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Perfect Competition and Market Factors

Table of Contents

Long-run Equilibrium
Defending Against New Entrant into the Market
Cross Price Elasticity of Demand
References List

There is free entry and free exit in a perfectly competitive market with the absence of entry barriers. The buyers and producers also have adequate information about the market with no additional transaction costs. Therefore, perfect competition is expected to make a profit in the short run but maintain an equilibrium in the long run. With the less dominant firms steering their prices towards those of dominant firms, the marginal revenues and costs have to be reflected in the price; profits tend to be towards zero. The prevailing market players also discourage new market entrants from creating a monopolistic environment and making profits. Therefore, a market with perfect competition reflects long-run equilibrium, has dominant players, and goods reflect cross-price elasticity of demand.

Long-run Equilibrium

In a market with perfect competition, long-run equilibrium is when marginal costs and revenue are leveled. The average total costs also have to be equal to marginal costs and marginal revenue for the market to have a perfect equilibrium. This means that for a long-run equilibrium to exist, there must be zero profits in a perfect competition market (Azevedo and Gottlieb, 2017). The firms, therefore, cannot make a profit; their only option is to break even so that they cannot incur losses. In the long-run equilibrium, the long run refers to the duration when fixed costs are absent; fixed are usually constant regardless of the output. Whether a business makes profits or losses, they have to pay the same amount over their business expenses. Equilibrium is, however, affected by certain market changes.

The market changes that affect equilibrium include supply, demand, and market efficiency. While looking at demand, any market perceived as perfect has an elastic demand that is also perfect. Therefore, an increase in demand will increase the equilibrium, while a decrease in demand will decrease the equilibrium. In this case, the demand curve will represent marginal revenue; therefore, demand points to the income gotten from the prospective market. On the other hand, with the market competition still maintained at perfection, an increase in supply decreases the equilibrium while a decrease in supply increases the equilibrium. Take the example of an executive car sold at $200,000 per unit. With this price, there will be low demand which will force the manufacturer to reduce the price. At this point, there is low demand and an oversupply. But when the price is reduced, the demand will increase while the supply will be low.

Another market factor that affects equilibrium is the efficiency of a perfectly competitive market. There are two types of market efficiency: production efficiency and allocative efficiency. Production efficiency occurs when good in the market is produced at the lowest cost possible; the maximum output from one good is expected in a perfectly competitive market using optimum resources. On the other hand, allocative efficiency has a production pattern that is reflective of consumer preferences; production ends where the marginal benefit the consumer finds from the good matches the marginal cost of production (Greenlaw, Taylor and Shapiro, 2017). Therefore, long-run equilibrium exists in markets with allocative efficiency while those with production efficiency have short-run equilibriums. Therefore, the key factor for market efficiency is perfect completion, which exists in both allocative and productively efficient markets.

Defending Against New Entrant into the Market

A threat that every incumbent firm faces is a new entrant where they might be dislodged from their position or have their market share reduced. However, there are several ways for the incumbent to protect their dominant position. The first way is to ignore the new competitor in the no action strategy. A no-action strategy protects the incumbent from wasting money out of panic by launching ineffective decisions. It also prevents the dominant firm from committing a mistake that would harm their business if the decision made backfires. Secondly, the incumbent can strengthen its brand if it is afraid that the new venture has a stronger brand than its brand. Strengthening the brand image helps maintain customer loyalty that the new entrant might not have (Virutamasen, Wongpreedee and Kumnungwut, 2015). This creates an advantage that the new entrant does not have, that has a massive following with ultimate loyalty.

Another thing that can be done to put off new entrants is by the incumbent upgrading. However, this move could make the entrant more confident as they will feel that shake up the core of the business perceived to be dominant to the point of upgrading. The upgrades can include but are not limited to improving existing facilities to match the current demand quantities by improving production. Lastly, the firm can carry out a defensive marketing strategy where the actions of the incumbent are directed towards defending its dominant position in the market (Yannopoulos, 2015). One defensive marketing strategy was Facebook when Google introduced the circles platform via the Google plus service. Facebook fought back by introducing a new feature where Facebook users could organize their friends depending on their relationship (Dieter and Lenze, 2018). Google gave up and pulled circles out of the market; this shows what defensive marketing is capable of.

