Perfect COmpetition

INTRODUCTION In classical economics, market pricing is primarily determined by the interaction of supply and demand. Price is interrelated with both of these measures of value. The relationship between price and supply is generally negative, meaning that the higher the price climbs, the lower amount of the supply is demanded. Conversely, the lower the price, the greater the supply is demanded. Price, the amount of goods for which a product is sold, may be seen as a financial expression of the value of the product. Setting the right price is an important part of effective marketing, being the only part of the marketing mix that generates revenue, as product, promotion, and place are all about marketing costs. Price is also the marketing variable that can be changed most quickly. For a consumer, price is the monetary expression of the value to be enjoyed/benefits of purchasing a product, as compared with other available items. A customer’s motivation to purchase a product comes firstly from a need and a want. The second motivation comes from a perception of the value of a product in satisfying that need/want. The perception of the value of a product varies from customer to customer, because perceptions of benefits and costs vary. Perceived benefits are often largely dependent on personal taste. In order to obtain the maximum possible value from the available market, businesses try to segment the market – that is to divide up the market into groups of consumers whose preferences are broadly similar – and to adapt their products to attract these customers. In general, a products perceived value may be increased in one of two ways – either by increasing the benefits that the product will deliver or by reducing the cost. For consumers, the price of a product is the most obvious indicator of cost hence the need to get product pricing right. This report focuses on Natural Price, Market Price and the relationship between them. It also discusses standard market forms – Monopoly, Oligopoly and Perfect Competition. In economics Natural price is the price for a good or service that is equal to the cost of production whereas market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics. There are four basic types of market structures by traditional economic analysis: perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a market structure in which a single supplier produces and sells a given product. An oligopoly is a market dominated by a few large suppliers. In economic theory, perfect competition describes markets such that no participants are large enough to have the market to set the price of a homogeneous product. NATURAL PRICE AND MARKET PRICE NATURAL PRICE There is in every society an ordinary or average rate both of wages and profit in every different employment of labour and stock. This rate is naturally regulated, partly by the general circumstances of the society, their riches or poverty, their advancing, stationary, or declining condition; and partly by the particular nature of each employment. Similarly there is an average rate of rent, which is regulated, partly by the general circumstances of the society or neighbourhood in which the land is situated, and partly by the natural or improved fertility of the land. These average rates may be called the natural rates of wages, profit, and rent, at the time and place in which they commonly prevail. When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price. The commodity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market. It does not comprehend the profit of the person who is to sell it again, if he sells it at a price which does not allow him the ordinary rate of profit in his neighbourhood, he is evidently a loser by the trade, as by employing his stock in some other way he might have made that profit. His profit, besides, is his revenue, the proper fund of his subsistence. As he is preparing and bringing the goods to market, he advances to his workmen their wages, or their subsistence; so he advances to himself, in the same manner, his own subsistence, which is generally suitable to the profit which he may reasonably expect from the sale of his goods. Unless they yield him this profit, they do not repay him what they may have really cost him. Though the price, therefore, which leaves him this profit, is not always the lowest at which a dealer may sometimes sell his goods, it is the lowest at which he is likely to sell them for any considerable time, at least where there is perfect liberty, or where he may change his trade as often as he pleases. The natural price itself varies with the natural rate of each of its component parts, of wages, profit, and rent; and in every society this rate varies according to their circumstances, according to their riches or poverty, their advancing, stationary, or declining condition. The natural price of labour is that price which is necessary to enable the labourers, to subsist and to perpetuate their race.The power of the labourer to support himself, and the family which may be necessary to keep up the number of labourers, does not depend on the quantity of money which he may receive for wages, but on the quantity of food, necessaries, and conveniences become essential to him from habit, which that money will purchase. The natural price of labour, therefore, depends on the price of the food, necessaries, and conveniences required for the support of the labourer and his family. With a rise in the price of food and necessaries, the natural price of labour will rise, with the fall in their price, the natural price of labour will fall. With the progress of society the natural price of labour has always a tendency to rise, because one of the principal commodities by which its natural price is regulated, has a tendency to become dearer, from the greater difficulty of producing it. However, the improvements in agriculture, the discovery of new markets, may for a time counteract the tendency to a rise in the price of necessaries, and may even occasion their natural price to fall, so will the same causes produce the correspondent effects on the natural price of labour. The natural price of all commodities, except raw produce and labour, has a tendency to fall, in the progress of wealth and population. Though, on one hand, they are enhanced in real value, from the rise in the natural price of the raw material of which they are made, this is more than counterbalanced by the improvements in machinery, by the better division and distribution of labour, and by the increasing skill, both in science and art of the producers. MARKET PRICE The actual price at which any commodity is commonly sold is called its Market price. It may either be above, or below, or exactly the same with its natural price. The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent, labour, and profit, which must be paid in order to bring it to market. Such people may be called the effectual demanders, and their demand the effectual demand, since it may be sufficient to effectuate the bringing of the commodity to