It is an assumption of the model of perfect competition that there is a large number of sellers in the market. If one of thee firms decides to double its output then the industry supply curve will shift to the right. However the shift will be very small, because the firm is very small, so the resulting change in price and demand will be so small it will be impossible to determine the effect the change has had. This is shown by the diagram below.
Using the example again of farming, if one farmer were to double his wheat output, it would have little effect on price and demand. If all the farmers where to double their output, the price of wheat would collapse. In other words, a firm in perfect competition can therefore expand or contract its output without changing price. Put another way, the firm cannot choose to raise its price and expect to sell more of its product. It can lower its price there is no advantage to this since it can sell its entire output at the higher market price. The demand curve for the individual firm is therefore horizontal. Therefore, the market is efficient, because the price and quantities in the market are very stable.
In the short run, a firm will not necessarily shut down if it makes a loss. It will only cease production if its revenue fails to meet its average variable cost. This is shown on the diagram below.
In perfect competition it is assumed that firms are short run profit maximisers. So the firms will produce at a level of output where marginal cost equals marginal revenue. The price it charges is fixed by the market because the individual firm is a price taker. The diagrams below show this situation. Fig3 shows the firm producing at its profit maximising equilibrium level of output OG where MC=MR. Because AR is greater than AC, it makes an abnormal profit of EFGH. Fig 4 show the firm producing at its profit maximisng equilibrium level of output OQ where MC=MR. In this case, because AR is less tan AC, it will make a loss shown by EFGH.
However, in the long run, the perfectly competitive will make neither losses nor abnormal profits. Fig5 below shows this when the firms are making short run losses. In the long run firms will leave the industry, pushing the supply curve from S1 to S2. at S2 there will no longer be any pressure for firms to leave because the will be able to make normal profit. Fig6 shows the long run where abnormal profits are being made in the short run. In this situation, firms will enter the industry, pushing the supply curve from S1 to S2. At S2 firms will no longer be attracted into the industry because they will only make normal profits.
An argument regularly used to support that fact that competition increases efficiency is that allocative efficiency will be reduced if a perfectly competitive firm becomes a monopoly. This is shown by the Fig7. In this example, were the industry producing under perfect competition, price and output would occur where price = MC, at output OB and price OE. If the industry were a monopoly, output would be where MC=MR at OA whilst price would be on the demand curve at OF. Price is higher and output lower in the monopoly industry. The welfare loss is the shaded triangle.
Therefore it is clear that perfect competition is economically more efficient as it produces a lower price with higher output, whilst the industry is very stable, with no firms making abnormal profits and none making losses. Both consumers and suppliers are totally satisfied by the situation they are in and it will continue unchanged without any difficulty.
- Assess the extent to which developments in information technology, such as the Internet, are making markets more competitive. (30 marks)
The Internet is a global network. It is instantly accessible, easy to use and becoming more and more available to households all over the world. Its creation has brought great scope for increased competition between firms. It increases not only the breadth and depth of the competition, but also gives people the ability to shop from their own home; something that many will see as its most useful feature. Firms can now compete on every aspect of their business, price, quality, customer service, delivery time, availability and also a new feature in security. Not only does it do this between the “normal” market for a firm, its local, competing stores but a worldwide competition with firms perhaps on the other side of the globe and this means firms must be far more efficient if they are to survive. Any firm without a website is unlikely to fare well against its web enabled competitors.
Previously, if a consumer wished to purchase something that was only available abroad, for example in America, they had to either fly there, or try and obtain a phone number for a supplier in America and phone them, both of which are very expensive options. Now, it is as simple as logging onto the Internet, performing a search and ordering the product. The process of finding and ordering the product has been greatly reduced in cost for the consumer, now that the Internet is in place.
Trading on the Internet reduces the expenses incurred in selling the products. There is no rent, heating or lighting to be paid. Furthermore, the company will be able to use less staff, as salespeople are not a requirement of an Internet store. These savings can be passed on to the consumer in the form of price reductions and frequently they are. This should increase competition. However, the reason behind cheaper prices on the Internet means that High Street stores are simply unable to compete with them, as they cannot make similar cost cuts. This does not mean that they are priced out of the market though, as, according to the model of perfect competition, they should be.
This may be for a number of reasons for this but I believe the main one is the “fear factor” regarding the use of the Internet. Many people are afraid of the safety of using the Internet, whether or not their credit card details will be secure, and other, now fairly irrational fears. Many of these problems have now been resolved, with the introduction of security standards and systems with the purpose of keeping details safe, but some people are not prepared to take the risk. This risk, however small, does enable firms selling on the Internet to compete on the security of the service they offer.
Also, customers may be unhappy to wait for the product to arrive by post, a large proportion of sales in this country, are, I believe, impulse purchases. The “fun” is taken out of these when the Internet is used as the expenditure (paying for the product) and the utility (actually receiving and being able to use it) are separated by a few days, possibly even a week or two.
Another possibility is that consumers do not know of the savings they can make. This means the consumers do not have perfect knowledge, a requirement of perfect competition. How is it possible for a firm to compete with another that its customers mostly do not know exists? There would be know point in a High Street store starting a price war with an Internet firm as many of their customers will never shop on the Internet anyway, so they will just be reducing their own revenue. For example Gameplay, the Internet computer games retailer, offers approximately a 20% discount on all, brand-new computer and console games. The High Street stores can make abnormal profits by selling at the recommended retail prices, so what would be the point in them reducing their prices.
In this respect the Internet is not making markets more competitive, as it is not affecting the entire market; many customers have never and will never use it. It is also a market that is unavailable to children, due to the payment method only being credit card, which children cannot have by law. So a child wishing to spend his “pocket money” has no option but to visit a High Street Retailer. So whilst the Internet is becoming more widely accepted, and even more widely available, there is a real chance that it could offer a genuine scenario for highly competitive markets, it will never reach perfect competition, due to the issue of branding, and it is a long way from being there yet. Personally, I use the Internet for purchases regularly to purchase a number of products and receive all safely, and at greatly reduced prices. That in itself is proof that it is possible, in terms of competition, it is just a case of waiting until others shop in a similar fashion.
There is more to developments in information technology than just the Internet though. Firms are now using computerised stock control and ordering systems that enable them to compete in terms of the quality of service they provide. For example, if you go into a shop and ask if they have a certain product in stock, you are likely to be far more satisfied if the type a description into their computer and tell you, “yes we have 6 they’re just here sir”, or “no we don’t but I can tell you which of our stores in this area do have any in stock.” Than if they say, “I’ll just go and have a look out the back sir” and ten minutes later return to tell you they do not, and they have no idea when they will be receiving some, and that they don’t know where else has any. Computerised stock control systems have enabled firms to be the former of these two. This has increased competition in the sense that firms must compete to maintain their customers loyalty.
So, in conclusion I will say that whilst there is great prospect for information technology, particularly the Internet, to drastically increase competition worldwide, there is no evidence that this “revolution” has happened yet, or will happen within the short-term future. When it does happen, there is a chance all the smaller, local business will be put out of business by the reduced prices of the Internet competitors, and so competition will actually stay the same, just the medium for purchasing may have changed. As for computerised stock systems, these seem to have become the normal amongst almost all High Street Stores and so whilst it may have increased competition to begin with, it now has minimal effect.
2,222 words.
