Economics Assignment

Name : Farman Raza(BME-1219)
Dated: 10-Nov-2011
GLOBAL ECONOMIC ISSUES

(ECO-501)
Presented to : Our respected teacher Mr. Rana Ilyas By : Farman Raza (BME-1219)
Page 1 of 4
Dated: 10-Nov-2011
Perfect Competition
Introduction
The degree to which a market or industry can be described as competitive depends in part on how many suppliers are seeking the demand of consumers and the ease with which new businesses can enter and exit a particular market in the long run. The spectrum of competition ranges from highly competitive markets where there are many sellers, each of whom has little or no control over the market price - to a situation of pure monopoly where a market or an industry is dominated by one single supplier who enjoys considerable discretion in setting prices, unless subject to some form of direct regulation by the government. In many sectors of the economy markets are best described by the term oligopoly - where a few producers dominate the majority of the market and the industry is highly concentrated. In a duopoly two firms dominate the market although there may be many smaller players in the industry. Competitive markets operate on the basis of a number of assumptions. When these assumptions are dropped - we move into the world of imperfect competition. These assumptions are discussed below
Assumptions behind a Perfectly Competitive Market

1. Many suppliers each with an insignificant share of the market this means that each firm is too small relative to the overall market to affect price via a change in its own supply each individual firm is assumed to be a price taker 2. An identical output produced by each firm in other words, the market supplies homogeneous or standardised products that are perfect substitutes for each other. Consumers perceive the products to be identical 3. Consumers have perfect information about the prices all sellers in the market charge so if some firms decide to charge a price higher than the ruling market price, there will be a large substitution effect away from this firm 4. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology, other factor inputs) and improvements in production technologies achieved by one firm can spill-over to all the other suppliers in the market 5. There are assumed to be no barriers to entry & exit of firms in long run which means that the market is open to competition from new suppliers this affects the long run profits made by each firm in the industry. The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long term 6. No externalities in production and consumption so that there is no divergence between private and social costs and benefits
The Effects of a change in Market Demand

In the diagram below there has been an increase in market demand (ceteris paribus). This causes an increase in market price and quantity traded. The firm's average revenue curve shifts up to AR2 (=MR2) and the profit maximising output expands to Q2. Notice that the MC curve is the firm's supply curve. Higher prices cause an expansion along the supply curve. Following the increase in demand, total profits have increased. An inward shift in market demand would have the opposite effect. Think also about the effect of a change in market supply perhaps arising from a cost-reducing technological innovation available to all firms in a competitive market.
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Dated: 10-Nov-2011
Monopoly
Monopolistic competition is imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes but, because of differences such as branding, not exactly alike). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson is also credited as an early pioneer of the concept. Monopolistically competitive markets have the following characteristics: There are many producers and many consumers in the market, and no business has total control over the market price. Consumers perceive that there are non-price differences among the competitors' products. There are few barriers to entry and exit. Producers have a degree of control over price. The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule. Major characteristics There are six characteristics of monopolistic competition (MC): Product differentiation Many firms Free entry and exit in the long run Independent decision making Market Power Buyers and Sellers have perfect information
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Dated: 10-Nov-2011
Market Structure comparison Number of Market firms power Perfect Competition Monopolistic competition Monopoly Infinite Many None Low
One
High
Elasticity of demand Perfectly elastic Highly elastic (long run)[15] Relativel y inelastic
Product differentiation None High[16]
Excess profits No Yes/No (Short/Lon g) [17] Yes
Efficienc y Yes[13] No[18]
Profit maximization condition P=MR=MC[14] MR=MC[14]
Pricing power Price taker[14] Price setter[14] Price setter[14]
Absolute (across industries)
No
MR=MC[14]
Page 4 of 4

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Name : Farman Raza(BME-1219)

GLOBAL ECONOMIC ISSUES

Name : Farman Raza(BME-1219)

Assumptions behind a Perfectly Competitive Market

The Effects of a change in Market Demand

Name : Farman Raza(BME-1219)

Name : Farman Raza(BME-1219)

Product differentiation None High[16]

Excess profits No Yes/No (Short/Lon g) [17] Yes

Efficienc y Yes[13] No[18]

Profit maximization condition P=MR=MC[14] MR=MC[14]

Pricing power Price taker[14] Price setter[14] Price setter[14]

Absolute (across industries)

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