Perfectly Competitive Market

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  Market Structure

  • (Author)
  • 2014(Publication Date)
  • Orange Apple

    (Publisher)

  ____________________ WORLD TECHNOLOGIES ____________________ Chapter- 8 Perfect Competition In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any Perfectly Competitive Markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imPerfectly Competitive Markets. Basic structural characteristics Generally, a Perfectly Competitive Market exists when every participant is a price taker, and no participant influences the price of the product it buys or sells. Specific characteristics may include: • Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price. • Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a Perfectly Competitive Market. • Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions. • Perfect information - Prices and quality of products are assumed to be known to all consumers and producers. • Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility). • Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit. • Homogeneous products – The characteristics of any given market good or service do not vary across suppliers. • Constant returns to scale - Constant returns to scale ensure that there are sufficient firms in the industry.

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  The Microeconomics of Wellbeing and Sustainability

  Recasting the Economic Process

  • Leonardo Becchetti, Luigino Bruni, Stefano Zamagni(Authors)
  • 2019(Publication Date)
  • Academic Press

    (Publisher)

  Recherches is partial, in that it refers to the price and quantity variables in a market isolated from the rest of the economy. Cournot's approach was taken up and perfected by Alfred Marshall, who defined a perfectly competitive equilibrium as the state a market would be in if all decision-making entities, and companies in particular, were devoid of market power. To be precise, a market is perfectly competitive in which:

  • agents are maximizers: producers who transform inputs into outputs maximize economic profit within cost constraints; consumers who buy the outputs maximize their utility function within their income constraints; agents' decisions in the market are independent of each other; there are no coalitions or collusion, and production and consumption decisions do not create external effects;
  • the number of buyers and sellers is sufficiently high that no one is able to exert a significant influence on the quantities bought or sold in the market; the intensity of competition in the market is measured by the number of players in a certain sector, from which it follows that agents are price-takers;
  • producers and consumers have complete information about the possibilities of production and consumption, thus there are neither uncertainties nor information asymmetries between agents.

  As we will see, every deviation from one or more of these ideal market conditions leads, depending on the case, to monopolistic competition, either to monopoly or oligopoly. In this sense we can state that the theory of perfect competition constitutes a sort of benchmark against which other market structures can be defined and analyzed, which we will discuss in the next chapter.

  One final important observation. Competition is the flip side of resource scarcity: only in a world without either material and/or immaterial scarcity would there be no need for competition. There is competition even in command economies – as were those of the Soviet bloc until 1989, the year the Berlin Wall fell – but of a different sort than what is prevalent in market economies. Thus the question to address is not whether or not to abolish competition, which is impossible, but to decide which type of competition we want to incline toward, either positional (the current prevalent form) or cooperative . We will focus on this in Chapters 10 and 11

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  Microeconomics

  A Global Text

  • Judy Whitehead(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  9 The Perfectly Competitive Market Equilibrium of the Firm and Industry in Short-run and Long-run; Perfect Competition and Economic Efficiency; Industry Dynamics: Changes in Demand, Costs and Taxes. The market structure of Perfect Competition is often considered a highly desirable one particularly from the point of view of economic efficiency in a static, distributive sense. This is in consonance with the view that trading in increasingly competitive markets is, in theory, beneficial to economic welfare because of the greater efficiency in the use of economic resources. While this may or may not hold true in reality, it is nevertheless of importance to understand the intricacies and mechanics of this model which has received so much attention. Perfect Competition is the centrepiece of the traditional theory of the firm. It is one of the four basic models of market structure that make up the traditional theory of the firm. The others are Monopoly, Monopolistic Competition and Oligopoly. As a model of market structure, it is used to explain and predict the behaviour of firms which are part of this industry. Furthermore, as one of the so-called ‘marginalist’ models of the firm, the firm is theorized to maximize profits by following the ‘marginalist’ rule of equating marginal revenue with marginal cost. These marginalist models are later contrasted with the more modern alternative models of the firm which are included in the study of market structure. Newer models have proliferated since the 1930 and particularly since the 1950s and include the Managerial, Behavioural, Average-cost/Mark-up Pricing and Entry-Prevention models. 9.1 ASSUMPTIONS AND FUNDAMENTALS OF THE MODEL 9.1.1 Basic assumptions The basic assumptions of the model of Perfect Competition are as follows: • There are many buyers and sellers (firms) in the industry.

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  Microeconomics

  A Global Text

  • Judy Whitehead(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  9 The Perfectly Competitive Market

  Equilibrium of the Firm and Industry in Short-run and Long-run ; Perfect Competition and Economic Efficiency ; Industry Dynamics: Changes in Demand, Costs and Taxes .

  The market structure of Perfect Competition is often considered a highly desirable one particularly from the point of view of economic efficiency in a static, distributive sense. This is in consonance with the view that trading in increasingly competitive markets is, in theory, beneficial to economic welfare because of the greater efficiency in the use of economic resources. While this may or may not hold true in reality, it is nevertheless of importance to understand the intricacies and mechanics of this model which has received so much attention.