market. It is different from the absolute demand. A very poor man may be said in some sense to have a demand for a coach and six, he might like to have it, but his demand is not an effectual demand, as the commodity can never be brought to market in order to satisfy it. When the quantity of any commodity which is brought to market falls short of the effectual demand, all those who are willing to pay the whole value of the rent, wages, and profit, which must be paid in order to bring it , cannot be supplied with the quantity which they want. Rather than want it altogether, some of them will be willing to give more. A competition will immediately begin among them, and the market price will rise more or less above the natural price, according as either the greatness of the deficiency. The wealth and want on luxury of the competitors happen to animate more or less the eagerness of the competition. Among competitors of equal wealth and luxury the same deficiency will generally occasion a more or less eager competition, according as the acquisition of the commodity happens to be of more or less importance to them. When the quantity brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole value of the rent, wages, and profit, which must be paid in order to bring it. Some part must be sold to those who are willing to pay less, and the low price which they give for it must reduce the price of the whole. The market price will sink more or less below the natural price, according as the greatness of the excess increases more or less the competition of the sellers, or according as it happens to be more or less important to them to get immediately rid of the commodity. The market price of labour is the price which is really paid for it, from the natural operation of the proportion of the supply to the demand; labour is dear when it is scarce, and cheap when it is plentiful. However much the market price of labour may deviate from its natural price, it has, like commodities, a tendency to conform to it. RELATIONSHIP BETWEEN NATURAL PRICE AND MARKET PRICE When the quantity brought to market is just sufficient to supply the effectual demand, and no more, the market price naturally comes to be either exactly, or as nearly the same with the natural price. The whole quantity upon hand can be disposed of for this price, and cannot be disposed of for more. The competition of the different dealers obliges them all to accept of this price, but does not oblige them to accept of less. The quantity of every commodity brought to market naturally suits itself to the effectual demand. It is the interest of all those who employ their land, labour, or stock, in bringing any commodity to market, that the quantity never should exceed the effectual demand and it is the interest of all other people that it never should fall short of that demand. If at any time it exceeds the effectual demand, some of the component parts of its price must be paid below their natural rate. If it is rent, the interest of the landlords will immediately prompt them to withdraw a part of their land and if it is wages or profit, the interest of the labourers in the one case, and of their employers in the other, will prompt them to withdraw a part of their labour or stock from this employment. The quantity brought to market will soon be no more than sufficient to supply the effectual demand. All the different parts of its price will rise to their natural rate, and the whole price to its natural price. If, on the contrary, the quantity brought to market should at any time fall short of the effectual demand, some of the component parts of its price must rise above their natural rate. If it is rent, the interest of all other landlords will naturally prompt them to prepare more land for the raising of this commodity, if it is wages or profit, the interest of all other labourers and dealers will soon prompt them to employ more labour and stock in preparing and bringing it to market. The quantity brought will soon be sufficient to supply the effectual demand. All the different parts of its price will soon sink to their natural rate, and the whole price to its natural price. When the market price of labour exceeds its natural price, that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family. When, however, by the encouragement with high wages give to the increase of population, the number of labourers is increased, wages again fall to their natural price, and indeed from a reaction sometimes fall below it. When the market price of labour is below its natural price, the condition of the labourers is most wretched. Poverty deprives them of those comforts which custom renders absolute necessaries. It is only after their privations have reduced their number, or the demand for labour has increased, that the market price of labour will rise to its natural price, and that the labourer will have the moderate comforts which the natural rate of wages will afford. The natural price therefore, is the central price, to which the prices of all commodities are continually gravitating. Different accidents may sometimes keep them suspended a good deal above it, and sometimes force them down even somewhat below it. But whatever may be the obstacles which hinder them from settling in this centre of repose and continuance, they are constantly tending towards it. STANDARD MARKET FORMS There are four basic types of market structures by traditional economic analysis: Monopoly, Oligopoly, Perfect competition and Monopolistic competition. A monopoly is a market structure in which a single supplier produces and sells a given product. If there is a single seller in a certain industry and there are not any close substitutes for the product, then the market structure is that of a "Pure Monopoly". Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being produced, but nevertheless companies retain some market power. This is termed monopolistic competition, whereas by oligopoly the companies interact strategically. Economists assume that there are a number of different buyers and sellers in the marketplace. This means that we have competition in the market, which allows price to change in response to changes in supply and demand. For almost every product there are substitutes, so if one product becomes too expensive, a buyer can choose a cheaper substitute instead. In a market with many buyers and sellers, both the consumer and the supplier have equal ability to influence price.  In some industries, there are no substitutes and there is no competition. In a market that has only one or few suppliers of a good or service, the producer(s) can control price, meaning that a consumer does not have choice, cannot maximize his or her total utility and has have very little influence over the price of goods.  A monopoly is a market structure in which there is only one producer/seller for a product. In other words, the single business is the industry. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers against entry into a monopolistic industry is that oftentimes, one entity has the exclusive rights to a natural resource. For example, in Saudi Arabia the government has sole control over the oil industry. