Friday, January 27, 2012

market forms

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a) The market conditions necessary for perfect competition are as follows.

It must consist of many separate buyers and sellers. It needs producers who aim to maximize profits and consumers who aim to maximize satisfaction. Freedom of entry to and exit from the market, this means that there are no barriers to prevent new firms from opening up production in the market or laws or administrative arrangements which prevent businesses from closing down production or getting out a market. Perfect knowledge about prices, production options, what competitors are doing, market forces and so forth. Also, perfect mobility so that consumers can buy products from the best supplier without transportation costs or difficulties. Perfect divisibility is also important so consumers can buy exactly the quantity of the product they want. Lastly, product homogeneity (identical product) is a market condition that is necessary for perfect competition. This is where the output of one producer cannot be told from the output of other producer, so consumers are not able to show preference towards particular producers.

Perfect competition is the ideal market form that has the maximum amount of competition between firms. Firms involved in perfect competition usually face a perfectly elastic demand curve. For example, the producer for the Agricultural markets faces a perfectly elastic demand curve. (Refer to diagram below).

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If price is set above the demand, there will be no consumers. (No one will buy). If the price is set lower then demand, the business (agricultural markets) will no longer stay in existence. This is not ideal for the producers. Consumers will always buy at lower price. This is called rational behaviour.

An Oligopoly is a small number of firms competing (usually about -8) producing a similar product (usually not identical) and the actions of one firm cause a reaction from the competitors. Examples of Oligopolies are cigarette producers, supermarkets etc. These firms often avoid price competition. This is called a ‘price war’ as once one firm drops the price, the other competes by dropping their price and in the end, if the prices are so low, only the consumer benefits.

The ‘barriers of entry’ are market conditions necessary for Oligopoly. This makes it difficult for new firms to enter an industry. These barriers will tend to decrease competition and increase prices. This is an example of a whole list of barriers

§ High setup costs�eg airlines, BHP

§ Patents� eg Copyright

§ Government legislation to retain monopoly�eg Australia Post

§ Scale of production required�eg car manufacturing

§ Access to infrastructure�eg Telstra

§ Existing consumer/brand loyalty�eg Coca Cola

§ Secret ingredients�eg KFC

§ Advertising�eg cars, home loans

§ Highly specialized employees�eg IT people

§ Multinational companies�eg Holden, Coca Cola

Those firms involved in Oligopoly face a kinked demand curve. It may be kinked because it is formed by two parts of separate demand curves on different assumptions about the behaviour of rival firms to a price cut and a price rise. Above a certain price demand is elastic. Consumers will continue to buy from a given producer, even with a small variety in price. Below a certain price demand is very inelastic. Even large changes in price will see small changes in the quantity purchased.

The diagram below is an example of a kinked demand curve. (The existing price in a market).

The top curve shows that if one firm increases price, other firms will try to keep theirs down. Therefore the firm will lose sales to the firms that have cheaper prices. Looking at the bottom curve, if the firm drops prices, the others will to, which will result in them not being able to increase sales.

b) The advantages for firms under perfect competition are

§ Lower prices

§ Greater choice

§ Greater efficiency or productivity (output per unit of input)

§ Greater innovation

§ Total employment is greater

§ Better customer service

§ Producers do not become too politically powerful

§ Increased flexibility

Looking at the above diagram again and referring to what was explained about it in part a), it is logical to say that perfect competition is not ideal for producers. The loser in this case is the inefficient producer. Therefore, perfect competition is better suited to the consumers. Although, in different circumstances the winners from perfect competition can either be the consumers or the producers.

The disadvantages of perfect competition or “why oligopoly is good” are

§ Economies of scale are harder to achieve

§ Some industries are suited to a few large firms

§ Small firms find it difficult to compete with imports

§ The market is unpredictable, making planning difficult

§ Cost cutting way lead to undesirable actions

§ Unnecessary duplication or services

§ Small firms cannot afford exclusive research into new technology

§ Below is a diagram that shows economies of scale.

This diagram shows that the cost of production for the small firm producing the good is at a much higher price compared to the larger firm producing the good (at lower price). This is due to the fact that the larger firm has access to better resources and buying in bulk.

Therefore the winners in Oligopoly are the producers and the losers are the consumers. This is because consumers want competition, as it will give them greater choices and lower prices. Oligopoly has limited choice with rare price competition occurring.

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