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ECONOMICS FOR MANAGERS

13 December 2010

The term market structure refers to the composition of the market in which the firm performs; this works in relation to the number of firms in the market, the type of goods that are being sold, quantity and also barriers to entry as well as exit. Perfect competition is one of the four main market structures that exist. It is a market structure in which the firms in an industry are price takers, wherein there is freedom of entry into and exit from the industry moreover where all the goods produced are homogenous (identical). The Assumptions In a market structure such as perfect competition there are a large number of firms making a lot of homogenous products. The ability of a firm to put forth competitiveness is dependent on the amount of power it has. If it has less power in the market in which it sells its goods in, then the more competitive the market will be. Therefore if a firm is in this position it isnt significant enough to set its prices thus making it a price taking firm. There is freedom to and exit from the industry/no barriers to entry of exit. In the short run it takes a relatively long time to set up a business so this rule for no barriers to entry/exit is only applicable on the long run. Seeing as all the goods are homogenous; it is practically impossible to brand your products. Furthermore there is no need for advertising. Producers and consumers have perfect knowledge/are fully aware of the market. Meaning the producers are completely conscious of the costs, market opportunities, prices and o on. In addition the consumers are also acquainted with the price, quality and periods of certain availability. Stuff about output profit maximization and long run average cost/marginal cost.

Samsung and LG are two firms that produce relatively the same range of goods, in a similar case two vegetable shop owners in a city are also selling the same range of goods. They are very different firms. In the case of Samsung and LG these firms have been given the opportunity of branding. Firms as such have the ability to add inviting features to their products with an increased price; for example televisions with LCD & LED screens, HD video quality, record and playback technology that will appeal to the market and may draw consumers towards one product instead of the other. In the case of the vegetable shop owners, the products they sell fruits and vegetables are homogenous. The public is completely aware of prices and availability of the goods, 1|Page

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furthermore it is practically impossible to brand such goods so to raise prices with the aim of increasing profits is an unreasonable initiative. This is because dozens of firms like this (vegetable shops) would be accessible all over town giving consumers a vast range of options. This leaves such individual firms with less power forcing them to reduce their product prices. In the general assumptions it states that there is free entry to and exit from market. In reality there really isnt any time for this in the short run, hence entry of new firms into the industry happens in the long run. In the short run the market price is determined by the interaction between the market supply and demand. The market price is one that every firm has to accept as they are all price taking firms; in addition profit is maximized when marginal revenue = marginal cost. Seeing as the price for each unit sold is constant the marginal revenue and average revenue would be equal causing them to follow the same curve. In figure 1 the firm is producing where average revenue is higher than average cost, keeping in mind that AR & MR are equal here and MC=MR is where profit is maximized ; Q1 is where the firm would sell there and at this point supernormal profits are gained, it is shown by the on figure 1 by the shaded area. Not all firms make supernormal profits in the short run. It all basically depends on the positioning of all their short run curves. The firms production may surpass the market price, and because they are price taking firms they would have to maintain that price. While in the long run; supernormal profits made by existing firms would draw interest to new firms and also encourage other firms to expand their own businesses. In the long run there is enough time for firms to enter the market and set up their firms. The outcome of entry of new firms and expansion of others is a general rise in the market supply. This action causes the market supply curve to move towards the right in the diagram for the industry; this furthermore leads to a fall in price reducing the supernormal profits. As time goes on, firms continue to join the industry and the supply continues to shift to the right causing prices to fall even more, this continues to happen till the Demand curve/Average Revenue Curve touches the bottom of the LRAC (long run average cost) curve, at this point normal profits are made.

The situations of how the perfect competition model leads to equilibrium are explained above. These situations come with benefits, benefits that cause welfare to the consumers and society as a whole; they are explained in detail below. 2|Page

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ECONOMICS FOR MANAGERS

13 December 2010

In a market structure like perfect competition, incompetent firms would not be able to stand on their feet. Taking into account that firms in this market structure are set to make normal profits on the long run, it can be argued very strongly that ineffective firms within this structure would be driven to exit. This is because if (on the long run) they are unable to make the basic normal profits, it may be the case that their next possible outcome would be a loss (though in reality factors such as high cost to exit would be examined). This system acts as a cleanup that removes the inept and leaves the efficient; also creating competition within the surviving firms, pushing them to invest in new technology and moreover to be increasingly innovative producing high quality goods for their consumers. This does not mean that there would mean that there would be a smaller number of firms in the industry, because many of them would still be able to make the cut. It means the consumers would be provided with the luxury of having a wide range of choices to choose from. Economic efficiency is where each good is produced at the minimum cost and where individuals and firms get maximum benefit from their income/resources. It can be suggested that the perfect competition model brings about economic efficiency. Production on the long run with firms under the perfect competition model would experience lower average production costs; with lower production costs there is a no need for firms to increase their products prices to make their profit; and in the case of perfect competition the firms may already be making their profits though simply on a normal scale. Basically they work conjugally to keep prices are a minimum. Productive efficiency

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