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market. Pfizer, for instance, had a patent on Viagra.  In an oligopoly, there are only a few firms that make up an industry. This select group of firms has control over the price and like a monopoly, an oligopoly has high barriers to entry. The products that the oligopolistic firms produce are often nearly identical and therefore the companies which are competing for market share are interdependent as a result of market forces. There are two extreme forms of market structure: monopoly and, its opposite, perfect competition. Perfect competition is characterized by many buyers and sellers, many products that are similar in nature and, as a result, many substitutes. Perfect competition means there are few, if any, barriers to entry for new companies, and prices are determined by supply and demand. Thus, producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. For example, in a perfectly competitive market, should a single firm decide to increase its selling price of a good, the consumers can just turn to the nearest competitor for a better price, causing any firm that increases its prices to lose market share and profits.  Monopoly A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity. Monopolies are thus characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods. The verb "monopolize" refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power, to charge high prices. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry (or market). A monopoly is distinguished from a monopsony, in which there is only one buyer of a product or service; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies, monopsonies and oligopolies are all situations such that one or a few of the entities have market power and therefore interact with their customers (monopoly), suppliers (monopsony) and the other companies (oligopoly) in ways that leave market interactions distorted. When not coerced legally to do otherwise, monopolies typically maximize their profit by producing fewer goods and selling them at higher prices than would be the case for perfect competition. Monopolies can be established by a government, form naturally, or form by integration. In many jurisdictions, competition laws restrict monopolies. Holding a dominant position or a monopoly of a market is not illegal in itself, however certain categories of behaviour can, when a business is dominant, be considered abusive and therefore incur legal sanctions. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. Patents, copyright, and trademarks are sometimes used as examples of government granted monopolies, but they rarely provide market power. The government may also reserve the venture for itself, thus forming a government monopoly Characteristics of monopoly Profit Maximizer: Maximizes profits. Price Maker: Decides the price of the good or product to be sold. High Barriers to Entry: Other sellers are unable to enter the market of the monopoly. Single seller: In a monopoly, there is one seller of the good that produces all the output. Therefore, the whole market is being served by a single company. Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging fewer prices for the product in a very elastic market and sells less quantities charging high price in a less elastic market. Formation of monopolies Monopolies can form for a variety of reasons, including the following: If a firm has exclusive ownership of a scarce resource, such as Microsoft owning the Windows operating system brand, it has monopoly power over this resource and is the only firm that can exploit it. Governments may grant a firm monopoly status, such as with the Post Office, which was given monopoly status by Oliver Cromwell in 1654. The Royal Mail Group finally lost its monopoly status in 2006, when the market was opened up to competition. Producers may have patents over designs, or copyright over ideas, characters, images, sounds or names, giving them exclusive rights to sell a good or service, such as a song writer having a monopoly over their own material. A monopoly could be created following the merger of two or more firms. Given that this will reduce competition, such mergers are subject to close regulation and may be prevented if the two firms gain a combined market share of 25% or more. Sources of monopoly power Monopolies derive their market power from barriers to entry – circumstances that prevent or greatly impede a potential competitor's ability to compete in a market. There are three major types of barriers to entry; economic, legal and deliberate. Economic barriers: Economic barriers include economies of scale, capital requirements, cost advantages and technological superiority. Economies of scale: Monopolies are characterised by decreasing costs for a relatively large range of production. Decreasing costs coupled with large initial costs give monopolies an advantage over would-be competitors. Monopolies are often in a position to reduce prices below a new entrant's operating costs and thereby prevent them from continuing to compete. Capital requirements: Production processes that require large investments of capital, or large research and development costs or substantial sunk costs limit the number of companies in an industry. Large fixed costs also make it difficult for a small company to enter an industry and expand. Technological superiority: A monopoly may be better able to acquire, integrate and use the best possible technology in producing its goods while entrants do not have the size or finances to use the best available technology. One large company can sometimes produce goods cheaper than several small companies. No substitute goods: A monopoly sells a good for which there is no close substitute. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits. Control of natural resources: A prime source of monopoly power is the control of resources that are critical to the production of a final good. Network externalities: The use of a product by a person can affect the value of that product to other people. This is the network effect. There is a direct relationship between the proportion of people using a product and the demand for that product. In other words the more people who are using a product the greater the probability of any individual starting to use the product. This effect accounts for fads and fashion trends. It also can play a crucial role in the development or acquisition of market power. The most famous current example is the market dominance of the Microsoft operating system in personal computers. Legal barriers: Legal rights can provide opportunity to monopolise the market of a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control of the production and selling of certain goods. Deliberate actions: A company wanting to monopolise a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and force. Types of monopolies Natural monopoly A natural monopoly is a company that