Explanation of Perfect Competition Market

Published: 2019-10-18 07:00:00
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A perfectly competition market is a market structure that comprises majorly of various sellers in the market who offer similar products produced using a standard method. Each firm in the market possesses complete information touching on pricing and market. There is free entry and exit to the market. All the firms are price takers meaning that they do not hold their own pricing policy. The individual sellers and buyers have no control over the prices. The sellers have no obligation except to accept the price ascertained by the demand and supply forces shaping the market and then sell the product at the prevailing prices in the market. Since the good offered for sale is identical in all aspects, no firm has the freedom of increasing the price higher than that prevailing in the market. In case any firm increases its pricing, then it is bound to lose all desirable demand to the rival firms (Becker, 2013).

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Explanation of Monopoly Market

Monopoly market is a type of market structure where the number of sellers selling similar but not exactly identical products, is big. The products/services offered for sale in this kind of market structure have close substitutes for each other. This market, according to-, has highly elastic demand curve. Since it is a non-price competition, it implies that the firms are price makers and that every firm possesses its own pricing strategy. Thus, the sellers have the freedom to make decisions pertaining to price and output based on the product (Stiglitz, 2015).

Detailed Graphical Differences between the two Markets

Perfect competition market in relation with abnormal profits

In the short run, in a perfect competition market, a firm would face difficulties to make abnormal profits. As shown in the diagram below, the point is shown where the price of the firm is (representing AR) exceeds the AC. Marginal cost (MC) will thus cut the AC at its lowest point near the point where MR=MC. Any other point after that will make the firm to start experiencing turnover maximization.

This condition of a certain firm generating abnormal profits can never last longer since there exists free knowledge and information, combined with existence of perfect factors of production. Since there are no obstacles to entry, new firms are thus enticed to come into this market. The influx of several new firms is bound to shift the supply curve to the right as indicated in the below fig. The resultant effect would be to push prices down and thus letting down revenue due to stiff competition. Any changes in output by one of the firms cannot affect the market price, but such change in price will only occur following either entry or exit of multiple firms.

As shown in the figure, the lower price is bound to move the AR curve downwards up to the point when the anomalous profit has been crowded out. This will cause the firms to return to the situation where they used to generate normal profits. In the long run, this change appear as shown in the figure below.

New firms still have the freedom to enter the market. The only limitation is that, since the demand curve facing each of the firms has been brought lower, majority of them will be forced to regulate their productivity to new profit-maximizing positions , whereby MR=MC. Resultantly, the market will then revert to a long run state of equilibrium and experience normal profit. For the monopoly, the condition would turn out to be entirely different.

There are certain variables that are bound to limit the entry to a market, including large startup and investment costs, export/import restrictions, patents, and government regulations. There is no limitation on entering a perfectly competitive market. Roberts, 2014, p. 23 explains that there is absolute liberty of entry for several firms and other setup firms are incapable of stopping new firms from entering the market. On the contrary, access to the monopoly is absolutely restricted of blocked. Such a restriction may be done for a variety of reasons including initial setup costs, legislation, and government regulations.

Monopoly in relation to abnormal profits

In a condition of short-run equilibrium, a monopoly will be able to maximize profit the same way it could have been the case with perfectly competition as indicated best in the equation of MR=MC. Since a monopoly firm is the major market supplier, its demand curve is similar to that of the market demand curve. That does not imply that they can set the price in the same way as perfect competition. The best they can do is to increase productivity whilst selling more items at lesser prices to a point where revenue average exceeds the average cost, and then they will start making abnormal profits (Ostroy, 2014, p. 65).

The kind of profit that would be made (as shown in the above fig) is a pointer to the disparity between Average Revenue (AR) and Average Cost (AC). The point where AR is above AC is the actual point whereby a monopolist makes anomalous profits. The distancing between AC and AR is a representation anomalous profits for each unit output. In a condition of the long run, a monopolist firm has the freedom of maintaining this point dependent on factors like barriers to entry that protect that kind of position and deter other firms from gaining entry into the industry (Becker, 2013).

Conclusion

After review of the above differences and explanations, it is vivid that monopolistic competition and perfect competition are quite different. The key point to note is that a monopoly has features of both the perfect competition and monopoly.

Reference List

BIBLIOGRAPHY Becker, G., 2013. The economic approach to human behavior.. s.l.:University of Chicago press..

Ostroy, J.M., 2014. The no-surplus condition as a characterization of perfectly competitive equilibrium. Noncooperative Approaches to the Theory of Perfect Competition, 3, p.65.

Roberts, K., 2014. The limit points of monopolistic competition.. Noncooperative Approaches to the Theory of Perfect Competition, Volume 3, p. 141.

Stiglitz, J. a. R. J., 2015. Economics of the Public Sector: Fourth International Student Edition.. s.l.:WW Norton & Company..

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