Perfect Competition Characteristics and Examples

MARKET STRUCTURES PERFECT COMPETITION Type of Goods/Product: Homogeneous (identical) goods. Number of Sellers: Many. Control Over Price: None; firms are price takers. Barriers to Entry: Very low or none; high competition Product Differentiation: None. Examples: Agricultural products like rice, wheat, corn; basic commodities such as salt, sugar, or crude oil in global markets. Explanation:​ No single firm has any market power to influence the price. Prices are determined purely by supply and demand. Since products are identical, consumers have no preference for one seller over another. Consumers see no difference, so the only basis of choice is price. Because there are no barriers to entry, new firms can easily enter and exit the market. This prevents long-term profits. degree of pricing power. A well-branded product can charge slightly more due to customer loyalty. Firms compete not only on price but also on branding, quality, service, and advertising. No single firm dominates the market. It's relatively easy to enter, but some capital, branding, or licenses may be needed. New businesses often enter but face strong brand competition. Example: Coffee shops in a city—like Starbucks, Dunkin’, and local cafés. All sell coffee, but each offers a unique experience, taste, or brand image. Consumers may be willing to pay more for one over another. Jollibee and McDonalds both serve fast food but are branded differently. OLIGOPOLY Type of Goods/Product: differentiated (e.g. cars). Homogeneous (e.g. fuel) or Number of Sellers: Few (interdependent). Small group of large firms dominate the market Example: A vegetable market in a rural town where many farmers sell the same type of tomatoes. Each seller must accept the market price; otherwise, buyers will go to another seller. Control Over Price: Moderate (some price power but avoid price wars). Tacit collusion MONOPOLISTIC COMPETITION Product Differentiation: Some. Type of Goods/Product: Differentiated products (style, brand, quality) Examples: Automobile industry (Toyota, Ford, Honda), Airlines (Delta, Emirates), Telecommunications (Globe, Smart in the Philippines). Number of Sellers: Many. Control Over Price: Some (limited). Barriers to Entry: Low to moderate. Product Differentiation: Significant (branding, quality, features). Examples: Restaurants, clothing brands (e.g., Zara, H&M), salons, cafés, toothpaste Explanation:​ This structure is similar to perfect competition in terms of the number of sellers, but product differentiation gives firms some Barriers to Entry: High (e.g., capital costs, brand loyalty). Explanation:​ Oligopolies are dominated by a few large firms that are interdependent; the decision of one firm affects the others. Each watches the pricing and behavior of competitors. Because of high entry barriers such as startup costs (huge capital), economies of scale, and legal restrictions (licenses), new competitors rarely enter. Brand loyalty and economies of scale make it hard for newcomers. Firms often avoid price wars and instead compete through non-price strategies like reputation, promotions, and features. Prices are stable due to tacit collusion (not illegal MARKET STRUCTURES agreements, but mutual understanding). In some cases, firms form cartels—explicit or secret agreements to fix prices or control supply. A cartel is a group of producers that collude to limit competition, fix prices, or restrict output. Illegal in many countries, cartels can inflate prices, reduce consumer welfare, and slow innovation. Firms in a cartel behave like a monopoly—sharing profits while avoiding open competition. Example is OPEC (legal cartel of oil-producing countries). Explanation:​ A monopoly exists when a single firm is the sole provider of a product or service, with no close substitutes. No direct competition exists. Because there are extreme barriers to entry—such as government licensing, ownership of key resources, or patents—monopolies can set prices without competition. They are price makers—sets the price and consumers must accept or go without. However, the price may still be regulated by the government. It's nearly impossible for new firms to enter. There's no need to differentiate because no substitutes exist. Example: A local electricity provider like Meralco in the Philippines. Households typically have no alternative source for electricity, giving the firm significant power over pricing. Pharmaceutical firms holding patents on exclusive medicines. Example: The mobile telecom industry in most countries—consumers usually have only 2–4 real options, and prices tend to be similar due to tacit collusion or strategic behavior. Telecom like Globe and PLDT. Airlines like PAL and Cebu Pacific. Fuel providers like Shell, Petron, and Caltex. MONOPOLY Type of Goods/Product: Unique product. No substitutes. Number of Sellers: One (supplies the entire market) Control Over Price: High (price maker)—may still be regulated by the government. Barriers to Entry: Very high (due to patents, regulations). Product Differentiation: Unique. Examples: Utility companies (water, electricity, natural gas), patented drugs (Pfizer’s COVID-19 vaccine before generics). MARKET STRUCTURES SUMMARY Decision-Making Principles 1. Whatever the market environment, the firm maximizes profit by establishing a level of output such that marginal revenue equals marginal cost. 2. In perfect competition, the firm faces infinitely elastic demand: Marginal revenue equals the market price. Thus, the firm follows the optimal output rule P MC. In long-run equilibrium, the firm’s output is marked by the equalities P MR MC ACmin, and the firm earns zero profit. 3. Economic transactions are voluntary. Buyers and sellers participate in them if and only if the transactions are mutually beneficial. 4. Competitive markets provide the efficient amounts of goods and services at minimum cost to the consumers who are most willing (and able) to pay for them. Worldwide competition and free trade promote global efficiency. Nuts and Bolts 1. In a perfectly competitive market, a large number of firms sell identical products, and there are no barriers to entry by new suppliers. Price tends toward a level where the market demand curve intersects the market supply curve. In the long run, price coincides with minimum average cost, and all firms earn zero economic profits. 