experiences increasing returns to scale over the relevant range of output and relatively high fixed costs. A natural monopoly occurs where the average cost of production "declines throughout the relevant range of product demand". The relevant range of product demand is where the average cost curve is below the demand curve. When this situation occurs, it is always cheaper for one large company to supply the market than multiple smaller companies; in fact, absent government intervention in such markets, will naturally evolve into a monopoly. An early market entrant that takes advantage of the cost structure and can expand rapidly can exclude smaller companies from entering and can drive or buy out other companies. A natural monopoly suffers from the same inefficiencies as any other monopoly. Regulation of natural monopolies is problematic. Fragmenting such monopolies is by definition inefficient. The most frequently used methods dealing with natural monopolies are government regulations and public ownership. Government-granted monopoly A government-granted monopoly is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or company to be the sole provider of a commodity; potential competitors are excluded from the market by law, regulation, or other mechanisms of government enforcement. Bilateral monopoly In a bilateral monopoly there is both a monopoly (a single seller) and monopsony (a single buyer) in the same market. In such, market price and output will be determined by forces like bargaining power of both buyer and seller. An example of a bilateral monopoly would be when a labor union (a monopolist in the supply of labor) faces a single large employer in a factory town (a monopsonist). A peculiar one exists in the market for nuclear-powered aircraft carriers in the United States, where the buyer (the United States Navy) is the only one demanding the product, and there is only one seller (Huntington Ingalls Industries) by stipulation of the regulations promulgated by the buyer's parent organization (the United States Department of Defense, which has thus far not licensed any other firm to manufacture, overhaul, or decommission. Complementary monopoly In a complementary monopoly, consent must be obtained from more than one agent in order to obtain the good. This leads to a reduction in surplus generated relative to an outright monopoly, if the two agents do not cooperate. This can be seen in private toll roads where more than one operator controls a different section of the road. The solution is for one agent to purchase all sections of the road. Complementary goods are a less extreme form of this effect. In this case, one good is still of value even if the other good is not obtained. Monopoly and efficiency According to the standard model, in which a monopolist sets a single price for all consumers, the monopolist will sell a lesser quantity of goods at a higher price than would companies by perfect competition. Because the monopolist ultimately forgoes transactions with consumers who value the product or service more than its cost, monopoly pricing creates a deadweight loss referring to potential gains that went neither to the monopolist nor to consumers. Given the presence of this deadweight loss, the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers by perfect competition. Where efficiency is defined by the total gains from trade, the monopoly setting is less efficient than perfect competition. It is often argued that monopolies tend to become less efficient and less innovative over time, becoming "complacent", because they do not have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of psychological efficiency can increase a potential competitor's value enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives. Examples of monopolies Global The salt commission, a legal monopoly in China formed in 758. The British Honourable East India Company; created as a legal trading monopoly in 1600. Netherlands East India Company; created as a legal trading monopoly in 1602. Western Union was criticized as a "price gouging" monopoly in the late 19th century. Standard Oil; broken up in 1911, two of its surviving "child" companies are ExxonMobil and the Chevron Corporation. U.S. Steel; anti-trust prosecution failed in 1911. United Aircraft and Transport Corporation; aircraft manufacturer holding company forced to divest itself of airlines in 1934. American Telephone & Telegraph; telecommunications giant broken up in 1984. Microsoft; settled anti-trust litigation in the U.S. in 2001; fined 493 million euros by the European Commission in 2004 which was upheld for the most part by the Court of First Instance of the European Communities in 2007. The fine was 1.35 Billion USD in 2008 for noncompliance with the 2004 rule. Indian Indian Railways has monopoly in Railroad transportation State Electricity board have monopoly over generation and distribution of electricity in many of the states. Hindustan Aeronautics Limited has monopoly over production of aircraft. There is Government monopoly over production of nuclear power. Operation of bus transportation within many cities. Land line telephone service in most of the country is provided only by the government run BSNL Laws in India against monopoly India has been very conscious about the competition in the market place and has been vigilant to frame laws curtailing monopolies and restrictive trade practices The Monopolies & Restrictive Trade Practices Act, 1969 is the first enactment to deal with competition issues and came into effect on 1st June 1970. The Government had appointed a committee in October 1999 to examine the existing MRTP Act for shifting the focus of the law from curbing monopolies to promoting competition and to suggest a modern competition law. Pursuant to the recommendations of this committee, the Competition Act, 2002, was enacted on 13th January 2003. The objectives of the Competition Act are to prevent anti-competitive practices, promote and sustain competition, protect the interests of the consumers and ensure freedom of trade. This Act provides for different notifications for making different provisions of the Act effective. ADVANTAGES OF MONOPOLIES Monopolies can be defended on the following grounds: They can benefit from economies of scale, and may be ‘natural’ monopolies, so it may be argued that it is best for them to remain monopolies to avoid the wasteful duplication of infrastructure that would happen if new firms were encouraged to build their own infrastructure. Domestic monopolies can become dominant in their own territory and then penetrate overseas markets, earning a country valuable export revenues. This is certainly the case with Microsoft. It has been consistently argued by some economists that monopoly power is required to generate dynamic efficiency, that is, technological progressiveness. This is because: High profit levels boost investment in R&D. Innovation is more likely with large enterprises and this innovation can lead to lower costs than in competitive markets. A firm needs a dominant position to bear the