp growth shown by China. China's economy expanded rapidly during this period, it also became the largest producer as well as the largest consumer of steel. Also, the economy began to rely more on the local manufacturers than on the foreign producers, local procurement increased and since China is the largest consumer of steel, foreign manufacturers realized that with the growth rate of Chinese steel industry, they may face an excess of supply over demand which would further lower the prices and consequently lower their profits. Another reason may simply be that as in any industry when prices fall, there are some producers who may be operating at their breakeven point or even earning subnormal profits. The decrease in the price means lower revenue and profits for the producers, hence increasing the gap between their costs and earnings and increasing the losses earned by them. This may cause them to cease production or divert their resources to some other commodity which is relatively more profitable. BIBLIOGRAPHY: Stanlake, G.F. & Grant, S.J. Introductory Economics, 7th edition. Harlow. Longman. 2000 Read More