Basic Aspects of Competitive and Imperfectly Competitive Markets - Coursework Example

Outline: The essay will discuss some basic aspects of competitive and imperfectly competitive markets. It will be based upon researching relevant theoretical material from certain books and journals. The research topics shall include the properties of perfectly competitive markets, monopolies and other imperfectly competitive markets. The changes in firm behaviour shall be focused upon and relevant factors like competitiveness, entry barriers etc shall also be researched through. Plan of research: To gather relevant information, books, journals and scholarly online articles shall be relied upon. Basic texts on principles of economics, Microeconomics textbooks and books on the relevant market structures shall first be scanned for identifying the topics that are to be read. These shall serve in developing the basic concepts. Then journals and online articles shall be searched for the topics to be focused on. These shall provide up to date information regarding the topics the essay is to be composed of. Structure of the essay: The essay will first introduce the outlines of the features of perfect competition and briefly explain the price taking behaviour of firms under perfect competition. Then the relevance of the model of perfectly competitive markets for the modern day researcher shall be addressed. The essay will next move on to the issue of monopoly, particularly focusing upon the justifiability of monopoly in spite of the related potential losses in social welfare and efficiencies. After this, the different regulations that are imposed to regulate the damages caused by monopoly shall be evaluated. Finally, the essay shall focus upon the impact that a rise in demand may have on the prices, outputs and profits of an imperfectly competitive industry. We shall conclude the essay with a brief discussion on how the presence of entry barriers may influence the impacts discussed in the previous section. Synopsis: Perfect competition is characterised by numerous buyers and sellers, identical products, no entry barriers, perfect information and this results in a horizontal demand curve for individual firms. Firms under perfect competition have insignificant market shares and thus act as price takers and maximise profits only through choosing outputs. The model of perfect competition is mainly important as it serves as a benchmark. A monopoly though is welfare reducing than perfect competition, it may be justified if certain potential benefits for society are realised. Though the regulations on monopoly may be effective, they are subject to certain conditionalities. Finally, it is found that if the demand for any imperfectly competitive industry rises then the price as well as output rise and thus profits also rise. However, the presence of entry barriers may lead to prices rising even further as there will not be any fear of new entry by rival firms. An outline of characteristics and behaviour of firms under perfect competition In a perfectly competitive market, there are a very large number of firms so that the share of each in the market becomes insignificant. Further, the number of buyers in the market is also very large as well. All firms sale the same product. Also, there are no barriers to entering the market. As a result the firms behave as price takers in the market. Each individual firm is able to sell any amount at the prevailing market price. So there is no need to reduce prices. Also it is assumed that all buyers have perfect information. So if any firm charges a higher price than the market price, it loses its market share as buyers will buy from other firms. The demand curve for each individual seller is a horizontal straight line equal to the price. Since firms do not have to reduce price to sell higher amounts, this line is the marginal revenue curve as well. Each firm takes the market price as given and maximises profits by choosing that amount of output which makes the marginal cost curve at its upward rising portion equal to the marginal revenue curve. The relevance of the perfect competition model to the modern day economist: The perfectly competitive market model serves as a benchmark. Though, in reality perfect competition is practically impossible and the number of firms in most markets is not so large. As a result, most firms have significant market shares. The other assumptions of product homogeneity, zero entry barriers as well as perfect information do not hold in the real world. However, given these assumptions it is shown in the perfect competition model that welfare is maximised. Since under perfect competition the price is equal to marginal cost, allocative efficiency is obtained. Further, long run equilibrium is obtained at the minimum point of the long run cost curves. So per unit production costs are minimised as well. This is known as productive efficiency. Given these advantages of the system, it is implied that more any market tends towards perfect competition, more preferable it is and more it tends away from perfect competition, more economically and socially damaging it is. Therefore, whenever issues regarding individual market shares of firms or market concentration increases, it is interpreted as a movement away from perfect competition and thus its benefits. Therefore, for any economist the perfect competition model serves as a benchmark using which benefits and properties of all other real markets systems can be compared and analysed. Justifying Monopoly: Monopoly is the opposite of perfect competition. There is one seller in the market and a large number of buyers. Though the welfare advantages of perfect competition are absent in case of monopoly, the existence of a monopoly maybe justified if certain potential benefits are realised. First, it is likely that a monopoly firm will produce much more than a firm in perfect competition as the monopolist have the benefit of the entire market share. So, as it produces at a greater scale, it is likely that a monopoly firm will enjoy economies of scale. These