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APMic U3 L7 perfect competition and introduction to market structure

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1. What is the meaning and dimensions of market structure?

2. What are the four principal types of market structure and what makes each type of market structure different from the others?

3. How does a price-taking firm determines its profit-maximizing quantity of output?

4. How can we assess whether or not a competitive firm is profitable?

5. Why does industry behavior differ between the short run and the long run?

6. What determines the industry supply curve in both the short run and the long run?

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Define (using graphs as appropriate) the characteristics of perfectly competitive markets and efficiency.

Explain (using graphs where appropriate) equilibrium and firm decision making in perfectly competitive markets and how prices in perfectly competitive markets lead to efficient outcomes.

Calculate (using data from a graph or table as appropriate) economic profit (loss) in perfectly competitive markets.

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Even with a common goal of profit-maximization, market structure constrains and influences prices, output, and efficiency.

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A perfectly competitive market is efficient. Firms in perfectly competitive markets face no barriers to entry and have no market power.

In perfectly competitive markets, prices communicate to consumers and producers the magnitude of others’ marginal costs of production and marginal benefits of consumption and provide incentives to act on that information (i.e., price equals marginal cost in an efficient market).

In perfectly competitive markets, firms can sell all their outputs at a constant price determined by the market.

At a competitive market equilibrium, firms are price takers and select output to maximize profit by producing the level of output where the marginal cost equals marginal revenue (at the price).

At a competitive market equilibrium, the price of a product equals both the private marginal benefit received by the last unit consumed and the private marginal cost incurred to produce the last unit, thus achieving allocative efficiency.

In a short-run competitive equilibrium, price can either be above or below its long-run competitive level resulting in profits or losses, motivating entry or exit of firms and moving prices and quantities toward long-run equilibrium.

In a long-run perfectly competitive equilibrium, productive efficiency implies all operating firms produce at efficient scale, price equals marginal cost and minimum average total cost, and firms earn zero economic profit.

Firms may be in a constant cost, increasing cost, or decreasing cost industry. Long-run prices depend on the portion of the long-run cost curves on which firms operate.

A perfectly competitive market in long-run equilibrium is allocatively and productively efficient.

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Competition is an essential element of market economies. Different firms have the freedom to attract customers based on price, quality, service and convenient. The type of competition will depend on the product and market structure. For example, in a market with many traders selling potatoes, price will be a key factor. Consumers will shop around to buy the cheapest. However, for a service like a restaurant meal - the price will be only one of many factors. In this case, firms will be seeking customers based on issues of quality of food, environment and a convenient location.

Different ways firms compete

Price. Some goods are price sensitive. For example, a good like petrol consumers will desire to buy the cheapest. Firms will struggle to differentiate the good as all petrol seems the same. Offering cut-price petrol will attract customers.

Brand loyalty. Consumers can develop a loyalty to their favourite brand and good. The consumer knows what to expect when they go to Starbucks Coffee. Trying to increase brand loyalty is a reason why firms spend money on advertising to gain.

Convenience. For many goods and services, convenience and being in the right location is the most important factor. It is no point selling cheap petrol if motorists have to drive many miles to purchase.

Service For some products, the quality of the service is important. With restaurants, the price of the meal may be considered secondary to the quality of the food and the environment of the restaurant.

Offering new products. Rather than reacting to consumer preferences, successful firms have developed new products that create new markets. For example Apple with innovative iPod and iPad.

Competition in perfect competition

Perfect competition is a theoretical market structure, in which there is perfect information and the good is homogenous. Therefore, the price is the determining factor and the model suggests that all firms will converge on selling at the market price.

In the real world, perfect competition is unrealistic except for a few products (foreign exchange markets)

Competition in Oligopoly

Most market structures are some kind of oligopoly. This is more realistic as it allows for a few firms to dominate the market. In an oligopoly, we can see more non-price competition as firms seek customers based on factors such as. Some models of oligopoly suggest prices will be stable - see: Kinked demand curve model

Loyalty card - encouraging repeat customers through discounts to loyal customers

Direct mailing - a key method of retaining customers is through gaining access to their email address and then sending targetted promotions and news about new features/products.

Ethical/charity concerns. Some firms may promote an ethical line of marketing, for example, 'fair-trade' coffee appeals to customers who wish to buy goods with a social conscience.

Unique selling points. In recent years, firms have concentrated on offering differentiated products and products that can be customised to consumer preferences. For example, when Henry Ford launched the Model T, he said, customers can have any product so long as it is black. But, the modern customer seeks greater specialisation. Innovative clothing companies allow customers to send in their own personal measurements to get clothes which fit, rather than generic sizes of S, M, L.

Advertising/brand loyalty. Firms spend billions on advertising because repeated exposure to famous brands can make consumers more likely to buy 'trusted' brands. High brand loyalty can also create barriers to entry. For example, many firms have tried to enter the market for cola, but have been unsuccessful, due to the success of Coca-Cola and Pepsi in creating strong brand loyalty.

After-sales service. For some goods, like TVs and car, offering free after-sales service can be a factor in encouraging customer trust.

