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4.3 Imperfect Competition
1. Basic
Definitions
a) The Market
A market is a closely related group of buyers and sellers.
Definition requires statement of the nature and number of both as
well as close substitutes in production and consumption.
In theory, the market is defined without reference to geography.
The size of the market affects factors such as minimum optimum
scale of production.
b) Market Demand Curve
The amount of a commodity buyers are willing to purchase at each
specified price in a given market at a given time.
The market demand curve is the horizontal summation of individual
demand curves. Individual
demand is the key initiator of the production process.
It is independent of all factors other than the preference curve,
prices and income constraint.
The law of demand: lower the price, greater amount demanded, i.e. demand
curve is negatively sloped.
c) Market Supply Curve
The amount of a commodity sellers are willing to produce at each
specified price in a given market at a given time.
The market supply curve is the horizontal summation of individual
firm supply curves.
Supply is identical to the rising section of the marginal cost
curve of the firm. The law of
supply: the higher the price the greater the amount supplied, i.e. the
supply curve is positively sloped.
d) Market Equilibrium
Equilibrium in a market is established where the demand curve
intersects the supply curve.
At this unique price the quantity demanded by consumers clears the
quantity supplied by producers.
Market equilibrium is stable if any change in the price or quantity
calls into action forces reestablishing the initial price-quantity
relationship.
2.
Benchmark: Perfect Competition
Perfect competition satisfies
the following conditions:
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firms produce identical commodities sold to consumers who
are identical from the point of view of producers, i.e. anonymity of
firms and consumers;
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both producers and consumers are numerous and sales or
purchases are small relative to total volume of sales or purchases, i.e.
ensures lack of market power on the part of individual buyers and
sellers;
-
consumers and producers possess perfect knowledge; and,
-
entry and exit is free for consumers and producers in the
long-run.
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for the producer,
perfect competition means, in the short-run, that price is equal to
marginal cost and equal to marginal revenue.
In the long-run, price is also equal to average cost.
The industry, i.e. all producers taken together, faces a
negatively sloped demand curve but the individual producer faces a
horizontal demand curve, i.e. the firm is a strict ‘price-taker’.
It can sell as much as it likes at the market price.
-
in theory, perfect competition generates the perfect
price, i.e. the price reflects the true value of the commodity ensuring
the ‘efficient’ allocation of resources, i.e. inputs. Furthermore, the
inability of individual participants to affect price or cost variables
insures that anonymous, impersonal market forces determine the outcome
of exchange.
3. Imperfect
Competition
Imperfect competition exists when one or more buyers or sellers
have a perceptible influence on price.
The type of imperfect competition is defined by the number of
buyers or sellers with such influence:
In perfect competition the demand curve faced by a firm is
horizontal. In imperfect
competition the demand curve is not horizontal.
At the extreme, in monopoly, the demand curve faced by the seller
is the market demand curve.
Unfettered by competition the monopolist knows impact of any
pricing decision has a negligible effect on competitors because there are
none. The monopolist can pursue
economic profit maximization.
And in all forms of imperfect competition there is a separation
between price and marginal revenue, i.e., a producer can sell more only if
the price is lowered.
Finally, 'imperfect' is also defined with respect to the
distribution of consumer and producer surplus. Under perfect
competition each gets to keep one's own. Under imperfect
competition, one gains at the loss of another, as does the economy as a
whole.
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