are in turn likely to reduce the average costs of production. If this reduction is significant, the consumers may obtain the product at lower prices compared to a competitive market. Secondly, since a monopolist earns supernormal profits, if a part of these are invested in research and development, then social welfare increases as the potential for technological progress increases. Such progress implies future availability of better products at lower prices which also raises consumer’s welfare. Most importantly, if a firm enjoys monopoly status in the domestic market, it has the potential to generate sustainable comparative and competitive advantage globally. This shall benefit the domestic economy overall. So, we find in all these cases there are important benefits that may be obtained from a monopoly. Thus in these cases the existence of a monopoly maybe justified. Another important type of monopoly that maybe justified is the government monopoly. In a planned economy, the government may choose to operate as a monopoly in a certain sector to ensure long run goals of social equity and welfare. Often there may be sectors where due to the bulk of the initial investment requirements or due to the lower profitability private investors do not invest. Yet, the sector maybe crucial for development of the economy. In such cases the government may choose to operate as a monopoly in such sectors. Such monopolies are also justifiable. Evaluating the Regulating measures imposed on monopoly: Compared to perfect competition, monopolists generally charge higher prices and produce lower outputs. This creates a welfare loss. The main ways to control these are through government regulations. The regulations can be on prices as well as on the entry barriers that are set up by monopolists to prevent new entries. Government regulations on prices in essence maintain a check on the price hikes. A ceiling is set on the price that prevents the monopolist from increasing the price beyond a certain margin. This prevents the fall in consumers surplus. However, the problem with such a measure is that it may lead to below optimal outcomes. The monopolist aims to maximise profits by choosing prices as well as output amounts. If a restriction is imposed on one dimension, the maximisation process may be moderated. As a result there may be inefficiencies. Again, governments may regulate monopolies and moderate their control on the market share by introducing new competition. This can be done through subsidizing new entrants. Since the monopoly is created due to very high entry barriers, through making entry easier for new firms, the government can curtail the market power of the monopoly. However, such measures are ineffective in cases of natural monopolies. Further, such support to new entrants actually may lead to distortions that may lead to inefficiencies. This may particularly be true if the new entering firms, given the support lose the incentive to operate efficiently. The impact of an increase in demand on an imperfectly competitive industry: In an imperfectly competitive market, firms face downward sloping demand curves. The marginal revenue curve lies below this demand curve. Now, in such a case a rise in demand implies that for each price, consumers are willing to purchase more of the product. Thus the demand at each price rises. This means that the demand curve will shift out rightwards. Correspondingly, the marginal revenue curve shall also shift outward. The necessary profit maximisation condition for each individual firm under imperfect markets remains MC = MR. The sufficiency condition requires that the slope of the marginal cost curve is greater than the slope of the marginal revenue curve. Thus, the result of this shift in demand will result in a changed equilibrium point and new optimum prices and output. We explore this in the following diagram. Assume that D1 is the initial demand that the firm faces. MR1 is the corresponding MR curve. The marginal cost curve of the firm, MC cuts MR1 from below for output level Q1. Therefore the equilibrium output for this firm is Q1. The corresponding price as obtained from the Demand curve is P1. Therefore, at the initial equilibrium, the firm produces Q1 output at the per unit price of P1. Now, suppose there is an increase in demand. The demand curve shifts to D2. MR2 is the new MR curve. If, the costs of the firm remain the same, then e2 shall be the new equilibrium point. Here, MC cuts MR2 from below. The output therefore increases to Q2 and the price increases to P2. Thus, as the price and output both rise, the profits will rise as well. So, this reflects the pattern of behaviour that can be expected from each firm in the industry. In that case, the prices and overall industry output shall rise. And firms will earn greater profits. Impact moderation under entry barriers: If there are strong barriers to entry, then firms may choose to increase prices more than they would, had there been no such barriers. If these barriers to entry had been weaker, then these firms could not have increased prices significantly. In fact if the entry barriers had been significantly weaker, then as soon as the profits increased, there would be new entry which would drive the input prices upwards and caused a reduction in the profits. Bibliography: Kreps, D. M. (1990), A Course in Microeconomic Theory, New York: Harvester Wheatsheaf. McNulty, P. J. (1967), "A note on the history of perfect competition", Journal of Political Economy, vol. 75, no. 4 pt. 1, August, pp. 395-399 Pearce, D.W. (ed) (1992) The MIT dictionary of Modern Economics, MIT press, Cambridge, MA Roberts, J. (1987). "perfectly and imperfectly competitive markets," The New Palgrave: A Dictionary of Economics, v. 3, pp. 837-41. Samuelson, P.A and W. D. Nordhaus (2001) Economics, McGraw-Hill,NY Stigler J. G., (1987) "competition," The New Palgrave: A Dictionary of Economics, Ist edition, vol. 3, pp. 531-46. Varian, H.R. (1996) Intermediate Microeconomics – A modern approach, fourth edition, W.W. 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