risks associated with innovation. Firms need to be able to protect their intellectual property by establishing barriers to entry; otherwise, there will be a free rider problem. If some of the profits are invested in new technology, costs are reduced via process innovation. The result is lower price and higher output in the long run. DISADVANTAGES OF MONOPOLY TO THE CONSUMER Monopolies can be criticised because of their potential negative effects on the consumer, including: Restricting output onto the market. Charging a higher price than in a more competitive market. Reducing consumer surplus and economic welfare. Restricting choice for consumers. Reducing consumer sovereignty. MONOPOLY VERSUS COMPETITIVE MARKETS While monopoly and perfect competition mark the extremes of market structures there is some similarity. The cost functions are the same. Both monopolies and perfectly competitive companies minimize cost and maximize profit. The shutdown decisions are the same. Both are assumed to have perfectly competitive factors markets. There are distinctions, some of the more important of which are as follows: Marginal revenue and price: In a perfectly competitive market, price equals marginal cost. In a monopolistic market, however, price is set above marginal cost. Product differentiation: There is zero product differentiation in a perfectly competitive market. Every product is perfectly homogeneous and a perfect substitute for any other. With a monopoly, there is great to absolute product differentiation in the sense that there is no available substitute for a monopolized good. The monopolist is the sole supplier of the good in question. A customer either buys from the monopolizing entity on its terms or does without. Number of competitors: PC markets are populated by an infinite number of buyers and sellers. Monopoly involves a single seller. Barriers to Entry: Barriers to entry are factors and circumstances that prevent entry into market by would-be competitors and limit new companies from operating and expanding within the market. PC markets have free entry and exit. There are no barriers to entry, exit or competition. Monopolies have relatively high barriers to entry. The barriers must be strong enough to prevent or discourage any potential competitor from entering the market. Excess Profits: Excess or positive profits are profit more than the normal expected return on investment. A PC company can make excess profits in the short term but excess profits attract competitors, which can enter the market freely and decrease prices, eventually reducing excess profits to zero. A monopoly can preserve excess profits because barriers to entry prevent competitors from entering the market. Supply Curve: in a perfectly competitive market there is a well-defined supply function with a one to one relationship between price and quantity supplied. In a monopolistic market no such supply relationship exists. A monopolist cannot trace a short term supply curve because for a given price there is not a unique quantity supplied.  3.2. OLIGOPOLY An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high (i.e. a large % of the market is taken up by the leading firms). Firms within an oligopoly produce branded products (advertising and marketing is an important feature of competition within such markets) and there are also barriers to entry. Another important characteristic of an oligopoly is interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. This creates uncertainty in such markets - which economists seek to model through the use of game theory. Economics is much like a game in which the players anticipate one another's moves. Game theory may be applied in situations in which decision makers must take into account the reasoning of other decision makers. It has been used, for example, to determine the formation of political coalitions or business conglomerates, the optimum price at which to sell products or services, the best site for a manufacturing plant, and even the behaviour of certain species in the struggle for survival. The on-going interdependence between businesses can lead to implicit and explicit collusion between the major firms in the market. Collusion occurs when businesses agree to act as if they were in a monopoly position. Characteristics Profit maximization conditions: An oligopoly maximizes profits by producing where marginal revenue equals marginal costs. Ability to set price: Oligopolies are price setters rather than price takers. Entry and exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favouring existing firms making it difficult for new firms to enter the market. Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms. Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent side-line firms from entering market to capture excess profits. Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles). Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic factors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price, cost and product quality. Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his or her objectives. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant. This high degree of interdependence and need to be aware of what other firms are doing or might do is to be contrasted with lack of interdependence in other market structures. In a perfectly competitive (PC) market there is zero interdependence because no firm is large enough to affect market price. All firms in a PC market are price takers, as current market selling price can be followed predictably to maximize short-term profits. In a monopoly, there are no competitors to be concerned about. In a monopolistically-competitive market, each firm's effects on market conditions are so negligible as to be safely ignored by competitors. Non-Price Competition: Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of non-price competition. Modeling There is no single model describing the operation of an oligopolistic market. The variety and complexity of the models is because you can have two to 10 firms competing on the basis of price, quantity, technological innovations, marketing, advertising and reputation. Fortunately, there are a series of simplified models that attempt to describe market behaviour under certain circumstances. Some of the better-known models are the dominant firm model, the Cournot-Nash model, the Bertrand model and the kinked demand model. Key Features of Oligopoly A few firms selling similar product Each firm produces branded products Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits. Interdependence between competing firms. Businesses have to take into account likely reactions of rivals to any change in price and output Theories about Oligopoly Pricing There are four major theories about oligopoly pricing: Oligopoly firms collaborate to charge the monopoly price and get monopoly profits Oligopoly firms compete on price so that price and profits will be the same as a competitive industry  Oligopoly price and profits will be between the monopoly and competitive ends of the scale  Oligopoly prices and profits are "indeterminate" because of the difficulties in modelling interdependent price and output decisions Importance of Price and Non-Price Competition Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition. Price competition can involve discounting the price of a product (or a range of products) to increase demand.  