Perfect Competition

Features of perfect competition

In a perfectly competitive market, there will be many sellers and many buyers – a lot of different
firms compete to supply a homogeneous product.
As there is fierce competition, neither producers nor consumers can influence market price –
they are all price takers. If any firm did try to sell at a high price, it would lose customers to
competitors. If the price is too low, they may incur a loss. There will also be a huge amount of
output in the market. Because of freedom of entry and exit, firms earn only normal profit in the
long run.

Advantages:
 High consumer sovereignty: consumers will have a wide variety of goods and services to choose
from, as many producers sell similar products. Products are also likely to be of high quality, in
order to attract consumers.
 Low prices: as competition is fierce, producers will try and keep prices low to attract customers
and increase sales.
 Efficiency: to keep profits high and lower costs, firms will be very efficient. If they aren’t efficient,
they would become less profitable. This will cause them to raise prices which would discourage
consumers from buying their product. Inefficiency could also lead to poor quality products.

Disadvantages:
 Wasteful competition: in order to keep up with other firms, producers will duplicate items; this
is considered a waste of resources.
 Mislead customers: to gain more customers and sales, firms might give false and exaggerated
claims about their product, which would disadvantage both customers and competitors.

Monopoly

Features of monopolies

Dominant firms who have market power to restrict competition in the market are called
monopolies. In a pure monopoly, there is only a single seller who supplies a good or service.
Since customers have no other firms to buy from, monopolies can set prices – that is they are able
to influence prices. These high prices result in monopolies generating excessive or abnormal
profits because of strong barriers to entry.

Monopolies don’t face competition because the market faces high barriers to entry – obstacles
preventing new firms from entering the market. That is, there might be high start-up costs (sunk
costs), expensive paperwork, regulations etc. If the monopoly has a very high brand loyalty or
pricing structures that other firm couldn’t possibly compete with, those also act as barriers to entry.

Disadvantages:
 There is less consumer sovereignty: as there are no (or very little) other firms selling the product,
output is low and thus there is little consumer choice.
 Monopolies may not respond quickly to customer demands.
 Higher prices which exceeds marginal cost.
 Lower quality: as there is little or no competition, monopolies have no incentive to raise quality,
as consumers will have to buy from them anyway.
 Inefficiency: Given the demand for the firm’s product is price inelastic, costs due to inefficiency
won’t create a significant problem in their profitability and so they can continue being inefficient.

Why monopolies are not always bad?

 As only a single producer exists, it will produce more output than what individual firms in a
competition do, and thus benefit from economies of scale. So, average cost is likely to be lower
under monopoly.
 They can still face competition from overseas firms which forces them to be both product and
process efficient.
 They could sell products at lower price and high quality if they fear new firms may enter the market
in the future. This is likely to be the case if the market is contestable.
 Monopolies, earning abnormal profits, have sufficient funds to finance research and development.
They, therefore, can engage in the process of creative destruction and be dynamically efficient.

Competitive Markets

Firms compete in the market to increase their customer base, sales, market share and profits.

Price competition involves competing to offer consumers the lowest or best possible prices of a
product.

Non-price competition is competing on all other features of the product (quality, after-sales care,
warranty etc.) other than price.

Informative advertising means providing information about the product to consumers. Examples
include advertising of phones, computers, home appliances etc. which include specific information
about their technical features.
Persuasive advertising is designed to create a consumer want and persuade them to buy the
product in order to boost sales. Examples include advertisements of perfumes, clothes, chocolates
etc.

Pricing Strategies
What can influence the price that producers fix on a product?

 Level and strength of consumer demand.

 The amount of competition from rival producers in the market.
 The cost of production and the level of profit targeted.

Pricing strategies can take the form of:

Price skimming: When a new and unique product enters the market, its producers charge a very
high price for it initially as consumers will be willing to pay more for the new product. As more
competitors begin to launch similar products, producers may lower prices. Apple’s iPhones are
good examples – they are very expensive at launch and get cheaper overtime.

Penetration pricing: when producers set a very low price which encourages consumers to try the
product, helping expand sales and increase loyalty. This way, the product is able to penetrate a
market, especially useful when there are a lot of existing rival products. Netflix, when it first started
out as a DVD rental service, used penetration pricing ($1 monthly subscription!) to encourage
customers to try their service which helped it create a large customer base.

Destruction pricing (predatory pricing): prices are kept very low (lower than the cost of
production per unit) in order to ‘destroy’ the sales of existing products, as consumers will turn to
the lowest priced products. Once the product is successful, it can raise prices and cover costs.
India’s Reliance Jio, a telecom company, was accused of predatory pricing during its initial launch
years. Predatory pricing is illegal in many countries as it creates a non-competitive business
environment and encourages monopoly practices.

Price wars happen when competing firms continually trying to undercut each other’s prices.

Cost-plus-pricing: this involves calculating the average cost of producing each unit of output and
then adding a mark-up value for profit. Price = (Total Cost/Total Output) + Mark-up This ensures
that the cost of production is covered and that each unit produces a profit.