Microeconomics essay 1 - What are the necessary conditions for perfect competition? Which markets do you think come closest to the perfectly competitive model? PDF

Preview

Summary

Assessed Essay that contributed to final module mark. I graduated with a 1st class degree....

Description

What are the necessary conditions for perfect competition? Which markets do you think come closest to the perfectly competitive model?

Perfect competition is an economic theory which ‘illustrates an extreme form of capitalism, whereby firms are entirely subject to market forces’ (Soloman, Hinde and Garratt, 2010). The model of perfect competition is built upon five distinct conditions that need to be present for perfect competition to exist. These conditions are very stringent and in the real word very few markets conform to them. The first of these conditions is that there is a large number of firms. Due to there being a large number of firms it makes them price takers. This is because there is no firm that produces enough of the total market supply to individually affect the price. The price is therefore ‘determined by the interaction of demand and supply in the whole market’ (Soloman, Hinde and Garratt, 2010). The second condition is that all firms in the market produce homogenous products. This means consumers cannot tell which firm produced a given product and thus there is no brand loyalty. The third condition is there is complete freedom in both entry and exit from the market. Existing firms cannot prevent new firms from entering the market and there are no sunken costs due to advertising not being necessary. A sunken cost is ‘a cost that has already been incurred and thus cannot be recovered’ (Investopedia, 2016). The fourth condition is that all agents in the market have perfect knowledge of all the different market conditions. This means that ‘producers are fully aware of prices, costs and market opportunities and consumers are fully aware of price, quality and availability of the product’ (Soloman, Hinde and Garratt, 2010). The fifth and final condition is perfect mobility of inputs. This means that inputs to production can change with ease. Inputs to production include labour and capital. As already discussed, in the real world there are very few examples of markets that meet all the criteria for perfect competition. However, there are some markets that come relatively close. An example of one of these markets is that of agriculture and produce. Farmers produce homogenous products which they sell at market. There is a large number of producers and as a result no one producer/farm has enough market power to influence price, thus making them price takers. It is very easy for consumers to compare prices at market and as a result all of the producers charge very similar prices. For example, 4 pints of milk is priced at £1 at nearly every major UK supermarket. There are also very few barriers to entry in becoming an agricultural producer. The stock market can also be described as perfect competition. The products, in this case shares, are all homogenous and due to consumers being able to easily research the price of sed shares there is perfect information. As a result of this the firms that sell shares are forced to be price takers. Stocks and shares can also be bought and sold instantly meaning there is complete freedom in entry and exit from the market. The final example of a market that is a close to fitting the model of perfect competition is ecommerce. Selling via the internet gives firms immense freedom of entry as costs are significantly reduced. As the consumer views and purchases the product online there is no

need for a store front or retail staff. Marketing costs can be lower as services such as search engine optimisation are often cheaper than more traditional forms of advertising such as television. It could be said consumers have perfect knowledge due to how easy it is for them to quickly find which firm offers the best price. This is made possible with services such as Google shopping which allow customers to look for a product and compare the price offered by a variety of retailers. There is also a large number of firms and this number will only continue to rise. Online market places make it possible for anyone to become an entrepreneur and start selling their products. An example of this is Etsy.com, which provides a platform for individual sellers to sell their own unique products like jewellery and artwork. Ebay.com is another example of an online market place and it also meets some of the criteria for perfect competition. There are many firms, or in this case individual sellers, who are free to enter and leave the market as they please. Consumers also have perfect information as they can search and compare the listings of a certain product from different sellers. The examples previously given are the markets that come closest to perfect competition but even then they do not perfectly match all the criteria. This is because in reality there are things such as brand loyalty, barriers to entry and imperfect information. Consequently the model of perfect competition is far more useful as a tool in understanding the different kinds of imperfect competition in a variety of markets. References Investopedia. (2016). Sunk Cost. [online] Available at: http://www.investopedia.com/terms/s/sunkcost.asp [Accessed 8 Nov. 2016]. Soloman, J., Hinde, K. and Garratt, D. (2010). Economics for Business. 5th ed. p.216....