Optimal Number of Firms in the Market - Essay Example

Academia Academia Research 10 June 2006 Optimal Number Of Firms In The Market "A position in which the aim of any economic unit is being served as effectively as it possibly can be, within the constraints applying. Where a situation is not optimal, gains in welfare can be made for some without any sacrifice by others. Essential to the meaningful application of the concept of an optimum is the existence of some objective and some constraint on the pursuit of that objective"(Bannock, Baxter, Davis 306:1998). When we talk about the "optimal" in the context of economics then we talk about almost a non-worldly case. It is unreal in terms because we cannot simply expect to have an equal demand and supply, always there would be greater deviations in the market and somehow both, supply and demand would get disturbed, of course it is unintentional but that is inevitable as a consequence of which we have to keep the constraints and solutions in mind. Imagine if the world is consuming what has been given to them, the world is being operated on daily basis, such as a limited amount of food is prepared daily and in order to prevent the food from getting stale, people consume every unit of it, is it possible Of course there is no chance for such situation, so we have to consider even bigger policies for production and consumption, may be we can use the past records of what is the optimal level of production and consumption or at which particular level firms are having maximum profit and minimum loss. We now have to consider the importance of the circular flow or economic cycle, the market system heavily relies on the supply and demand to solve the three major arising problems that are What goods and services will be produced, it is determined by the daily purchasing decisions of the customers as keeping it on the yearly basis can be very risky, one can see that over the past few years the bird flue took place significantly, therefore we cannot rely on yearly basis as the behavior of consumers can change unpredictably. The second problem is How things or goods produced would be rated in terms of pricing, of course there is a competition everywhere, so the problem of differentiating the product arises. Taking the example of bird flue there are many other issues that are very common in every day life such as at times there is drastic change in the technological market, such as everyday a new computer technology replaces the old one which eventually results in greater competition and brand switching. The third issue is For whome things are produced, here the focus is obviously on consumers and their level of consumption, but supply and demand has a major role to play here. The immediate task the companies have to face is to determine the wages, land rents, interest rates and many factors related to everyday life, it is explained thoroughly later in this discussion. The circular flow is all based on the previously discussed three problems. What the flow intends to show is that all the money is constantly moving within a frame of a country, there are minor changes but over all the flow is constant until and unless some big change takes place such as war. The circular flow is all comprised of four things, those are product markets (prices are set by the markets keeping in view the scenario), Household markets (the buyer behavior which keeps on shifting but over all the money utilization and spending is unchangeable), the business sector (which pays the rents and wages to the people working, who are also at the same time are households) and the factor markets (which keep on changing the rents, wages, interests but over all the wealth remains within the country, if less rent for one person may be much higher for another person). Until and unless these problems would not be solved which of course cannot be solved the firms would find it impossible to be operated at an optimal level. "Dollar votes of households interact with business supply in the product markets at top, helping to determine what is produced. Further, business demand for inputs meets the public's supply of labor and other inputs in the factor markets to help determine wage, rent and interest paymens; income thus influence for whom goods are delivered. Business competition to buy factor inputs and sell goods most cheaply determines how goods are produced"(Samuelson, Nordhaus 30: 1998). The number of firms in a market depends upon the optimal market structure concerning the factors like competition, buying power, and costing before entering the market and awareness of the firms whether the government is able to regulate firms in the market or not. If the firms are given an auction mechanism to allow to serve the market and show that the optimal number of licenses results in the socially optimal market structure, the firms would be confronted to the situation where all the potential candidates would be actual bidders, as the optimal number of firms in the market increases with the number of candidates and decreases with the social cost of public funds. When the market size is small, as the net profit in the market decreases with the number of selected firms, entry is endogenous. A small market where on one hand decrease the threat of competition on the other hand it would confront to less supply. (Mougeot & Naegelen, p. 393-416) The major question that the firm in a competitive market faces is how much output should be produced by a firm in order to meet demand and supply of consumers. The optimal output depends upon the market structure, as it may be problematic in some contexts. In a well-informed structural analysis, the economics of power generation and transmission, as well as the organizational and regulatory structures have natural monopoly attributes and/or are potential sources of market failure, and creating a system that yields appropriate price signals, linking generators with the network operator. Three alternative supply arrangements can be considered while bidding for the feasibility at the initial contract award stage: a once-for-all contract, a series of short-term contracts, and vertical integration. The dilemma posed by once-for-all contracts is this: lest independent parties interpret contractual ambiguities to their own advantage, which differences can be resolved only by haggling or, ultimately, litigation, contingent supply relations ought exhaustively to be stipulated. But exhaustive stipulation, assuming that it is feasible, is itself costly. Thus although, if production functions were known, appropriate responses to final demand or factor price changes might be deduced, the very costliness of specifying the functions and securing agreement discourages the