4. Competition (cont'd)

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:

  • firms produce identical commodities sold to consumers who are identical from the point of view of producers, i.e. anonymity of firms and consumers;

  • 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.

  • 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:

  • monopoly/monopsony

  • duopoloy/duopsony

  • oligopoly/oligopsony

  • monopolistic competition where there are a large number of firms but product differentiation permits them to exercise some degree of control over price.

          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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