Perfect competition is an example of the laissez-faire theories of Adam Smith in that it allows consumer sovereignty and the market to set the price rather than the companies and firms that sell the products. Perfect competition in reality is only a model and is unachievable in the real world as it is impossible for a market to fulfill the requirements needed to make a market perfectly competitive. Examples of industries where perfect competition has almost been achieved are the insurance industries, banking etc.
Monopolistic Competition is the second type of market structure that is demonstrated in the above diagram. This is where there various small firms operating within a market and yet neither firm has any real dominance in the market. Examples of this type of market structure are small restaurants, individual shops, etc. Therefore this is a much more common form of market structure because it is much more achievable and realistic than perfect competition as there are many markets that it can occur in and it requires fewer acquisitions to be achieved.
The Oligopoly market structure is the third and most common form of market structure. This type of market structure incorporates features from both pure monopolistic conditions and perfect competition conditions. Oligopoly is where only a few big firms dominate the entire market- this shows that whilst there are low levels of firms competing with one another, at least there is competition between firms. Yet it is possible that price fixing can occur in this type of market situation because the leading companies can join together to set the price of the product that they are selling at whatever level they want as consumers will have no option but to pay the same price at whichever company that they choose. An example of an Oligopoly in the real world is the supermarket war in Britain. In this market there are three major brands, Tesco’s, Asda, and Sainsbury’s. These companies between them own almost the entire market and are the perfect example of an Oligopoly in practice in the real world. This can lead to the downfall of a market, but can also insure that at time consumer may benefit from lower prices due to the price war between rival firms.
The Duopoly is where there are only two companies that control the market. Therefore this stimulates some level of competition but only between two firms. Therefore whilst it creates a small level of competition within the market, it does make it easier for price fixing to take place as the two companies can simply agree at what the price should be, regardless of what the market price should be. Therefore it will ensure that the firms will be price makers in the market rather than price takers as they should be under the free market system.
The final type of market structure is also just a model and is impossible to achieve in the real world and that is pure monopolistic control. This is where one firm dominates the entire market for a good or service. This means that the company that enjoys the majority of the monopolistic power is able to set the price to whatever level that they want because consumers have no choice but to go to them because there is literally no one else in the market. This allows monopolies to become price makers and consequently exploiting consumers. This thankfully is impossible because no company could gain that sort of hold over an entire global market, but if such power emerged the government would intervene and deploy legislation to decrease monopoly power. Yet one company has come close to that sort of market dominance in recent times and that was Microsoft but it never quite got to total control over the entire market. Unfortunately due to globalization it is now becoming easier for companies to gain market share all around the world and many forms are close to almost eliminating their competition.
- How / why does e-commerce and the Internet resemble the theory of perfect competition.
There are various reasons why it is now considered that the E-commerce and the Internet can almost be seen as the model form of perfect competition (e.g. ebay). It can be argued that E-commerce resembles the model form of perfect competition because it is perfectly “transparent and exposed to all consumers” as referred to by economists at Warburg Dillion Read “the nude economy”. This is because if consumers want the product then they have the available resources to be able to find out everything that they want to know about the product, as all the information is available online. For that reason it represents the basic requirement that the entire market needs to be transparent for competition to be at its most effective and consumers must have all available information before they make their choice of product.
The E-commerce market can be considered to closely resemble the mode of perfect competition because it is one of the few markets that have a restricted level of barriers of entry. The only outlay for a company wanting to setup as an E-commerce company is the cost of acquiring the actual Internet address needed for the business practice.
E-commerce can be considered an almost perfectly competitive market because there are many small companies that are involved in the market. The large numbers of small dot.com companies ensures that no company is able to gain the significant amount of market share that would be needed to create monopolistic power for a single firm in the market.
Expansion in dot.com companies now result in a substantial range for the consumer to choose from. This shows that the level of competition within the market is always increasing and therefore the market is slowly fulfilling the requirements needed to be perfectly competitive. Therefore consumers have the level of choice that is needed to ensure that companies are price takers rather than price makers and allows the consumer to have consumer sovereignty over the market.
E-commerce also resembles the prevention of monopolistic power being formed, as the number of dor.com firms increase monopolistic power become increasingly harder to achieve with so many small firms being active. E-commerce is available all over the world and therefore we cannot have geographical monopolies, as the market is a global one. This also prevents globalization, as the barriers of entry and exit are no existent.
There are many reasons why the introduction of E-commerce makes our economy more competitive. The fact that it ensures that companies now have to operate within the new market and therefore have to ensure that they appeal to consumers in the new available market resulting in the operation of far more competitive E-commerce markets as opposed to the retail markets. In being forced to be competitive, businesses have to ensure that they have something in their product or image that sets them apart from the rest of their competitors in the market (a unique selling point) and this forces them to be different. This therefore makes the businesses price takers as opposed to price makers and the economy far more competitive when companies will do anything to keep hold of consumers.
E-commerce also makes our economy more competitive in the global market because the Internet is accessible worldwide and therefore British based companies who operate within the E-commerce market have the opportunity to reach more consumers than ever before, however they have to realize that their product or service has to comply with government legislation in different countries. This means that firms can increase their revenue by selling in oversea markets and can boost the UK economy. Exports will increase, so more money will be coming into the British circular flow of income and this can only benefit the British economy if we have a greater monetary value on our economy therefore reducing our trade deficit.