effort. The problem is made even more severe where a changing technology poses product redesign issues. Here it is doubtful that, despite great effort and expense, contractual efforts reasonably to comprehend the range of possible outcomes will be successful. An adaptive, sequential decision process is thus indicated. If, however, contractual revisions or amendments are regarded as an occasion to bargain opportunistically, which predictably they will be, the purchaser will defer and accumulate adaptations, if by packaging them in complex combinations their true value can better be disguised; some adaptations may be foregone altogether. The optimal sequential decision-making process can in these respects be distorted. "Short-term contracts, which would facilitate adaptive, sequential decision making, might therefore be preferred. These pose problems, however, if either (1) efficient supply requires investment in special-purpose, long-life equipment or (2) the winner of the original contract acquires a cost advantage, say by reason of "first mover" advantages"(Carroll 22: 1999). (Such as unique location or learning, including the acquisition of undisclosed or proprietary technical and managerial procedures and task-specific labor skills). The problem with condition (1) is that optimal investment considerations favor the award of a long-term contract so as to permit the supplier confidently to amortize his investment. But, as indicated, long-term contracts pose adaptive, sequential decision-making problems. Thus optimal investment and optimal sequential adaptation processes are in conflict in this instance. It might be argued that condition (2) poses no problems since initial bidders will fully reflect in their original bids all relevant factors. Thus, although anticipated downstream cost advantages (where downstream is used both here and subsequently in the sense of time rather than place) will give rise to small numbers competition for downstream supply, competition at the initial award stage is sufficient to assure that only competitive returns will be realized over the entire supply interval. One might expect, therefore, that the low bidder. A number of potential problems are posed, however. For one thing, unless the total supply requirements are stipulated, "buying in" strategies are risky. Also, and related, the alternative supply price is not independent of the terms that the buyer may subsequently offer to rivals. Moreover, alternative supply price is merely an upper bound; an aggressive buyer may attempt to obtain a price at the level of current costs on each round. Haggling could be expected to ensue. Short-term contracts thus experience what may be serious limitations in circumstances where nontrivial first-mover advantages obtain. In consideration, therefore, of the problems that both long- and short-term contracts are subject to, vertical integration may well be indicated. The conflict between efficient investment and efficient sequential decision-making is thereby avoided. Sequential adaptations become an occasion for cooperative adjustment rather than opportunistic bargaining; risks may be attenuated; differences between successive stages can be resolved more easily by the internal control machinery. Price Discrimination. The problem here is first to discover differential demand elasticities, and secondly to arrange for sale in such a way as to preclude reselling. Users with highly elastic demands which purchase the item at a low price must not be able to service inelastic demand customers by acting as a middleman; all sales must be final. Although vertical integration may facilitate the discovery of differential elasticities, it is mainly with respect to the non-resale condition that it is regarded as especially efficacious. Integration, nevertheless, is a relatively extreme response. Moreover, price discrimination is clearly practiced in some commodities without recourse to vertical integration (witness electricity and telephone service). What are the distinguishing factors Legality considerations aside, presumably it is the cost of enforcing (policing) terms of the contract that are at issue. Some commodities apparently have self-enforcing properties, which may obtain on account of high storage and repacking costs or because reselling cannot be arranged inconspicuously. The absence of self-enforcing (policing) properties is what makes vertical integration attractive as a means of accomplishing discrimination. Entry Barrier Effects. That the vertical integration of production might be used effectively to bar entry is widely disputed. Bork (1969, p. 148) argues that "in general, if greater than competitive profits are to be made in an industry, entry should occur whether the entrant has to come in at both levels at once or not. I know of no theory of imperfections in the capital market which would lead suppliers of capital to avoid areas of higher return to seek areas of lower return." But the issue is not one of profit avoidance but rather involves cost incidence. If borrowers are confronted by increasingly adverse rates as they increase their finance requirements, which Hirshleifer suggests is a distinct possibility (1970, pp. 200-201), cost may not be independent of vertical structure. The firm is more than a production function; it is also a governance structure. Thus, I aver that the firm "possesses coordinating potential that sometimes transcends that of the market" and that "the properties of the firm that commend internal organization as a market substitute . . . fall into three categories: incentives, controls, and . . . inherent structural advantages". The firm, for example, has differential access to fiat for purposes of dispute resolution and to exercise command and control more generally. Because firms supplant markets selectively rather than comprehensively, there is a need to ascertain the limits of firms. I ascribe these limits to bureaucracy, which places a differential burden on hierarchy. Also, the attributes of transactions that support self-enforcing contracts, hence operate to the advantage of markets, need to be worked up. More generally, the need is to work out the trade-offs that characterize firm and market organization, as these vary with the attributes of transactions. (Operationalization took a decade and more and the combined efforts of many scholars). Reference Carroll G.R, "Firms, Markets, and Hierarchies: The Transaction Cost Economics Perspective", New York: Oxford University Press, 1999. Mougeot Michel & Naegelen Florence, "Journal of Industrial Economics" Vol: 53 Issue: 3, p. 393-416 . Bannock G, Baxter R.E, Davis E, "Dictionary of Economics", Middlesex: Penguin Books, 1998. Samuelson P.A, Nordhaus W.D, "Economics" (n.p.): 1998. Read More