Competitive Markets and Their Characteristics - Term Paper Example

Competition – Abhisek.M.Jain Topic – Competition – 25/10/09 This paper contains the different types of competitive markets and their characteristics. It also provides an overview on how the firms will determine its price and output in order to maximise the profits. INTRODUCTION Market generally means a place or a geographical area, where buyers with money and sellers with their goods meet to exchange goods for money. In economics, market refers to a group of buyers and sellers who involve in the transaction of commodities and services. On the basis of competition markets can be classified into PERFECT COMPETITION Perfect competition refers to a market situation where there are infinite numbers of sellers that no one is big enough to have any appreciable influence on the market price. The market price in a perfect competition is determined by the market forces namely, the demand and supply of the products. The features of perfect competition are as follows, 1. Large number of buyers and sellers There are a large number of buyers and sellers in a perfect competitive market that neither a single buyer nor a single seller can influence the price. The price is determined by the market forces namely the demand for the supply of the products. Thus the sellers in the perfectly competitive market are price takers and quantity adjusters. 2. Homogenous products The products produced by all the firms in a perfectly competitive market must be homogenous and identical in all respects i.e. the products in the market are same in quantity, size, taste etc. The products of different firms are perfect substitutes and the cross elasticity is infinite. 3. Perfect knowledge about the market conditions Both the buyers and the sellers are fully aware of he current price in the market. Therefore the buyer will not offer higher price and the sellers will not accept a price less than the one which is prevailing in the market. 4. Free entry and free exit There must be complete freedom for the entry of new firms or the exit of the existing firms from the industry. In times of profits, new firms will enter into the markets and in time of loss the existing firms will leave the industry. 5. Perfect mobility of factors of production The factors of production must be free to move from one use to another or from one industry to another easily to get better facilities or remuneration. 6. Absence of transportation cost In a perfect competition it is assumed that there are no transportation costs. Because in perfect competition, a commodity is sold at same price throughout the market. So if transportation costs are incurred firms closer to the market will charge a lesser price than the firms far away. So, it is assumed that there are no transportation costs. DETERMINATION OF PRICE UNDER PERFECT COMPETITION Under perfect competition price is determined by the market forces namely the demand for and supply of the commodities. Hence there is uniform price in the market. As a result the average revenue is perfectly elastic. The AR curve is horizontally parallel to x-axis. Since the average revenue is constant the marginal revenue is also constant and coincides with the average revenue. MONOPOLY Monopoly is a market structure in which there is a single seller, there are no close substitutes for the commodity it produces and there are no barriers to entry. Under monopoly there is no difference between a firm and an industry. The following are the features of a monopoly 1. Single seller There is only one seller in a monopoly. He can control either the price or the supply of his products. But he cannot control the demand for his products as there are many buyers. 2. No close substitutes There are no close substitutes for the products. The buyers have no alternatives or choice. Either they have to buy the product or go without it. 3. Price The monopolist has a control over the supply so as to increase the price. Sometimes he may adopt price discrimination. He may fix different prices for different sets of consumers. A monopolist can either fix the price or the quantity of output but he cannot do both at the same time. 4. No entry There is no freedom for the other producers to enter into the market as the monopolist is enjoying monopoly powers. There are strong barriers for the entry of new firms. 5. Firm and industry Under monopoly there is no difference between a firm and an industry. As there is only one firm that single firm constitute the whole industry. DETERMINATION OF PRICE UNDER MONOPOLY A monopoly firm faces a downward sloping average revenue curve. This implies that larger output can be sold only by reducing the price. Its marginal revenue curve will be below the average revenue curve. The monopolist will be in equilibrium when MC=MR and the MC curve cuts the MR curve from below. The monopoly price is higher than the marginal revenue and the marginal cost. MONOPOLISTIC COMPETITION Monopolistic competition is a blend of monopoly and perfect competition. Monopolistic competition refers to a market structure in which large number of sellers produces goods which are close substitutes of one another. The products are similar but not identical. The following are the characteristics of the monopolistic competition 1. Existence of large number of firm The number of firms producing a commodity will be very large. Each firm will act independently on the basis of product differentiation. Each firm will determine its own price-output policies. 2. Product differentiation Product differentiation is the essence of monopolistic competition. Product differentiation is the process of altering goods that serve the same purpose so that they differ in minor ways. 3. Selling costs Under monopolistic competition firms has to incur expenses in order to popularize its brands. This expenditure involved in selling the product is called selling costs. Most important form of selling costs is by way of advertisement. 4. Freedom of entry and exit of firms There is a freedom to any firm to enter into the market and produce the commodity under its own brand name and any firm can go out of the field if so chosen. There are no barriers as in the case of monopoly. DETERMINATION OF PRICE UNDER MONOPOLISTIC The monopolistic firm will come to equilibrium on the principle of equalising MR with MC. Each firm will chose that price and output where it is maximising its profits. The different firms in monopolistic competition may be making either abnormal profits or losses in the short period depending on their cost and revenue curves. WORKS CITED 1. Jain, Ashish(1997), “Micro Economics”, Mumbai: Premeire, p17-22 2. Dev, Kapoor(2001), “Micro and Macro Economics”, Chennai: Macmillan, p25-45 Read More