- Explain the theory of perfect competition in both the short and long run.
The short run is the period in time in which at least one factor of production remains fixed. Therefore when all factors of production become variable the period of time becomes the long run. Each business though can have many short runs because if each company has many fixed costs in the short term, each time one of the costs becomes a variable cost, a new period of short run begins until every factor of production becomes variable. The below diagrams represent the effect of perfect competition on the short run period of the market.
In the short run, the forces of market demand and market supply determine the equilibrium market clearing price for the market at (Q, P1), the diagram on the left shows this at point. This is where the price, P1 has been established and output Q has been produced. Therefore at this level there is perfect demand to match supply and there is neither excess demand nor supply. This therefore determines the price that companies are forced into taking and therefore becoming price takers. This therefore demonstrates the model of perfect competition as the market is successfully clearing itself as at that moment in time the market is in perfect balance and firms have no control over the price that is set for the particular good or service.
The diagram on the right represents the individual firm and how perfect competition within a market can affect the individual market within the short run. The average revenue curve represents the firms individual demand curve. Since the market price is constant under perfect competition the average revenue curve can also therefore become the marginal revenue curve. Therefore AR=MR. The firm is maximising output at the point Q1 where MC=MR. This output generates a total revenue of price x output. The total cost of producing the output can be calculated by multiplying the average cost of a unit and the output produced. Since total revenue exceeds total cost, the firm is making abnormal profits. This is not necessarily the case for all firms as it depends on each individual firms short run cost curves. Some firms may experience subnormal profits, others abnormal profits or even normal profits.
However in the long run the level of profit decrease due to certain factors. If most firms are making abnormal profits in the short run, this encourages the entry of new firms into the market. As new firms enter the competitive market due to a profit incentive, the level of supply of the good or service increase as a result the supply curve shifts to the left as shown below, causing P1-Q1 to be changed to P2-Q2. The new profit maximising price in the diagram below is the point Q2. The increase in market supply has reduced the market price until price=long run average cost. At this point each firm is making normal profits only.
There is no further incentive for movement in firms in and out of the industry and equilibrium has been restored. The diagram on the right represents the affect perfect competition has on the individual firm. The point QX represents the optimum level of output where the firm will produce the level of output required to achieve normal profits where average costs equals average revenue. Therefore at any point to the right of Q2 is where the company is achieving subnormal profits where costs are greater than revenue; any pint left of the point Q2 the company is achieving abnormal profits because they have achieved lower costs than total revenue.
- Evaluate how useful the p.c. model is
It can be argued that the model for perfect competition is a useful way to measure the competitiveness of a market and it can also be argued that it performs the opposite and makes it near impossible for any type of market structure to be achieved. Therefore just how useful is the model of perfect competition in the real world?
It can be argued that the perfect competition model is an extremely useful tool in the real world for classifying markets because it allows regulatory bodies to analyse the state of markets and to determine whether one firm has too much control in the market.
This will ensure that the market will stay competitive, as there is a body usually setup by the government in place that can ensure that the monopolistic markets do not immerge keeping the market competitive. Therefore the model gives the competition commission the chance to analyse whether markets require intervention to ensure that no one company has achieved enough of a market share to ensure that they can become price makers in the market as opposed to price takers (a close example of this the market share of Tesco’s).
Another reason why the model of perfect competition is useful in the real world is because it can show how well the market is operating and whether or not the market is operating at the level that should be dictated by the free market system.
The model of perfect competition is useful because it allows every single market in the world to be analysed and categorised such that consumers can tell if they are part of a captive market that is part the monopoly snare or if they are getting value for their money under transparent competition (e-commerce and the internet).
It can also be argued that in the real world the model of perfect competition has no value. This can be justified because each end of the spectrum (Perfect Competition and Pure Monopoly) cannot be achieved in reality as no one firm can dominate any market and no market is perfectly competitive. Therefore the model needs revising such that it becomes far more realistic as it is now impossible with the emergence of a global marketplace and the Internet for either extreme to be achieved. Thus the model is now useless and needs to be updated in account of the developments of globalization where brands can operate at minimal cost across the world and sit in the middle of the model.
Another reason why the model of perfect competition can be considered useless in the real world is because it can cause government intervention. This is potentially a bad thing because if the competition commission decides that a market is under monopoly power and force the government to intervene it is possible that the situation could only be made worse.
Government Intervention perceives to try and correct the situation within the market, however could end up creating new companies in the marketplace that fail in their objectives and end up increasing the monopoly power of that one company.
Overall I believe the perfect competition model is only useful to a certain extent as it gives a brief overview of the different types of possible market structures. However most of these models never exist in reality and if they do they are extremely rare, so there is no need to express these extremes. Nevertheless in an economic point of view these situation are just models and express a theory which could possibly exist, therefore it is just an assumption that has to be taken into account when looking at competition in markets. The fact that markets have changed and a trend of increasing perfect knowledge exist is eradicated as economics is only the study of the efficient allocation of scares resources, therefore an economist has to take into account all types of market structures.
