According to Shaun and Gottret (2004), the residual curve refers to the individual demand curve of a firm that is the part of the market demand which is not provided by other competing firms in the market. It can, therefore, be defined as the market demand function after it has been subtracted from the quantity supplied by other competing firms at each price. Suppose the market demand is D (p) and the supply provided by the other firms is S o (p), then there are several ways to calculate the demand for the firm. The first one is by expressing the relationship between the market demand and the residual demand in terms of elasticities. Another method is through observing the price elasticity of the market demand, and elasticity of supply of the other firms which is most likely to be positive. As expected, the elasticity residual demand of one particular firm is much greater than the elasticity demand for the whole market, thus a firm will find its demands very sensitive to the change of prices.
Consumption is the chief of all the economic activities, and work only becomes economically meaningful if it produces something that is valuable to someone i.e. if there is and end consumer who is ready to buy the good or services. Putting the customer interest first imposes a lot of competition among different firms and also improves the quality of the goods produced. Demand is in most cases proportional to supply, the goods and services which are commonly used by many people are the ones which are commonly found in the market. Many firms like to produce what they know that many people would use due to large market (American Bar Association, 2005 p.15). However, some firms produce unique products which are not produced by many firms. These services tend to be expensive since they are not common in the market. The demand of these products can be determined by observing their prices. If the prices are high, it proves that there is a high competition for the products since competition leads to increased demand hence increase in prices. Low prices of the products on the other hand indicate low completion for the goods (Corker and Feldman, 2004 p. 23).
The residual demand can be used to assess the competitiveness of a market through the Residual Demand Model. In this method, the ability of single suppliers to increase price by withholding their goods is considered. The firms which produce products that are not produced by other firms can decide to withhold the goods and create a temporary market shortage. This creates a high demand leading to increase in prices of the commodities. In this model, the possibility of withholding the commodities is thus considered. The other method in this model is by clearing the other entire supplier’s requests against load and the load which remains consists of the Residual Demand which is faced by the single supplier. The economic model of imperfect competition can be applied on the remaining residual demand and supplier. The simulated outcome is then compared to the competitive market outcome where price is equal to the variable cost (Shaun and Gottret, 2004 p.45).
When competition is increased, it tightens the screws of the market discipline thus benefiting the customers but making it more difficult for organizations to make honest earnings or above the usual returns on an organization’s investment. Some of the characteristics of a perfect competition include perfect homogenous goods. This is where all the firms which supply the market produce an identical product which the consumers view as identical. A similarity of this trait is the perfect divisibility of output. This characteristic is often missing in residual demand since a firm produces goods that are not supplied by other firms (Lundy and Mark, 2010 p.17).
The other characteristic of perfect competition is perfect information. The buyers and sellers, producers and consumers have the relevant information regarding quality, the prices and the costs of all the products produced. The similarity of this trait is the no transaction costs. Those who purchase and those who sell do not encounter enforcement or monitoring costs, bargaining, delivery is free and takes place when needed. Another similarity of this is the spillover costs and benefits or no externalities which are not covered by the parties to the exchange. These are not found in residual demand since there is no much competition. Since only one firm produces a certain product, there is no much competition. The firm therefore does not produce a lot of information about the product and the prices may change from time to time according to the organization’s decision due to monopoly (Fanning, 2005 p.24).
Price taking is a common character of a perfect competition. This is where the buyers and sellers cannot affect the buying and selling price of the commodities on their own. In the residual demand, the sellers can influence the price of the commodity on their own. This is because there are no many producers of the commodity thus even when they change the price, buyers will not have an alternative product to purchase thus they end up purchasing the same product. The trait which is similar to this is the free entry and exit. This is where a firm can enter or leave the market without incurring any cost (American Bar Association, 2005 p.13).
A demand schedule shows readiness and capacity to pay while a supply schedule shows the readiness and capacity to sell. Adding the difference between the price paid and what the customers are ready to pay represents the exchange value given by a certain good. This is known as the consumer surplus and can be determined in a graph by calculating the area above the price line and below the demand schedule. On the other hand, the area below the price line and above the supply schedule is known as the producer surplus. A monopoly which is unconstrained and profit-maximizing and which produces a perfectly homogenous commodity and charges a single price can set price and output to give marginal revenue which has marginal cost. This leads to a substantial deadweight loss (Ming, 2010 p.78).
