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This is a free essay sample about one of the basic models used in microeconomics - perfect competition or competitive markets. This essay sample defines perfect competition and describes its characteristics. After this the essay uses microeconomic analysis to answer the primary questions of every business with respect to the chosen market model: how much to produce in order to maximize profit, when to enter the competitive market, when to exit from it and when to shut down.

Perfect Competition or Competitive Markets 

Microeconomics supposes there are several models of market exist. Perfect competition is one of the basic models used in microeconomics. In this paper we will try to find the answers to actual questions of microeconomics in terms of competitive market: decision to enter or exit from the market, decision to continue operating on the market or shut down operations, profit maximization, decision on determining optimal production volume.

The model of perfect competition or competitive market has the following features: a large number of market players (buyers and sellers), which are comparably small in relation to the whole market, and, therefore, are not able to affect the market prices emphatically. In simpler words, market players do not have market power to influence prices. Another characteristic of a competitive market implies that sellers offer identical products to the buyers. Hence, both sellers and buyers have to accept the market price. The last character of perfectly competitive market is the option to enter or exit the market freely. Some scientists and researches include some other features like mobility of resources and zero operational costs.

Perfect competition stipulates the following rule of thumb: marginal revenue equals the price of the good and, correspondingly, marginal revenue is equal to marginal costs. In a perfect competition companies use the following principle: if marginal revenue exceeds marginal cost then companies increase production volumes. If marginal revenue is less than marginal cost – companies decrease production volumes. The general rule for choosing optimal production volume is to operate at the margin, when marginal revenue equals marginal cost.

When a company looses money, it is time to decide whether to continue operating on the market or to shut down operations for a certain time period. In order to make a right decision it is necessary to analyze total revenue and total costs (both fixed and variable), and compare them. As far as the fixed costs are equal whether the company operates or shuts down, we only need to assess variable costs. Companies in a competitive market shut down if their revenue is less than variable costs. So if the price per product unit is less than the costs per product unit it means that total revenue (quantity of product multiplied by price) is less than total costs (fixed plus variable) and the company would benefit from shut down decision. The same can be said if price for the product is less than average variable cost of the production. In the opposite, if total revenue is larger than total costs the company should continue operating. When total costs are equal to total revenue – it is called the shut down price and it does not matter for company whether to shut down or operate further.

In the long-run companies receive zero economic profit and thus other companies are not interested in entering the market (it means that sellers completely satisfy the demand). But if the demand suddenly increases – the prices would increase too and new participants would enter the market until the price won’t reach equilibrium. So if price for the product exceeds the average total cost of production the market becomes more profitable and it is very likely that new firms would enter the market.

Decision to exit from market can be made if total revenue of a firm is less than its total cost or if price for the product is less than average total costs of production.

In practice, perfect competition does not exist in the way it is described and modeled. It is very abstract and can be used to describe the market in general terms only.

I would like to introduce my own example and provide my rationale for thinking it is quite suitable one: e-trading. Trading through the Internet is very popular now – there are many sellers and consumers, there are no any serious obstacles or barriers to enter or leave the market. A more precise example – online book stores. The product (books) is quite homogenous, the price level is close to equilibrium and producers can not seriously influence it nor can customers, resources are quite mobile (especially information – there are plenty of resources in the Internet), transaction cost are quite low (but not zero of course). If the average price of the product, book in our case, is larger than average variable cost, costs on selling and delivering book in our case, then the company receives profit and it can be said that it operates successfully (in the long run there will occur incentives to enter the market); and vice versa – some companies, most probably, would leave the market and may be try to sell something else.

Finally, I would like to conclude that perfect competition is quite abstract microeconomic model, which describes market under the certain conditions. This model gives good economic basis for firms to think in advance about their operational activities or business decisions. The general rule for choosing optimal production volume is to operate at the margin, when marginal revenue equals marginal cost. In a competitive market shut down decision is optimal if total revenue of the company is less than its variable costs or if the price for the product is less than average variable cost of production. If price for the product exceeds the average total cost of production the market becomes more profitable and it is likely that new firms would enter the market.

Statistics:
pages: 2.5
words: 896