Non-price competition focuses on other strategies for increasing market share. Consider the example of the highly competitive UK supermarket industry where non-price competition has become very important in the battle for sales Mass media advertising and marketing  Store Loyalty cards  Banking and other Financial Services (including travel insurance)  In-store chemists / post offices / crèches  Home delivery systems  Discounted petrol at hyper-markets  Extension of opening hours (24 hour shopping in many stores)  Innovative use of technology for shoppers including self-scanning machines Financial incentives to shop at off-peak times  Internet shopping for customers Price Leadership in Oligopolistic Markets When one firm has a dominant position in the market the oligopoly may experience price leadership. The firms with lower market shares may simply follow the pricing changes prompted by the dominant firms. We see examples of this with the major mortgage lenders and petrol retailers. Comparison between Monopoly and Oligopoly Monopoly and oligopoly are economic market conditions. Monopoly is defined by the dominance of just one seller in the market; oligopoly is an economic situation where a number of sellers populate the market. Comparison chart Domains Monopoly Oligopoly Meaning An economic market condition where one seller dominates the entire market. An economic market condition where numerous sellers have their presence in one single market. Characteristics A single firm controls a large market share in the industry, thereby gaining the ability to set price. A small number of firms dominate the industry. These firms compete with each other based on product differentiation, price, customer service etc. Prices High prices may be charged since there is no competition Moderate/fair pricing due to competition in market. But much higher than perfect competition(where there is a large number of buyers and sellers) Sources of Power Market making ability by virtue of being virtually the only viable seller in the industry. Market making ability because of very few firms in the industry. Each firm can therefore significantly influence the market by setting price or production quantity. Barriers to entry A monopoly usually exists when barriers to entry are very high - either due to technology, patents, distribution overheads, government regulation or capital-intensive nature of the industry. Barriers to entry are very high as it is difficult to enter the industry because of economies of scale. Examples Microsoft (Operating systems, productivity suites), Google (web search, search advertising),DeBeers (diamonds), Monsanto (seeds), Long Island Rail Road etc. Health insurers, wireless carriers, beer (Anheuser-Busch and MillerCoors), media (TV broadcasting, book publishing, movies) etc. Characteristics Monopolistic markets are controlled by one seller only. The seller here has the power to influence market prices and decisions. Consumers have limited choices and have to choose from what is supplied. The monopolist asserts all the power while the consumer is left with no choice. This market condition usually arises from mergers, take-overs and acquisitions. Oligopoly, on the other hand, is a market condition where numerous sellers co-exist in the market place. This market situation is very consumer-friendly because it induces competition amongst sellers. Competition in turn ensures moderate prices and numerous choices for consumers. A decision taken by one seller in an oligopolistic market has a direct effect on the functioning of other sellers. Sources of power A monopolistic market derives its power through three sources: economic, legal and deliberate. A monopolistic entity will use the position it is in to its advantage and drive out competitors either by reducing prices to such an extent that survival for another seller may become impossible or by virtue of economic conditions like large capital requirement for start-up companies. Legal barriers like intellectual property rights also help a monopolistic entity retain its power. Deliberate attempts for monopolistic markets would include collusion, lobbying governmental authorities etc. Though an oligopolistic market does not have any sources of power, it comes into existence solely due to the accommodating nature of other sellers. Prices A monopolistic market may quote high prices. Since there is no other competitor to fear from, the sellers will use their status of dominance and maximize their profits. Oligopoly markets on the other hand, ensure competitive hence fair prices for the consumer. Examples Four music companies control 80% of the market - Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group Six major book publishers - Random House, Pearson, Hachette, HarperCollins, Simon & Schuster and Holtzbrinck Four breakfast cereal manufacturers - Kellogg, General Mills, Post and Quaker Two major producers in the beer industry - Anheuser-Busch and MillerCoors Two major providers in the healthcare insurance market - Anthem and Kaiser Permanente 3.3. Perfect competition In economic theory,  perfect competition  (sometimes called pure competition) describes markets such that no participants are large enough to have the market to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets say for commodities or some financial assets may approximate the concept. Perfect competition serves as a benchmark against which we can measure real-life and imperfectly competitive markets. The degree to which a market or industry can be described as competitive depends in part on how many suppliers are seeking the demand of consumers and the ease with which new businesses can enter and exit a particular market in the long run. The spectrum of competition ranges from highly competitive markets where there are many sellers, each of whom has little or no control over the market price - to a situation of pure monopoly where a market or an industry is dominated by one single supplier who enjoys considerable discretion in setting prices, unless subject to some form of direct regulation by the government. In many sectors of the economy markets are best described by the term oligopoly - where a few producers dominate the majority of the market and the industry is highly concentrated. In a duopoly two firms dominate the market although there may be many smaller players in the industry. Basic structural characteristics Generally, a perfectly competitive market exists when every participant is a "price taker", and no participant influences the price of the product it buys or sells. Specific characteristics may include: Infinite buyers and sellers – An infinite number of consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price. Zero entry and exit