Source: http://www.willamette.edu/~fthompso/ManEX/Sem109_ Competition/MplyComp.html
A revenue increasing entity takes place where there is no marginal revenue at all i.e. where it is zero. A natural monopoly is the one where average total cost (ATC) lessens at a decreasing rate throughout the necessary range of output. This is so since marginal cost is constant, while big capacity or fixed costs are stretch throughout the total output. Under the conditions where one price is imposed for each unit of output, the resulting deadweight loss is significant. Natural monopolies are not insufficient in all cases, though the absence of competition encourages laziness among other bad things like (Shaun and Gottret, 2004).
Source: http://www.willamette.edu/~fthompso/ManEX/Sem109_ Competition/MplyComp.html
In order to analyze both price noncompetitive and competitive industries, two concepts can be used. These include; the residual demand curve, which is the demand curve of an organization’s good or service and the price elasticity of supply or demand. The price elasticity demand or supply helps in the way a firm is likely to respond to variations in supply or demand. The residual demand of a single firm enables one to understand and use the demand for his goods and services. When either the supply or the demand curve shifts, the competitive equilibrium varies, and the shapes of the supply and demand curves affect the way the new equilibrium is similar to the initial one. If the demand curve is completely flat, the competitive price does not change even when the supply curve changes drastically (Claessens and Evenett, 2010 p.34).
A concept that is used to describe the shape of the supply and demand curves is the elasticity of supply or demand. Since the elasticity is a ratio of two percentage terms, it is invariant to variations in scale of either the quantity or price i.e. it is a pure number with no scale itself. If the price is measured in cents instead of dollars, the elasticity does not change though the gradient of the demand curve varies. The elasticity of supply can be approximated as the percentage change in quantity given in response to a 1 percentage variation in price. The elasticity of supply is in most cases though not always positive number while elasticity of demand is mostly a negative number. When a 1 percent increase in price results to a greater than 1 percentage in the quantity required resulting to a fall in the total amount pain in the market, a demand curve is known as elastic (International Monetary Fund, 2005 p.23).
Source: http://www.willamette.edu/~fthompso/ManEX/Sem109_ Competition/MplyComp.html
The organizations which are price competitive are commonly referred to as the price takers. They have the believe that they can never influence the market price and thus they must take it or accept the way it is given. This result can be stated in three equivalent methods: the elasticity of demand of a competitive firm is never ending, the demand curve of a price competitive firm is horizontal at the market place and a price competitive firm is a price taker. A firm can be described as a price taker if it has a horizontal demand curve, since a horizontal demand curve has an unlimited price elasticity of demand. When a firm which has unlimited price elasticity increases its price even minutely, its sales are lost. On the other hand, by decreasing its quantity, the firm cannot make the price to increase. However, a firm with a downward slanting demand curve can increase its price by lowering its output (Claessens and Evenett, 2010 p.110).
When several firms in an industry (an industry consists of all firms the supply goods and services which have identical attributes) is big, the demand curve of any one of them is almost horizontal (elasticity of demand is unlimited) although the demand curve of the industry is downward slanting. In general, for many market demand curves, it is not a must that there are many firms in the industry for the elastic of demand of a certain firm to be big. To demonstrate this, it is vital to first determine the demand curve of a certain firm which is called the residual demand curve. This is where a firm produces or sells to consumers whose demands are not met by the other firms in the industry. The horizontal difference which exists between the supply of the other organizations and the market demand curve is known as the residual demand a certain firm (Ming, 2010 p.23).
When represented graphically, the residual demand curve of a firm is always much flatter compared to the market demand curve. In the same way, the single firm’s demand elasticity is higher compared to the market elasticity. In conclusion, the firms residual demand elasticity is always many times as elastic as the market elasticity (Claessens and Evenett, 2010 p.123).
References
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Claessens, S. and Evenett, S., 2010. Rebalancing the Global Economy: A Primer for Policymaking. London: CEPR Publishers.
Corker, R. J. and Feldman, R. A. , 2004. Promoting Business and Technology Incubation for Improved Competitiveness of Small and Medium-Sized Industries through Application of
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Fanning, S. F. , 2005. Market analysis for real estate: concepts and applications in valuation and highest and best use. Washington D.C: Appraisal Institute.
International Monetary Fund, 2009. Measures of External Competitiveness for Germany.
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International Monetary Fund, 2005. United Germany: The First Five Years: Performance and Policy Issues: Volume 125 of Occasional Paper - International Monetary Fund: Issue
125 of Occasional Paper. Washington D.C.: International Monetary Fund.
Lundy, M, and Mark, L., 2010. Increasing the competitiveness of market chains for smallholder Producers: Module 3: Territorial approach to rural-agro-enterprise development.
Philadelphia: CIAT.
Ming, Z., 2010. Competitiveness and Growth in Brazilian Cities: Local Policies and Actions for Innovation. Washington D.C.: World Bank Publications.
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