  Perfect Competition is the centrepiece of the traditional theory of the firm. It is one of the four basic models of market structure that make up the traditional theory of the firm. The others are Monopoly, Monopolistic Competition and Oligopoly. As a model of market structure, it is used to explain and predict the behaviour of firms which are part of this industry. Furthermore, as one of the so-called ‘marginalist’ models of the firm, the firm is theorized to maximize profits by following the ‘marginalist’ rule of equating marginal revenue with marginal cost.

  These marginalist models are later contrasted with the more modern alternative models of the firm which are included in the study of market structure. Newer models have proliferated since the 1930 and particularly since the 1950s and include the Managerial, Behavioural, Average-cost/Mark-up Pricing and Entry-Prevention models.

  9.1 Assumptions and Fundamentals of the Model

  9.1.1 Basic assumptions

  The basic assumptions of the model of Perfect Competition are as follows:

  • There are many buyers and sellers (firms) in the industry. There are so many buyers and sellers that no single buyer or seller can influence price or output sufficiently to alter the equilibrium of the industry.

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  Microeconomics for MBAs

  The Economic Way of Thinking for Managers

  • Richard B. McKenzie, Dwight R. Lee(Authors)
  • 2016(Publication Date)
  • Cambridge University Press

    (Publisher)

  426 Competitive and monopoly market structures A market. Indeed, many markets are inhabited by a few large, powerful firms that do not take price as a given. Many firms either are monopolies or possess a high degree of monopoly power. Demanders and suppliers are rarely as well informed as the model suggests. But the model of perfect competition was never meant to represent all, or even most, markets. It is merely one of several means economists use to think about markets and the consequences of changes in market conditions and government policy. We know from the perfectly competitive model that the predicted outcomes of the model hold if there are numerous producers and consumers. However, as noted earlier, it does not follow that if there are fewer – even far fewer – than “numerous” producers and consumers, the predicted outcomes of the perfectly competitive model do not hold. So long as the number of producers and consumers is sufficiently large that no one believes they have control over the price and acts accordingly, the perfectly competitive model can be useful in analyzing and predicting market behavior. Hence, the perfectly competitive outcomes could hold with no more than a couple of dozen producers and consumers in the market (Smith 1962 ). (Still, we take up more real-world markets, called “contestable markets,” in online Reading 10.1 .) Finally, the Perfectly Competitive Market can help us gain insight about production decisions precisely because its required conditions are “unreal.” The model of market competition simplifies the analysis, helping us see with clarity the essential features of competitive markets and showing us exactly how managers can improve their thinking as they consider the complex tasks of achieving maximum profitability and surviva-bility.

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  Managerial Economics

  • William F. Samuelson, Stephen G. Marks, Jay L. Zagorsky(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  Each firm takes the price as given—indeed, determined by supply and demand. Similarly, each consumer is a price taker, having no influence on the market price. It is important to remember that these conditions characterize an ideal model of perfect competi- tion. Some competitive markets in the real world meet the letter of all four conditions. Many other real-world markets are effectively perfectly competitive because they approximate these conditions. At present, we will use the ideal model to make precise price and output predictions for perfectly com- petitive markets. Later in this and the following chapters, we will compare the model to real-world markets. In exploring the model of perfect competition, we first focus on the individual decision problem the typical firm faces. Then we show how firm-level decisions influence total industry output and price. Decisions of the Competitive Firm The perfectly competitive firm is a price taker; that is, it has no influence on market price. Two key conditions are necessary for price taking. First, the competitive market is composed of a large number of sellers (and buyers), each of which is small relative to the total market. Second, the firms’ outputs are perfect substitutes for one another; that is, each firm’s output is perceived to be indistinguishable from any other’s. Perfect substitutability usually requires that all firms produce a standard, homogeneous, undifferentiated product, and that buyers have perfect information about cost, price, and quality of competing goods. Together, these two conditions ensure that the firm’s demand curve is perfectly (or infinitely) elas- tic. In other words, it is horizontal like the solid price line in Figure 7.3a. Recall the meaning of per- fectly elastic demand. The firm can sell as much or as little output as it likes along the horizontal price line ($8 in the figure). If it raises its price above $8 (even by a nickel), its sales go to zero.

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  Principles of Economics 3e

  • Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
  • 2022(Publication Date)
  • Openstax

    (Publisher)

  If a perfectly competitive firm attempts to charge even a tiny amount more than the market price, it will be unable to make any sales. In a Perfectly Competitive Market there are thousands of sellers, easy entry, and identical products. A short-run production period is when firms are producing with some fixed inputs. Long-run equilibrium in a perfectly competitive industry occurs after all firms have entered and exited the industry and seller profits are driven to zero. Perfect competition means that there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers. 8.2 How Perfectly Competitive Firms Make Output Decisions As a perfectly competitive firm produces a greater quantity of output, its total revenue steadily increases at a constant rate determined by the given market price. Profits will be highest (or losses will be smallest) at the quantity of output where total revenues exceed total costs by the greatest amount (or where total revenues fall short of total costs by the smallest amount). Alternatively, profits will be highest where marginal revenue, which is price for a perfectly competitive firm, is equal to marginal cost. If the market price faced by a perfectly competitive firm is above average cost at the profit-maximizing quantity of output, then the firm is making profits. If the market price is below average cost at the profit-maximizing quantity of output, then the firm is making losses. If the market price is equal to average cost at the profit-maximizing level of output, then the firm is making zero profits. We call the point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, the “zero profit point.” If the market price that a perfectly competitive firm faces is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately.