barriers – A lack of entry and exit barriers makes it extremely easy to enter or exit a perfectly competitive market. Perfect factor mobility – In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions. Perfect information - All consumers and producers are assumed to have perfect knowledge of price, utility, quality and production methods of products. Zero transaction costs - Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market. Profit maximization - Firms are assumed to sell where marginal costs meet marginal revenue, where the most profit is generated. Homogenous products - The qualities and characteristics of a market good or service do not vary between different suppliers. Non-increasing returns to scale - The lack of increasing returns to scale (or economies of scale) ensures that there will always be a sufficient number of firms in the industry. Property rights - Well defined property rights determine what may be sold, as well as what rights are conferred on the buyer. In the short run, perfectly-competitive markets are not productively efficient as output will not occur where marginal cost is equal to average cost (MC=AC). They are allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue (MC=MR). In the long run, perfectly competitive markets are both allocatively and productively efficient. In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P=MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a monopoly does not have a supply curve". The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition. ASSUMPTIONS BEHIND A PERFECTLY COMPETITIVE MARKET I. Many suppliers each with an insignificant share of the market – this means that each firm is too small relative to the overall market to affect price via a change in its own supply – each individual firm is assumed to be a price taker. II. An identical output produced by each firm – in other words, the market supplies homogeneous or standardised products that are perfect substitutes for each other. Consumers perceive the products to be identical III. Consumers have perfect information about the prices all sellers in the market charge – so if some firms decide to charge a price higher than the ruling market price, there will be a large substitution effect away from this firm IV. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology, other factor inputs) and improvements in production technologies achieved by one firm can spill- over to all the other suppliers in the market V. There are assumed to be no barriers to entry & exit of firms in long run – which means that the market is open to competition from new suppliers – this affects the long run profits made by each firm in the industry. The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long term VI. No externalities in production and consumption so that there is no divergence between private and social costs and benefits SHORT RUN PRICE AND OUTPUT FOR THE COMPETITIVE INDUSTRY AND FIRM In the short run the equilibrium market price is determined by the interaction between market demand and market supply. In the diagram shown above, price P1 is the market-clearing price and this price is then taken by each of the firms. Because the market price is constant for each unit sold, the AR curve also becomes the Marginal Revenue curve (MR). A firm maximises profits when marginal revenue = marginal cost. In the diagram above, the profit-maximising output is Q1. The firm sells Q1 at price P1. The area shaded is the economic (supernormal profit) made in the short run because the ruling market price P1 is greater than average total cost. Not all firms make supernormal profits in the short run. Their profits depend on the position of their short run cost curves. Some firms may be experiencing sub-normal profits because their average total costs exceed the current market price. Other firms may be making normal profits where total revenue equals total cost (i.e. they are at the break-even output). In the diagram below, the firm shown has high short run costs such that the ruling market price is below the average total cost curve. At the profit maximising level of output, the firm is making an economic loss (or sub-normal profits) EFFECTS OF CHANGE IN MARKET DEMAND In the diagram below there has been an increase in market demand (ceteris paribus). This causes an increase in market price and quantity traded. The firm's average revenue curve shifts up to AR2 (=MR2) and the profit maximising output expands to Q2. Notice that the MC curve is the firm's supply curve. Higher prices cause an expansion along the supply curve. Following the increase in demand, total profits have increased. An inward shift in market demand would have the opposite effect. Think also about the effect of a change in market supply - perhaps arising from a cost-reducing technological innovation available to all firms in a competitive market. LONG RUN ADJUSTMENT PROCESS If most firms are making abnormal profits in the short run there will be an expansion of the output of existing firms and we expect to see the entry of new firms into the industry. Firms are responding to the profit motive and supernormal profits act as a signal for a reallocation of resources within the market. The addition of new suppliers causes an outward shift in the market supply curve. This is shown in the diagram below. Making the assumption that the market demand curve remains unchanged, higher market supply will reduce the equilibrium market price until the price = long run average cost. At this point each firm is making normal profits only. There is no further incentive for movement of firms in and out of the industry and a long-run equilibrium has been established. The entry of new firms shifts the market supply curve to MS2 and drives down the market price to P2. At the profit-maximising output level Q3 only normal profits are being made. There is no incentive for firms to enter or leave the industry. Thus a long-run equilibrium is established. Does perfect competition lead to economic efficiency? Perfect competition is used as a yardstick to compare with other market structures (such a monopoly and oligopoly) because it displays high levels of economic efficiency. In both the short and long run, price is equal to marginal cost (P=MC) and therefore allocate efficiency is achieved – the price that consumers are paying in the market reflects the factor cost of resources used up in producing / providing the good or service. Productive efficiency occurs when price is equal to average cost at its minimum point. This is not achieved in the short run – firms can be operating at any point on their short run average total cost curve, but productive efficiency is attained in the long run because the profit maximising output is achieved at a level where average (and marginal) revenue is tangential to the average total cost curve. The long run of perfect competition, therefore, exhibits optimal levels of static economic efficiency. There is of course another form of economic efficiency – dynamic efficiency – which relates to aspects of market competition