11/04/2013

Analysis of Perfectly Competitive Markets

EC 102. Basic Economics, • Perfect Competition
- when no consumer or firm is powerful
Agrarian Reform, and Taxation
enough to affect prices
- market of “price-takers”
Lecture 10 • Perfectly Competitive Firm
- sells one identical product (homogenous
Imperfect Market Structures good) sold by other firms (competitors)
in an industry
- small relative to its market size such that
it cannot affect the market size
- faces a horizontal demand curve for its
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Analysis of Perfectly Competitive Markets Analysis of Perfectly Competitive Markets

Horizontal Demand Curve for Perfectly Competitive
Firms • Characteristics of Perfect Competition:
1. Many small firms selling a homogenous good
Coconut Industry Coconut Farmer
that are too small to affect the market price.
PC PC 2. Perfectly Competitive Firms individually face
MSC
horizontal demand curves.
PC* PC* 3. Since producers face a horizontal demand
DC curve, the extra or marginal revenue they
receive is equal to the price (P=MR).
MDC
QC QC
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Analysis of Perfectly Competitive Markets
• 3 Barriers to Perfect Competition:
1. Existence of Imperfect Competition (i.e.
Monopoly & Monopsony)
2. Externalities
- correction of externalities (by
government) may create unfair
competition or difference among firms (i.e.
pollution restrictions)
3. Imperfect Information
- blocks the creation of a “standard market
price”
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Imperfect Competition
• Types of Imperfect Competition:
2. Oligopoly
- limited number of sellers (2-15)
controlling the industry
- may affect the price of a good in 2 ways:
a. competition – may drive down the price
as oligopolists race to the bottom
b. collusion – may bring up the price as
oligopolists agree on a certain level of
output and price to release in the market
(i.e. cartel)
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Imperfect Competition
• Imperfect Competition
- when a seller or a buyer has some
influence over the price of a good
• Types of Imperfect Competition:
1.Monopoly
- single seller with complete control over
an industry
- negative effects:
a. high prices
b. low output
5 c. inferior quality
Imperfect Competition
• Types of Imperfect Competition:
3. Monopolistic Competition
- large number of sellers selling
differentiated products (goods are
essentially similar or of the same purpose
but has a slight edge)
- negative effect:
a. high prices due to differentiation
b. advertising/marketing costs (to the firm
and to the consumers)
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Imperfect Competition Imperfect Competition

• Causes of Imperfect Competition: • Causes of Imperfect Competition:

1. Costs & Market Imperfection 2. Barriers to Entry

a. Economies of Scale a. Legal Restrictions
- attaining a high level of productivity following an - refers to government sanctions that sometimes prevent
increase in all factors of production competition in some industries
- more likely to happen among large firms which can - e.g. patents, franchise monopolies (entry restrictions by
make them edge out their competitors the government)
b. Natural Monopoly b. High cost of entry
- output can be efficiently produced by a single firm only - high start-up costs of businesses can stop competitors
- either: from entering the market
i. firm has started earlier vs. its competitors achieving c. Advertising & Product Differentiation
specialization - creates brand loyalty such that successful sellers in
ii. firm is the only one who knows the technique in the advertising may end up as sole sellers
production of the good or own the major input of the
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