Determinethe Market Structure of an Industry
Perfect(pure) competition refers to an ideal form of marketplace structure,which offers the basis for comprehending the way markets operatewithin capitalist economies. The other marketplace structures can aswell be understood well if perfect competition is utilized as areference standard (Keat et al. 2013, pg. 113). Even so, the publicdoes not usually understand perfect competition well. For instance,when businesspersons talk of intense competition within themarketplace for a commodity, they are likely, speaking about theirrival suppliers, for whom they bear some information.
Nevertheless,when economists imply perfect competition, they specifically refer tothe impersonal make-up of this marketplace structure. Thisimpersonality is because of the presence of several suppliers of thecommodity (Besanko et al., 2013, pg. 126). Perfect competition isuncommon, though it is an important model, as it helps assessindustries with characteristics parallel to pure competition. Anexample of this model of the market structure is the agriculturalindustry.
Characteristicsof the Agricultural Industry (Perfect Competition)
Several Sellers or Suppliers – There are enough sellers in the sense that the decision of one seller has no effect on the marketplace price
Standardized or Homogenous Goods – The product of each seller is similar to the product of its competitors
Free Exit and Entry – No considerable barriers hinder companies from exiting or entering the agricultural industry
Companies are Price/Cost Takers – Individual companies have to accept the marketplace price and they are not able to exert no impact on price.
Individualfirms would view their demands as perfectly elastic. Perfectlyelastic demand curves are horizontal lines at the prices. Theindustry’s (agricultural) demand curve is not perfectly(impeccably) elastic it appears that way only to individualcompanies because they have to take the marketplace prices regardlessof the amount they produce. Thus, the demand curve of the firm ishorizontal at the marketplace price (Besanko et al., 2013, pg. 324).MR (marginal revenue) refers to the rise in total revenue, whichresults from a single-unit rise in output. In perfect competition,price is constant thus, P=MR.
Here,the agricultural firms have fixed resources, and they minimize lossesor maximize profits through adjusting outputs. Firms need to producewhen the gap between revenue and cost is profitable (i.e. EP>0),or when the loss is no more than the fixed costs (i.e. EP>-FC).Companies need not produce but need to shut down in short-run whentheir losses exceed the fixed costs (Porter,1980, pg.126).Through shutting down, their losses would just be equivalent to thefixed costs. In reality, fixed costs would be office rent, equipmentlease, and business license, to mention just a few. The point ofshutdown is the price and output level at which the company onlycovers its TVC (total variable cost).
Ifthe marginal revenue of the commodity is no more than the minimum AVC(average minimum cost), the agricultural firm would shut down sincesuch an action minimizes the loss of the firm. In such cases, theeconomic loss of the firm is equivalent to its TFC (Total fixedcosts). When MR< minimum AVC, then all additional units producedwill upsurge the loss (Besanko et al., 2013, pg. 243). In the case ofpure competition, marginal revenue is equivalent to the price sincethe agricultural firm is experiencing perfectly elastic demand. Forshort-run, therefore, if Price< minimum AVC, then the companyshould shut down.
Generally,the agricultural firm cannot experience losses for a long period. Forlong-run analysis, three assumptions come in handy:
Exit and entry are the only adjustments of the long-run
The agricultural industry is in continual return to scale
Companies in the agricultural industry have the same cost curves
Inlong run analysis, when the economic gains are acquired, companiesenter the agricultural industry, which upsurges the marketplacesupply, causing the prices of products to decrease. Until zeroeconomic gains are acquired, then the market supply would be stable(Keat et al. 2013, pg. 378). When losses are experienced inshort-run, companies would leave the sector, which lowers themarketplace supply, causing an increase in the product price untilthe losses disappear. In long run, the perfect competition is one ofnil economic profits.
Inbrief, perfect competition refers to a theoretical marketplacestructure. Primarily, it is utilized as a benchmark for comparingseveral other real-life marketplace structures. As mentioned above,the industry, which most narrowly resembles this model in the realworld, is agriculture. In perfect competition, new companies caneasily make an entrance in the marketplace, generating extracompetition (Besanko et al., 2013, pg. 367). Firms only earn anadequate profit for remaining in the industry and no more, since ifthey earn surplus profits, several other firms would get into themarketplace and reduce profits significantly.
Besanko,D., Dranove, D., & Shanley, M. (2013). Economics of strategy.Princeton, N.J: Recording for the Blind & Dyslexic.
Keat,P.G., Young, P.K.Y. & Erfle, S.E. (2013). Managerial Economics(7th edition).Upper Saddle River, NJ: Pearson Prentice Hall.
Porter,M. E. (1980). Competitivestrategy: Techniques for analyzing industries and competitors.New York: Free Press.