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Perfect Competition .docx

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ECON 1010
Sarrah Vakili

Perfect Competition Perfect competition – a pure market Perfect competition describes a market structure whose assumptions are extremely strong and highly unlikely to exist in most real-time and real-world markets. The reality is that most markets are imperfectly competitive. Nonetheless, there is some value in understanding how price, output and equilibrium is established in both the short and the long run in a market that holds true to the tough assumptions of a world of perfect competition. Economists have become more interested in pure competition partly because of the rapid growth of e-commerce in domestic and international markets as a means of buying and selling goods and services. And also because of the popularity of auctions as a rationing device for allocating scarce resources among competing ends. Basic assumptions required for conditions of pure competition to exist  Many small firms, each of whom produces an insignificant percentage of total market output and thus exercises no control over the ruling market price.  Many individual buyers, none of whom has any control over the market price – i.e. there is no monopsony power  Perfect freedom of entry and exit from the industry. Firms face no sunk costs - entry and exit from the market is feasible in the long run. This assumption ensures all firms make normal profits in the long run  Homogeneous products are supplied to the markets that are perfect substitutes. This leads to each firms being passive “price takers” and facing a perfectly elastic demand curve for their product  Perfect knowledge – consumers have readily available information about prices and products from competing suppliers and can access this at zero cost – in other words, there are few transactions costs involved in searching for the required information about prices  No externalities arising from production and/or consumption which lie outside the market The real world of imperfect competition! Clearly the assumptions of pure competition do not hold in the vast majority of markets. Some suppliers may exert some control over market supply and seek to exploit their monopoly power. On the demand-side, some consumers may have monopsony power against suppliers because they purchase a high percentage of total demand. There are nearly always some barriers to the contestability of the market (see revision notes on barriers to entry) and far from being homogeneous, most markets are full of heterogeneous products due to product differentiation. Consumers nearly always have imperfect information (for example information gaps) and their preferences and choices can be influenced by the effects of persuasive marketing and advertising. In every industry there is always asymmetric information where the seller knows more about quality of good than buyer. The real world is one in which negative and positive externalities from both production and consumption are numerous – both of which can lead to a divergence between private and social costs and benefits. Finally there may be imperfect competition in related markets such as the market for essential raw materials, labour and capital goods. We can come fairly close to a world of perfect competition but in practice there are nearly always barriers to pure competition. Establishing price and output in the short run under perfect competition The previous diagram shows the short run equilibrium for perfect
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