such as the rate of innovation in a market, the quality of output provided over time. CONDITIONS FOR PERFECT COMPETITION When economists analyse the production decisions of a firm, they take into account the structure of the market in which the firm is operating. The structure of the market is determined by four different market characteristics: the number and size of the firms in the market, the ease with which firms may enter and exit the market, the degree to which firms' products are differentiated, and the amount of information available to both buyers and sellers regarding prices, product characteristics, and production techniques. Four characteristics or conditions must be present for a perfectly competitive market structure to exist. First, there must be many firms in the market, none of which is large in terms of its sales. Second, firms should be able to enter and exit the market easily. Third, each firm in the market produces and sells a non-differentiated or homogeneous product. Fourth, all firms and consumers in the market have complete information about prices, product quality, and production techniques. Price-taking behaviour:-A firm that is operating in a perfectly competitive market will be a price-taker. A price-taker cannot control the price of the good it sells; it simply takes the market price as given. The conditions that cause a market to be perfectly competitive also cause the firms in that market to be price-takers. When there are many firms, all producing and selling the same product using the same inputs and technology, competition forces each firm to charge the same market price for its good. Because each firm in the market sells the same, homogeneous product, no single firm can increase the price that it charges above the price charged by the other firms in the market without losing business. It is also impossible for a single firm to affect the market price by changing the quantity of output it supplies because, by assumption, there are many firms and each firm is small in size. EXAMPLES Though there is no actual perfectly competitive market in the real world, a number of approximations exist: Perhaps the closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. By design, a stock exchange resembles this, not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e.g. investment banks) may solely influence the market price. This, of course, violates the condition that "no one seller can influence market price". Horse betting is also quite a close approximation. When placing bets, consumers can just look down the line to see who is offering the best odds, and so no one bookie can offer worse odds than those being offered by the market as a whole, since consumers will just go to another bookie. This makes the bookies price-takers. Furthermore, the product on offer is very homogeneous, with the only differences between individual bets being the pay-off and the horse. Of course, there are not an infinite amount of bookies, and some barriers to entry exist, such as a license and the capital required setting up. Free software works along lines that approximate perfect competition as well. Anyone is free to enter and leave the market at no cost. All code is freely accessible and modifiable, and individuals are free to behave independently. Free software may be bought or sold at whatever price that the market may allow. Some believe that one of the prime examples of a perfectly competitive market anywhere in the world is street food in developing countries. This is so since relatively few barriers to entry/exit exist for street vendors. Furthermore, there are often numerous buyers and sellers of a given street food, in addition to consumers/sellers possessing perfect information of the product in question. It is often the case that street vendors may serve a homogenous product; in which little to no variations in the product's nature exist. EQUILIBRIUM IN PERFECT COMPETITION Equilibrium in perfect competition is the point where market demands will be equal to market supply. A firm's price will be determined at this point. In the short run, equilibrium will be affected by demand. In the long run, both demand and supply of a product will affect the equilibrium in perfect competition. A firm will receive only normal profit in the long run at the equilibrium CONCLUSION The market price of every particular commodity is continually gravitating, towards the natural price, yet sometimes particular accidents, sometimes natural causes, and sometimes particular regulations of police, may, in many commodities, keep up the market price, for a long time together, a good deal above the natural price. When by an increase in the effectual demand, the market price of some particular commodity happens to rise a good deal above the natural price, those who employ their stocks in supplying that market are generally careful to conceal this change. If it was commonly known, their great profit would tempt so many new rivals to employ their stocks in the same way that, the effectual demand being fully supplied, the market price would soon be reduced to the natural price, and perhaps for some time even below it. If the market is at a great distance from the residence of those who supply it, they may sometimes be able to keep the secret for several years together, and may so long enjoy their extraordinary profits without any new rivals. Secrets of this kind, however, it must be acknowledged, can seldom be long kept; and the extraordinary profit can last very little longer than they are kept. Market economies are assumed to have many buyers and sellers, high competition and many substitutes. Monopolies characterize industries in which the supplier determines prices and high barriers prevent any competitors from entering the market. Oligopolies are industries with a few interdependent companies. Perfect competition represents an economy with many businesses competing with one another for consumer interest and profits.  5. REFERENCES An Inquiry into the Nature and Causes of Wealth of Nations, by Adam Smith (http://geolib.com/smith.adam/won1-07.html) On The Principles of Political Economy and Taxation, by David Recardo (http://www.marxists.org/reference/subject/economics/ricardo/tax/ch05.htm) The monopolies and restrictive trade practises act , 1969 published by universal law publishing co. Pvt. Ltd. (www.unilawbooks.com) THECOMPETITION ACT,2002No. 12 OF 2003as amended by The Competition (Amendment) Act, 2007 Goodwin, Nelson, Ackerman, & Weissskopf, Microeconomics in Context 2d ed. (Sharpe 2009) at 307. Samuelson & Marks, Managerial Economics 4th ed. (Wiley 2003) at 365. Monopoly, George J. Stigler (http://www.econlib.org/library/Enc/Monopoly.html) Economics Basics: Monopolies, Oligopolies and Perfect Competition (http://www.investopedia.com/university/economics/economics6.asp#axzz2JWo77soL) Perfect competition – the economics of competitive market (http://tutor2u.net/economics/content/topics/competition/competition.htm) Monopoly vs Oligopoly (http://www.diffen.com/difference/Monopoly_vs_Oligopoly) 28