Market structure Essay Example | Topics and Well Written Essays - 1750 words

Market structure - Essay Example According to Baumol and Blinder (2011 p. 200), such a market must satisfy four conditions. First, the market has many small firms and customers such that no participants are large enough to have market power to affect the price of a product. If one producer reduces the price, there would be no effect on the market since the producer is negligible compared to the whole market. This condition rules out the possibilities for collusion or trade associations; each firm acts independently (Tucker, 2010). Secondly, all the suppliers sell a homogeneous product; there are no close substitutes (McEachern, 2011). As such, the consumers buy products from any seller since the products are the same thus competition is very powerful. The demand curve is perfectly elastic hence if a seller increases the price of the product, customers shift to buy competitors products. The firms have no choice but to meet and not exceed the price charged by others hence are â€Å"price takers† (Baumol & Blind er, 2011 p. 201). Thirdly, there are no barriers to entry or exit in the market. Barriers to entry may be in form of legal, technical or cost advantage but in a perfectly competitive market, any seller willing to enter the industry can do so to take advantage of economic profits and provide an identical product (p. 200). The new entrant is at the same level with the old firms; there are no advantages for existing firms so the new firm can compete effectively. Lastly, the infinite buyers and sellers have perfect information regarding the price and quality of products in the market. As a result, there is no need for advertising as it would have no effect; the customers know where to buy their products and besides, all products are identical and the price is determined by the market. According to Landsburg (2011), in a perfectly competitive market there are no transaction costs and perfect factor mobility. This enables the market to adjust accordingly in case of changing market conditi ons. Q2: Price and Output Decisions of a Perfectly Competitive Market As noted above, there are infinite buyers and sellers in the market such that none has an effect on price. The price in such a market is determined by forces of supply and demand hence the sellers are â€Å"price takers†. Sexton (2012) argues that since the market price is given, the only decision that firms have to make is determining the level of output that would maximize profit. The question firms should ask themselves as asserted by McEachern (2011 p. 176) is â€Å"how much should I produce?† He notes that firms aim at producing a quantity at which total revenue is higher than total cost by the greatest amount. The profit maximizing output in a perfectly competitive market occurs where marginal revenue (MR) is equal to marginal cost (MC); MR=MC therefore the firms are seen to allocate resources efficiently. A perfectly competitive firm has a horizontal demand curve thus it can sell as much quant ity as it wants at the given market price. Whether the firm increases its output or not, the price remains the same as there are many sellers. It also does not have to reduce the price so as to attract demand as it would lead to loss of revenue for the firm (Baumol & Blinder, 2011). Since total revenue is the output multiplied by the price, the average revenue is the same as price. The firm is also a price taker hence the marginal revenue is equal to