2. The total value associated with an economic transaction is the sum of consumer and producer surplus. Consumer surplus is the difference between what the individual is willing to pay and what she or he actually pays. 3. For any market, the height of the demand curve shows the monetary value that consumers are willing to pay for each unit. Consumer surplus in the market is given by the area under the demand curve and above the market price line. 4. In equilibrium, a competitive market generates maximum net benefits. The optimal level of output is determined by the intersection of demand and supply, that is, where marginal benefit exactly equals marginal cost. MONOPOLISTIC COMPETITION In perfect competition, all firms supply an identical standardized product. In monopoly, a single firm sells a unique product (albeit one that may have indi- rect substitutes). As the term suggests, monopolistic competition represents a mixture of these two cases. The main feature of monopolistic competition is product differentiation: Firms compete by selling products that differ slightly from one another. Product differentiation occurs to a greater or lesser degree in most consumer markets. Firms sell goods with different attributes (claimed to be superior to those of competitors). They also deliver varying levels of support and service to customers. Advertising and marketing, aimed at creating product or brand-name allegiance, reinforce (real or perceived) product differences. Product differentiation means that competing firms have some control over price. Because competing products are close substitutes, demand is rela- tively elastic, but not perfectly elastic as in perfect competition. The firm has some discretion in raising price without losing its entire market to competi- tors. Conversely, lowering price will induce additional (but not unlimited) sales. In analyzing monopolistic competition, one often speaks of product groups. These are collections of similar products produced by competing firms. For instance, “designer dresses” would be a typical product group, within which there are significant perceived differences among competitors. The determination of appropriate product groups always should be made on the basis of substitutability and relative price effects. Many, if not most, retail stores operate under monopolistic competition. Consider competition among supermarkets. Besides differences in store size, types of products stocked, and service, these stores are distinguished by locational convenience—arguably the most important factor. Owing to locational convenience and other service differences, a spectrum of different prices can persist across supermarkets with- out inducing enormous sales swings toward lower-priced stores. Monopolistic competition is characterized by three features. First, firms sell differentiated products. Although these products are close substitutes, each firm has some control over its own price; demand is not perfectly elastic. Second, the product group contains a large number of firms. This number (be it 20 or 100) must be large enough so that each individual firm’s actions have negligible effects on the market’s average price and total output. In addition, firms act independently; that is, there is no collusion. MARKET STRUCTURES Third, there is free entry into the market. One observes that the last two conditions are elements drawn from perfect competition. Nonetheless, by virtue of product differentiation (condition 1), the typical firm retains some degree of monopoly power. Let’s consider the output and price implications of these conditions. Figure 8.5a shows a short-run equilibrium of a typical firm under monopo- listic competition. Because of product differentiation, the firm faces a slightly downward-sloping demand curve. (If it raises price slightly, it loses some, but not all, customers to competitors.) Given this demand curve, the firm maximizes profit by setting its marginal revenue equal to its marginal cost in the usual way. In the figure, the resulting output and price are Q and P, respectively. Because price exceeds average cost, this typical firm is earning positive economic profits. In a long-run equilibrium, the free entry (or exit) of firms ensures that all industry participants earn zero economic profits. Thus, in the long run, the outcome in Figure 8.5a is not sustainable. Attracted by positive economic prof- its, new firms will enter the market. Because it must share the market with a greater number of competitors, the typical firm will find that demand for its product will be reduced; that is, its demand curve will shift to the left. Figure 8.5b shows the firm’s new long-run demand curve. As in part (a), the firm is profit maximizing. The firm’s optimal output is QE, where marginal revenue equals marginal cost. However, even as a profit maximizer, the firm is earning zero economic profit. At this output, its price, PE, exactly equals its aver- age cost. In fact, the firm’s demand curve is tangent to (and otherwise lies below) its average cost curve. Any output other than QE, greater or smaller, implies an economic loss for the firm. A comparison of Figures 7.3 and 8.5 shows the close correspondence between the graphical depictions of monopolistic competition and perfect competition. The essential difference centers on the individual firm’s demand curve—either downward sloping (reflecting differentiated products) or infi- nitely elastic (indicating standardized products that are perfect substitutes). In both cases, the long-run equilibrium is marked by the tangency of the demand line with the average cost curve. Under perfect competition, this occurs at the point of minimum average cost. In contrast, the typical firm in monopolistic competition (by virtue of its differentiated product) charges a higher price (one above minimum average cost) and supplies a smaller output than its coun- terpart in a competitive market. SUMMARY Decision-Making Principles 1. Whatever the market environment, the firm maximizes profit by establishing a level of output such that marginal revenue equals marginal cost. 2. A monopolist sets MR MC, where MR is determined by the industry demand curve. The magnitude of monopoly profit depends on demand (the size and elasticity of market demand) and on the monopolist’s average cost. 3. In monopolistic competition, the firm’s long-run equilibrium is described by the conditions MR MC and P AC. Nuts and Bolts 1. Under pure monopoly, a single producer is shielded from market entrants by some form of barrier to entry. To maximize profit, the monopolist restricts output (relative to the competitive outcome) and raises price above the competitive level. 2. A cartel is a group of producers that enter into a collusive agreement aimed at controlling price and output in a market. The cartel restricts output and raises price to maximize the total profits of its members. The incentive for individual members to sell extra output (at discounted prices) is the main source of cartel instability. 3. A natural monopoly occurs when the average cost of production declines throughout the relevant range of product demand. Regulation via average-cost pricing is the most common response to natural monopoly. 4. In monopolistic competition, a large number of firms sell differentiated products, and there are no barriers to entry by new suppliers. Because each firm faces a slightly downward-sloping demand curve, price exceeds minimum average cost. SUMMARY Decision-Making Principles 1. The key to making optimal decisions in an oligopoly is anticipating the actions of one’s rivals. 2. In the dominant-firm model, smaller firms behave competitively; that is, they take price as given when making their quantity decisions.