The fundamental rule of economics is that it is a study of interaction of various market forces for utilization of the limited resources towards the satisfaction of unlimited demands of the society. The interaction and power of the forces of demand and supply determines the nature of the market. Microeconomics is the study which deals with the interaction of the individual demand and supply forces. The nature of such interaction and the relative influence of demand and supply forces would determine the kind of competition that exists in the market i.e., perfect competition or imperfect competition. The paper has been organized to describe the distinct characteristics of various forms of competition based on the level of competition prevailing therein.
Perfect Competition
Perfect competition refers to that state of the market wherein both demand and supply forces are in a position to influence the market price. In such a market there are multiple buyers and multiple sellers combined with free entry and exit of the sellers in the market due to non-existence of barriers to entry and exit and no sunk cost is associated with the easy and exit. Another condition for perfect competition to exist is that all the buyers and sellers should be small or similar in size relative to the market and scale of operations. None of the suppliers have a position of dominance in the market and hence no supplier can alter the price in the long run.
Changes in individual demand would not have any significant impact or very less impact on the market demand and similarly change in the individual supply would not have significant impact on the market supply of the product. Therefore, price is not determined by the market participants but by the market forces. The subsequent condition is that the product is homogenous in nature and the customer can easily shift to other product in case of increase in price or for any other reason. The consumer has many choices available in the market and is not dependent on the product of a particular supplier. The product is available at similar price by other suppliers in the market and the consumers are aware of the options available. Information symmetry exists in the market and the consumers have the knowledge of the prices, quality etc of the products of other market players. All the sellers are aware of the production methods and no seller has any information about any efficient method of production which is not available to others. All sellers have access to similar inputs i.e., same level of technology and cost incurred in production of the product.
The individual supplier cannot choose the price and but can only choose the appropriate level of production such that the marginal cost is equal to the selling price of the product. The supplier is in a position to sell any quantity of product provided he is supplying the product at the price determined by the market. Resultantly, the supplier would be choosing the marginal cost level to arrive at the market determined price rather than choosing a price level which is determined by the marginal cost incurred by the firm over the production of the product. In case the supplier increases the price, the fact that the product is homogenous in nature would lead to a shift of all the demand to other suppliers who are offering the product at the determined market price. In case the supplier lowers the price below the market price, i.e., below the marginal cost incurred by him which in effect would mean that he would be selling the product at loss. Although all the customers would come to such seller but since the supplier is small in size, he won’t be able to cater to the entire market demand sustainably as he would be incurring loss on every product which is sold in the market at such lower cost. This coupled with the fact that any supplier can sell as much quantity as he wants at the price determined by the market, there is no incentive to lower the selling price below market price. This form of competition ensures that the consumers get the best price of the products.
Monopoly
Monopoly is the opposite of a perfect competition. In fact, it is a situation wherein no competition exists. A monopoly market is characterized by a single seller selling goods, having no any close substitutes, to a large number of buyers. There are no rival firms existing in the market. The monopoly firm enjoys the entire market demand and there is no demand left for others to cater to. Due to the high entry barriers, the firm holding the monopoly is also not subject to the risk of a new entrant to the market. The monopoly firm enjoys the privilege of deciding the price for the goods and hence is a price maker and not a price taker.
A firm may gain the status of being a monopoly due to many factors which acts as entry barriers to the other firms. The factors which can provide advantage to the firm can be economies of scale, location, sunk cost, restricted ownership of raw materials, government restrictions, etc.
This market is also characterized by high fixed costs associated with the production of such product. In case of high fixed costs, if there are multiple firms in the market, than each firm has to incur those high fixed costs and would have lesser market to recover those costs due to division of customers among other firms operating in the market. Accordingly if only one firm exists then only that firm has to incur those high costs and could easily recoup the same from the customers. This would also lower the cost per quantity and hence lower the final price of the product. Such a situation is also known as natural monopoly as the factual circumstances justifies existence monopoly. Monopoly also exists due to the government allowing only state to function in some sectors, since no private company is allowed to enter into the market, in such a case state/ government becomes the exclusive supplier for the goods and monopoly is created. Such a monopoly is based on the analogy that certain sectors of the economy are strategic and sensitive and should be regulated closely and not left subject to the forces of demand and supply.
Since in a monopoly, the firm is a price maker and firm’s objective is to maximize the profits, such a structure could be harmful for the society. There is a need to regulate such markets and to dilute the negative effects and to keep a check on the unjust behavior of the firm enjoying the monopoly position. Ahlerston extensively writes on the negative impacts of monopoly and states that price regulations by the government by capping the maximum price for such product and increasing competition by changing the government regulation which vested the monopoly with such exclusive position are the ways to reduce the harmful effects of monopoly market (94).
Another distinct market condition which can exist is a bilateral monopoly. Such market is comprised of one buyer and one seller and both of them have the ability to decide on the price. Accordingly the price is decided on the negotiations between the parties.
Monopolistic
According to Samuelson and Nordhaus, a monopolistic has characteristics of both a perfect competition and a monopoly market. Since there are many sellers, no individual seller has the ability to affect the market. This characteristic is similar to a perfect competitive market. Another feature similar to perfect competitive market is existence of few barriers to entry and exit the market (157).
Many suppliers supply the products which are similar but not identical in nature. The supplier has some control over the price of the product by differentiating its product from the product of the other supplier in the market. The products can be subject to either vertical differentiation or horizontal differentiation. Vertical differentiation means variation in two products on account of the difference in their quality, i.e., higher/ lower. On the other hand, horizontal differentiation is based on difference of the functions performed by the two products.
This power to influence the price is affected by attractive marketing or packaging or celebrity endorsement etc. The power of the supplier to influence the price of such product on account of the following activities is due to information asymmetry among the consumers. As the consumers don’t have exact knowledge of the product, the sellers can influence the perception of consumers towards their product and make them believe that their product is different from others.
The monopolistic competition is different from a monopoly as unlike in a monopoly, there are multiple firms operating in the market along with no high entry barriers and hence the existing sellers have competition from each other and also face competition from the new entrants in the market. But it is similar to monopoly in the sense the seller have slight control over setting the price of the product.
Oligopoly
The term oligopoly means few sellers. The market is characterized by few large players and each player has the ability to affect the price of the product. The firms are mutual dependent on each other and each firm reacts on actions of the other firm or acts in anticipation of the other firm. Each firm strives to know the price, quantity or strategy of the other firm and reacts according to the information on the other firm. The firm is the price maker but is also impacted on the behaviour of the other sellers in reaction to his alteration of the price. The quality of products manufactured by firms may be identical or may be differentiated. There are higher barrier to the entry of such market than monopolistic competition but not as strict as a monopoly competition.
Conclusion
Every nation’s economy would have all the above market forms in some products or the other. The competition angle should also be observed on the basis of the category of the product, i.e., whether the goods are essential commodities or luxury goods. It is essential to strike a cohesive balance between the conflicting needs of the suppliers and the end customers. The government has to intervene to ensure that the suppliers who are holding a dominant position in the market do not misuse it to their advantage at the cost of the consumer. While doing so it, it is quintessential for the government to adhere to the needs of the firms operating in the market. Overall this is a complex matrix governed by multiple factors and a comprehensive analysis is required in light of the interplay of the various factors in the real world and their respective repercussions to understand the nuances of the different market forms.
Works Cited
Samuelson Paul and William Nordhaus. Economics. 18th ed. McGraw-Hill, 2004. Print
Ahlerston, Kristen. Microeconomics. Bookboon (2008). PDF file
