Microeconomics - Perfect competition

The type and degree of competition in a given sector are determined by market structures. The grocery store company, which deals with the supply of fresh fruits and vegetables, is fiercely competitive. The market framework described above is attractive for this business venture because it ensures profit maximization. Furthermore, it ensures long-term efficiency; the volume of productivity reduces the overall expense of the small supermarket. Furthermore, the business framework enables the venture to adjust capital distribution in response to shifts in demand. Moreover, a perfect market protects the customer from exploitation while ensuring that the grocery earns the minimum level of profits essential in retaining the firm as a player in the agricultural industry. Additionally, entry into and exit from the market is free and there is minimal government regulation in a perfect competition (Hendry 3). It is also possible to shift the operations of the grocery to a new location due to mobility of factors of production. These are some of the reasons that prompted the researcher to invest in the grocery business, which are characteristics of a perfect competition. The venture serves more than 200 customers and there are 50 grocery stores in the region vending fruits and vegetables.

A perfect competition is characteristic of many buyers and sellers. Both parties are price takers and the output of the grocery store makes an insignificant contribution to the aggregate supply. Furthermore, fresh fruits and vegetables sold by the venture are homogenous; this makes the customer indifferent while selecting sellers of these products. Additionally, buyers and sellers have perfect knowledge of the market and the venture does not incur transport costs. Minimizations of these expenses make the grocery business attractive. These attributes are desirable for the grocery store venture, which fits in a perfect competition.

Short-run equilibrium of a perfect competition

The grocery store is in equilibrium at the point where it maximizes profits; alteration of either the price or the output level would not increase profitability. The figure below shows how the venture can yield supernormal profits in the short-run.

The output of the grocery store will be point q; at this point, marginal revenue (MR) is equal to marginal cost (MC), and the average cost (AC) is equivalent to C. The venture will make supernormal profits in the shaded area, which makes the grocery venture desirable in the short term.

Long run equilibrium for the firm

Supernormal profits would attract new entrants considering the freedom of entry into the industry. The supply of fruits and vegetables, in turn, would increasing leading to a fall in prices. The grocery store will face a falling perfectly inelastic curve from D1 to D2, which reduces the surplus profit. The figure below signals the above situation.

The process will continue until the grocery resumes to making normal profits, which are essential in supporting the operations of the venture. At this level, the price will equal the average total cost (ATC); the demand curve, on the other hand, is a tangent to the ATC curve at the minima. The figure below indicates the scenario prevailing in this market structure.

The downside of the grocery store being in a perfect competition, however, is lack of innovation. The firm lacks funds for research as the profit margins are low and the venture is small. Additionally, entities do not have the will to innovate in this market due to free flow of information and lack of barriers for new entrants, which leads to immediate imitation by competitors. Moreover, the grocery cannot capitalize on advantages accruing from economies of scale due to its low levels of operation.

Monopoly

The above market structure has a sole seller, which may take the form of unified ventures or an association of separately controlled firms that combine their products; this makes a monopolist face the market or industry demand. Sources of monopoly include exclusive ownership and control of input factors. Patent rights and market franchise also give rise to monopolies. In view of these characteristics, a monopoly is not an adequate market structure for the grocery store with such complexities in its formulation unlike is the case in a perfect competition.

A monopolist is the price maker as opposed to a price taker. A monopoly can set the output quantity and the level of demand will establish the price for the product; alternatively, they can also set prices and the price mechanism would determine the optimal output level.

Short-run equilibrium

Monopolies seek to maximize profits or minimize losses; two mutually exclusive events that they control are price and output. Profit maximization for a monopoly venture occurs at the output level or point where marginal cost (MC) is equal to marginal revenue (MR) as signaled in the figure below.

A monopolist cannot produce less than Qo units, which is the optimal output level; at this point, MC is less than MR. The optimal price is Po.

Practices in the market

A characteristic in the practice of monopolies is collective boycott and exclusive dealing to supply; this restricts the level of competition as it makes market penetration hard for new entrants. Additionally, monopolists can dictate to wholesalers and retailers on pricing of commodities; resale price maintenance is another strategy for avoiding competition from firms that would offer competitive prices. Monopolists are notorious for exploiting consumers by overcharging them. Price discrimination allows a monopolist to impose varying prices to different sets of consumers depending on their elasticity of demand; they can also charge same customers differently depending on the number of units that they purchase. Considering these practices, a monopoly is not an appropriate market structure for the grocery store. A downside of monopolies is inefficiency and lack of innovation due to absence of competition. Additionally, it can suffer from diseconomies of scale as the firm grows in size. Nevertheless, prices are stable due to absence of competition in the market and the monopolist is the price maker. Besides, it does not lead to wastage of resources in advertising campaigns and product differentiation, and this is similar to a perfect competition market structure.

Monopolistic competition

The above market structure, which is also known as imperfect competition, combines features from a monopoly and perfect competition. The number of producers and consumers are many and this is similar to a perfect market; however, monopolists differentiate their products unlike their counterparts who deal with homogenous commodities, and this makes it unattractive for the grocery venture (Monopolistic Competition and Oligopoly 423). Nevertheless, freedom of entry and exit into this market structure remains unrestricted just like in a perfect competition. Products in a monopolistic competition have a sole seller due to availability of differentiated substitutes; this feature is present in a monopoly. However, the demand curve for a monopolistic competition is more elastic when compared to a monopoly. As such, an increase in prices by a firm in an imperfect market structure will lead to loss of a substantial proportion of customers to rivals unlike in a monopoly and vice versa. Some consumers, however, will remain loyal irrespective of fluctuation in prices in a monopolistic competition; this depends on success of differentiation initiatives, which is inappropriate for the grocery venture due to accruing costs.