Incumbents usually focus on how to be better than the new entrants or what they can do better than them. Most of the time, they do not realize the advantages they have against new entrants. One of the advantages is that a newcomer does not have a loyal customer base like the incumbent (Cozzolino and Rothaermel, 2018). The incumbent, therefore, can use this to ensure that the customer base they have is not shifted towards the newcomers market share. The incumbent also has partnered with mutual interests. The strategic relationship with partners could be leveraged to freeze the entrant from taking over the market with a storm. The incumbent firm is also conversant with the market through market studies they have carried out coupled with experience in handling the customers. The firm, therefore, has tools for decision-making on what to do to meet customer needs, a luxury that new entrants do not have.

Cross Price Elasticity of Demand

Cross price elasticity of demand refers to the effect that the price of a good has on the demand for another good. Looking at the goods that can elicit this reaction, there are substitute and complementary goods. Substitute goods act as perfect competitors since they have the same functions (Norman and Chisholm, 2014). Examples of substitute goods include two different brands of sugar or two different brands of toothpaste. A customer could opt to use one brand instead of the other. Substitute goods always have a positive cross-price elasticity. For example, when Sensodyne toothpaste further increases the price of their product because of the utility, a cheaper Pepsodant toothpaste could benefit as customers will buy it more due to the price difference.

Another type of good that can elicit cross-price elasticity of demand is complementary goods. Complementary goods add value to other goods since they concurrently exist in the market (Berry et al., 2014). A good example of a complementary good is a mobile phone and a sim card. For one to own a mobile phone, they should have a sim card. If the price of a phone drops below N200,000 because it is outdated and a new one has come, the price of sim cards will remain the same, but the demand would increase since there are many phones in the market. But when the phone price increases, customers would not buy the phone and hence the demand for sim cards would below.

The effect of cross-price elasticity is also different when the goods are in a monopoly and when the market has perfect competition. In perfect competition, substitute goods will be indistinguishable, and the market will view them as being sold by different firms. Take a look at Oil Libya selling petrol at their gas stations. They might be expensive than the one sold and Total petrol stations. The two petrol stations are then within the vicinity of one another. Therefore, customers will opt for the cheaper petrol at the Total petrol station and leave the expensive one at Oil Libya fuel pumps. However, in a monopoly, demand is not price sensitive as there is no competition (Bilbiie, Ghironi and Melitz, 2019). Take the example of generic drugs such as paracetamol and Panadol extra. Their chemical composition is not different, with a slight variance existing. An increase in the price of paracetamol will not affect the demand for Panadol extra since they are not perfect substitutes due to perception of brand name of store name.

In conclusion, for perfect competition to exist in a market, the market has to move towards long-run equilibrium since profits range in the region of zero. Long-run equilibriums exist because new entrants price their products like the dominant players; hence, their prices reflect marginal costs and revenues. The market must also have dominant players despite the threat of free entrants that might threaten their dominancy. Lastly, a positive cross-price elasticity has to be witnessed because most of the goods in the market are substitute goods, albeit with a few monopolistic ventures controlling the market.

References List

Azevedo, E. and Gottlieb, D., 2017. Perfect competition in markets with adverse selection. Econometrica, 85(1), pp.67-105.

Berry, S., Khwaja, A., Kumar, V., Musalem, A., Wilbur, K., Allenby, G., Anand, B., Chintagunta, P., Hanemann, W., Jeziorski, P. and Mele, A., 2014. Structural models of complementary choices. Marketing Letters, 25(3), pp.245-256.

Bilbiie, F., Ghironi, F. and Melitz, M., 2019. Monopoly power and endogenous product variety: distortions and remedies. American Economic Journal: Macroeconomics, 11(4), pp.140-174.

Cozzolino, A. and Rothaermel, F., 2018. Discontinuities, competition, and cooperation: coopetitive dynamics between incumbents and entrants. Strategic Management Journal, 39(12), pp.3053-3085.

Dieter, D. and Lenze, J., 2018. Google+ Case Study: Create a social network or risk everything. Performance improvement, 57(10), pp.26-36.

Greenlaw, S., Taylor, T. and Shapiro, D., 2017. Principles of macroeconomics.

Norman, G. and Chisholm, D., 2014. Substitute Goods.

Virutamasen, P., Wongpreedee, K. and Kumnungwut, W., 2015. Strengthen brand association through SE: Institutional Theory Revisited. Procedia Social and Behavioral Sciences, 195, pp.192-196.

Yannopoulos, P., 2015. Perceived importance of defensive marketing strategies: an exploratory study. World Journal of Management, 6(1), pp.24-33.

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