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  Microeconomics

  • David Besanko, Ronald Braeutigam(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  40 There is an area between a downward-sloping industry supply curve and the market price in a decreasing- cost industry. To interpret what this area means would take us beyond the scope of this text, and so we will not discuss it here. CHAPTER 9 Perfectly Competitive MarketS 406 Short Run Long-Run Competitive Equilibrium Economic profit for industry = total revenue − total cost = total revenue − total cost = 0 Producer surplus for industry = total revenue − total nonsunk cost = total revenue − total cost = 0 Area between industry supply curve and market price industry = producer surplus for industry In a constant-cost industry, this area equals zero. In an increasing-cost industry, this area is positive and equals the economic rent captured by owners of scarce industry-specific inputs. C H A P T E R S U M M A R Y • Perfectly Competitive Markets have four characteris- tics: the industry is fragmented, firms produce undiffer- entiated products, consumers have perfect information about prices, and all firms have equal access to resources. These characteristics imply that firms act as price takers, output sells at a single price, and the industry is charac- terized by free entry. • Economic profit (not accounting profit) represents the appropriate profit-maximization objective for a firm. Economic profit is the difference between a firm’s sales revenue and its total economic costs, including all relevant opportunity costs. • Marginal revenue is the additional revenue a firm generates by selling one additional unit or the revenue it sacrifices by producing one fewer unit. • A price-taking firm’s marginal revenue curve is a horizontal line equal to market price. • A price-taking firm maximizes its profit by produc- ing an output level at which marginal cost equals the market price, and the marginal cost curve is upward sloping.

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  Construction Microeconomics

  • Christian Brockmann(Author)
  • 2023(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  This is quite different from what you know about mass production, where different producers provide close substitutes to the market and they all sell more or less at the same price. Once you start thinking about it, you wonder what constitutes a market. In the moment, you do not worry too much. Demand is high and you can procure good contracts. Last year you made a profit of 8% on turnover and it has been similar all the three CASE STUDY (continued ) 5 Interaction in Perfectly Competitive Markets 98 The demand of consumers and the supply of producers meet in a market. The market price lies at the intersection between the demand and supply curve. This intersection also deter- mines the market quantity. The curves are presented in Figure 5.1 as straight lines for rea- sons of simplicity only. It took mankind approximately 2500 years to develop this graph that looks so very self‐ evident today. Please, do not forget to remember all the assumptions that are required to reach the result (Chapters 3 and 4). Any parrot can pronounce supply and demand but that does not mean that it understands the functioning of markets. If you listen closely, there are still today many people who claim that a price is not correct (too high or too low). Maybe, the argument goes, the price does not reflect the amount of labor required by a Demand Quantity (q) Price (p) q* Supply p* Figure 5.1 Market equilibrium in Perfectly Competitive Markets. years that you ran your company. In the end, this is a result close to your own initial analysis of market chances and it persuaded you to set up your own firm. Sometimes you worry about further competitors who certainly would reduce your profits, but somehow your area does not attract that much attention and you don’t know of any new startups. While you feel comfortable with the situation, you also wonder what it means to society.

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  An Introduction to the Market System

  • Kalman Goldberg(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  The market system’s response to scarcity has succeeded. It has indeed expanded the range of human satisfaction for those fortunate enough to be able to take an active part in it. However, in the process, the institutions, behavior, and circumstances that were prerequisite to the system have changed. Indeed, the market system model has now become the paradigm for formerly command and traditional economies. Each of them, as they develop industrially, will adapt their own institutions and values to fashion a wide range of individualized versions of the model, just as the Western world countries have done.

  Thus, it is critically important to remember that this Perfectly Competitive Market analysis is founded on conditions that are perfect to a degree never attained in any economy. Competition has rarely, if ever, existed as we have described it in this chapter; highly industrialized, urbanized, unionized institutions, particularly, do not lend themselves to the refined operations of the Perfectly Competitive Market system. However, the analysis is nonetheless valuable because our modern economic society and most of the societies of the world are patterned after the one described by the perfectly competitive model, with important reliance on the price mechanism. Because of our attitudes about what kind of system is “good” and “right,” our ideological commitments, are also fashioned out of the neoclassical mold, and because many of our current economic policies are based on these normative goals.

  Summary

  The solutions to the How and For Whom to produce problems are both made through the forces of demand and supply in the factor markets in the neoclassical market system. The example of the labor market illustrates key demand relationships of the perfectly competitive firm in the labor market.

  The marginal revenue product (MRP) curve is the firm’s demand curve for labor. It slopes downward and to the right because with additions to the work force, marginal product (and, therefore, MRP) declines.

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