Price and output in the short run

Product differentiation allows a firm to change its prices without losing turnover in sales; they achieve this through actions such as after-sales services, advertising, branding, and packaging. Furthermore, brand loyalty guarantees stability of sales, and this makes entities in the market structure less susceptible to risks and uncertainties emanating from intense price competition. Differentiation also enhances consumer sovereignty due to a wide consumer choice and it further guarantees consistency in quality of output.

Nevertheless, product differentiation reduces competition in the market and this makes it unattractive for the grocery store venture. Consumer loyalty curtails firms from competing as it makes customers reluctant to substitute one product for another; furthermore, it makes market penetration cumbersome for new entrants unlike is the case in perfect competition that favors the grocery business. Moreover, efforts and expenses accruing from product differentiation initiatives are wasteful; these, in turn, yield unwarranted increases in price. Additionally, the large number of firms’ floods the market with many brands; the above scenario limits realization of full economies of scales in generation of output.

Long run output

Profitability in the long-term depends on conditions of entry into the market. New entrants will be present if firms make supernormal profits. However, the market share of each entity in the industry will dwindle, hence decreasing profitability. Furthermore, the new entrants may increase the cost of inputs, which makes the market structure undesirable for the grocery venture. Entry of firms in the market will stabilize when entities start making zero profits and losses may prompt them to exit. These characteristics are not adequate in the long-term for the grocery venture. The figure below indicates the long-run output and price in this market structure.

Waste in imperfect competition

Wastage in a monopolistic competition can occur due to entry of new firms in the industry, which cause a fall in demand for products of individual firms, thus prompting them to reduce the level of output. Such actions yield underutilization of resources. Furthermore, product differentiation initiatives as a customer retention strategy lead to wastage of resources, which a firm can use for expansion and exploitation of economies of scale. These conditions are unfavorable for the grocery store venture.

Oligopoly

In the above market structure, there are few but large firms that are price makers unlike in a perfect competition. Commodities on offer are close substitutes. Furthermore, product differentiation is a common form of non-price competition strategy adopted by entities that earn supernormal profits, both in the short and in the long-term ( Huishuang). Decisions made by sellers are mutually interdependent. The characteristics of the above market structure are unfavorable for the grocery venture.

Pricing and output decisions

The above depend on whether the firm operates in a pure or differentiated oligopoly. The level of differentiation in a pure oligopoly market is weak; pricing can be either collusive or non-collusive. In a collusive oligopoly, sellers coordinate while setting prices for commodities and the collusion can be formal or informal. Firms in formal collusive oligopoly come together to protect their interests; a sole decision maker establishes the output price and quantity for the industry. A central agency determines quotas for every firm, which later distributes the maximized joint profits. The characteristics of this market structure are inadequate for a grocery. Entities in informal collusive oligopoly, on the other hand, occur in the absence of cartels; firms may also agree not to engage in price competition for their mutual benefit. Firms can enter into tacit market sharing agreements; price leadership allows a benchmark entity to set prices for the entire industry. A low cost firm can set the trend for the market if conflict of interest arises from cost-differentials. The second yardstick is price leadership by a large firm, which determines the value of output in the entire market.

In contrast, the differentiation level in a non-collusive oligopoly is high in a market structure filled with great uncertainty. An increase in prices by one firm may lead to a loss of a substantial proportion of customers to rivals and vice versa. If a firm lowers prices and other firms retaliate by lowering them further, price wars occur in the market. The cycle may continue and lower prices to a point where consumers find no need for customer switching. Considering the above trend, the demand curve of firms in a non-collusive oligopoly is elastic and tends towards inelasticity with the onset of price wars. The demand curve in this market structure, therefore, consists of two parts as indicated in the figure below.

If one firm raises prices of commodities while in the inelastic part, competitors in the market will not follow suit. However, an entity stands to lose a substantial proportion of customers to rivals if it raises prices beyond the kink; price p, therefore, would guarantee stability in sales turnover. Barriers to entry in a pure oligopoly may be artificial or natural. Some of the artificial barriers include price wars, control of supply of raw materials, and state protection through issuance of patent rights and exclusive market licenses. These traits are unnecessary for the grocery venture.

Conclusion

In conclusion, the study emphasizes characteristics of a perfect competition that prompted the researcher to invest in a grocery businesses. Noted is the short-run equilibrium of the market structure and strategies for profit maximization; the researcher highlights how supernormal profits attract competitors in the long-term, which leads to an increase in supply and decrease in prices. The study further highlights the merits and demerits of perfect competition, which is adequate for the grocery venture. Monopoly is the second market structure discussed in the review; noted are complexities in its formulation and entry requirements of new firms. The researcher articulates the short-term and long run equilibrium of a monopoly and highlights the advantages and disadvantages of the market structure. The third market structure reviewed by the analyst is monopolistic competition, which has characteristics of a monopoly and a perfect competition. The level of product differentiation is high, which makes market penetration cumbersome for new entrants; the researcher highpoints the benefits of such initiatives to both the consumer and producers and their drawbacks. Ease of entry for new firms in the industry influence profitability of a venture in the long term. Oligopoly is the final market structure reviewed in by the researcher, which is inadequate for the grocery venture. The study highlights pricing and output decisions of both pure and differentiated oligopolies; it further highlights barriers to entry in the market structure.

Works Cited

Huishuang, H E. “Product Differentiation and Cartel Stability With Costs of Collusion.” Canadian Social Science 9.3 (2013): 46-50. Print. 23 April 2017. .

Hendry, John. “An Introduction to Theories of the Firm.” Theories of the Firm (2011): 1-5. Print. 24 April 2017. .

Monopolistic Competition and Oligopoly. Connect Economics, 2012. Print. 24 April 2017. .