Cultivation of good reviews. In an online world, good reviews are increasingly important - especially for industries like tourism. Therefore, firms have an incentive to encourage happy customers to leave reviews.

Foreseeing trends in markets. Many successful retailers have gone out of business because they were stuck with old business models. Successful firms need tremendous adaptability and innovation to move into new markets and trends. For example, retailers who successfully moved into an online presence have been more adaptable to trends in consumer behaviour.

Pay for best workers. In some industries, success may all depend on the quality of staff. For example, restaurants may want to employ the top chef. Football clubs the best footballers and managers. In other industries, firms may work hard to keep the workforce motivated by share employee schemes - giving workers a share in the firm's fortunes.

Different forms of price competition

Firms can also use different types of price competition to attract customers.

Premium pricing. This occurs when a firm makes a good more expensive to try and give the impression that it is better quality, e.g. 'premium unleaded fuel', fashion labels.

Loss Leaders This involves setting a low price on some products to entice customers into the shop where hopefully they will also buy other goods as well. However, it is illegal to sell goods below cost, so firms could be investigated by OFT.

Price Discrimination. This involves charging a different price to different groups of consumers to take advantage of different elasticities of demand. There are different types of price discrimination from first degree to third degree.

Reference Pricing. This involves setting an artificially high price to be able to later offer discounts on previously advertised price.

See more at pricing strategies

Other ways firms may compete

Collusion - a way to avoid price competition - entering into tacit agreements to restrict output and fix prices. This is illegal in many countries

Preventing the entry of new firms. To retain monopoly power, firms may use limit pricing, spend money on advertising and seek to control different stages of production, e.g. retain landing slots at major airports.

Mergers - buying rivals to reduce competition
Related

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Competition is an essential element of market economies. Different firms have the freedom to attract customers based on price, quality, service and convenient. The type of competition will depend on the product and market structure. For example, in a market with many traders selling potatoes, price will be a key...

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In the long run, with the entry of new firms in the industry, the price of the product will go down as a result of the increase in supply of output and also the cost will go up as a result of more intensive competition for factors of production. The firms will continue entering the industry until the price is equal to average cost so that all firms are earning only normal profits.

The short run cost curves that lies at the lowest point of the long run average cost curve has no incentive to leave the industry.

The firms will continue leaving the industry until the price is equal to average cost so that the firms remaining in the field are making only normal profits. Normal Profits, also known as break-even or zero economic profit, includes the profit paid to the entrepreneur (included in total cost, for bringing in scarce resources and taking on risk), and total cost is equal to total revenue. A firm making normal profits will remain in the industry.

In the Perfect Competition Long Run, the loss making firms will exit the industry, and new firms will enter the market. Losses are the key to establishing Long Run equilibrium.

In the long run equilibrium, firms enjoy market efficiencies, which leads to scarce resources not being wasted.

Perfect Competition Long Run Profit Maximization Formula

Where Long Run Marginal Cost (Long Run MC) = Short Run Marginal Cost (SMC) = Marginal Revenue (MR)

1. Productive Efficiency

When the firm produces at the lowest short run average cost. When productive efficiency is achieved, price equals minimum average total costs. Therefore, any firm that cannot produce at the minimum Average Total Cost will be forced to leave the industry.

2. Technical Efficiency

When the firm produces at maximum average product. This is also a consequence of productive efficiency.

3. Allocative/Pareto Efficiency

When price is equal to marginal cost. The greatest allocative efficiency has been achieved when there is no other combination of goods and services that would be more desired by society.

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Perfect Competition Long Run | Intelligent Economist

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In the long run, with the entry of new firms in the industry, the price of the product will go down as a result of the increase in supply of output and also the cost will go up as a result of more intensive competition for factors of production.

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Perfect Competition in the Short Run- Microeconomics Topic 3.7 (1 of 2)

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Micro 3.10 Perfect Competition in the Long Run- AP Micro

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Mr. Clifford's 60 second explanation of perfect competition in the long run. The firm starts in the short run making profit and then firms enter driving the price down. The firm ends up in long-run equilibrium. Please keep in mind that these clips are not designed to teach you the key concepts.

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Micro 3.11 Graphing Perfect Competition Practice

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Mr. Clifford's 60 second explanation of how to draw a perfect competitive firm making a profit. This is a great way to see if you really understand the graphs. Identify which one of the four graphs is drawn correctly. Be sure to identify what is wrong with the incorrect graphs.

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Is there really such a thing as perfect competition? 

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Is there really such a thing as perfect competition? 

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Kathryn Graddy: Fishing for perfect competition

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Introduction to the Competitive Firm | Microeconomics Videos

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How does a company really behave? We tend to assume profit - the bottom line - is the main motivation for a firm's actions.

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Production, cost, and the perfect competition model | Khan Academy

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This unit covers production and cost analysis and the behavior of firms in perfect competition. Topics include an introdduction to the short-run production function, diminishing marginal returns, the link between productivity and costs, the relationships that exist among cost curves, long-run costs, economies and diseconomies of scale, profit maximization, and the behavior of firms in perfectly competitive markets in the short run and the long run.

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AP Microeconomics: 3.7 Perfect Competition