Prices and Markets Assignment 3 PDF

Preview

Summary

Download Prices and Markets Assignment 3 PDF

Description

Is the foreign exchange market a perfect competition?

Introduction: The analysis of market structure is crucial when determining the performance of a firm. How the market will behave will depend on many factors such as the number of buyers and sellers and entry and exit barriers. This report will analyse in particular, the foreign exchange market, what makes it a perfect competition and what effect its perfect competition market structure has on its conduct and performance. What is a perfect competition? To begin the report, a description of a perfect competition is necessary. Perfect competition is a market structure in which competition is at its greatest possible level. In other words, it is a market which exhibits certain characteristics such as everyone sells an identical product, there are no entry and exit barriers, all firms are price takers (they cannot influence the market price of a product) etc. Under perfect competition, no one in the market is able to develop a monopoly as there are many buyers and sellers and prices reflect supply and demand. Any firm earns enough profit to survive, any excess profit produced will be taken away as other firms enter the market and drive the profit. In the case of the foreign exchange market, if one currency is overvalued, market participants will sell that currency and purchase another currency and eventually, the price of the overvalued currency will come back down to its fair price. \

Figure 1: Graphs of firms and industries in perfect condition

Analysis: The foreign exchange market is a global market for trading currencies. Many economists believe the market is the closest thing to a perfect competition as it meets many characteristics of a perfect market. In the foreign exchange market, traders buy and sell

currencies. As there is only currency of each kind, the product is homogenous. There are a large number of buyers and sellers simultaneously trading currencies, therefore, no player in the currency market can influence the price, they are all price takers. Most buyers and sellers have access to real time market information and background research analysis on the factors driving each currency’s price (McDermott, JFM 2015). However, there are some limitations to the nature of a perfect competition market. Firstly, the market can be influenced by official intervention by the government buying and selling currencies or by central banks operating on their behalf. Also, there are high fixed costs involved in a bank or other financial institutions when establishing a new trading platform for currencies. Despite these limitations, the foreign currency markets is close to a perfect competition. Some economists claim that perfect competition is not a good market structure for high levels of research and development spending and the resulting product and process innovations (Makowski, L 1980). It may be the case that monopolistic or oligopolistic markets are more effective long term in creating the environment for research and innovation to succeed. Furthermore, a highly contestable market provides the discipline on firms to keep their costs under control, to seek to minimise wastage of resources and to refrain from exploiting the consumer by setting high prices and high profit margins. Therefore, the long run of perfect competition exhibits optimal levels of economic efficiency.

Figure 2: the effect of an increase in demand for the industry

Conclusion: To conclude this report, it is clear the foreign exchange market is a clear example of a perfect competition. It displays all the features of a perfect competition such as all firms selling a homogeneous product, all firms are price takers and cannot influence the price of the currencies, firms can enter or exit the market without cost etc. References: ‘ Per f ectc ompet i t i onandt het r ansf or mat i onofeconomi c s( BookRevi ew) ’1996,Jour nal of Ev ol ut i onar yEconomi cs,v ol .6,no.3,p.327, Mak ows ki ,L1980,‘ Per f ectCompet i t i on,t hePr ofitCr i t er i on,andt heOr gani zat i onofEconomi c Act i v i t y’ ,J our nalofEc onomi cTheor y,v ol .22,no.2,pp.222–242 McDer mot t ,J FM 2015,‘ Per f ectcompet i t i on,met hodol ogi c al l ycont empl at ed’ ,J our nalofPos t Keynes i anEc onomi cs,v ol .37,no.4,pp.687–703,...