Marketing – Part 3

IT IS a pleasure to be with you all once again. This lesson is a continuation of last week’s lesson on the market structure – perfect competition. The previous lesson considered the definition and features of perfect competition. We will now discuss the advantages and disadvantages of this market structure even though, in the strictest sense, this market structure does not exist in reality.

ADVANTAGES OF PERFECT COMPETITION

All buyers and sellers are treated equally. There is only one price ruling in the market at a time and this price is not determined by any single buyer or seller but by the market forces of demand and supply.

Competition keeps prices lower than under other market structures.

Since the product is homogenous, sellers do not have to spend money on advertising. Competition between firms also forces them to be efficient. Firms under perfect competition respond to changes in consumer demand; therefore, the consumer is said to be sovereign or king.

DISADVANTAGES OF PERFECT COMPETITION

There is a lack of variety because an undifferentiated good is produced.

Firms may not be able to afford the technology that allows them to be efficient.

The number of firms in the industry makes it impossible for firms to benefit from collusion.

There may be frequent changes in price as the market forces of demand and supply change.

Let us now consider the possible profits that can be earned in the short run and in the long run under perfect competition.

SHORT-RUN EQUILIBRIUM

In the short run, some of the firms will earn normal profit, some will earn supernormal profit and some will earn subnormal profit. Normal profit is that level of profit which is just enough to keep a firm in the industry. Once a firm is earning this level of profit, it will not leave the industry. In this situation, average revenue (AR) is equal to average cost (AC). This level of profit is often referred to as zero economic profit. If supernormal profits are being earned, this is so because AR is greater than AC. When AC is above AR or AR below AC, the firm is earning subnormal profit. You may consult an economics textbook to see how these levels of profit are illustrated graphically.

LONG-RUN EQUILIBRIUM

In the long run, all the firms under perfect competition will be in the situation where they are earning just normal profit AR=AC. Just how did this come about?

In the long run, all the firms that had been earning subnormal profit in the short run AR<AC will leave the industry and will go into industries where they can at least earn normal profit. When these firms leave, supply will fall and prices and profits will rise.

The firms that are earning supernormal profits AR>AC will attract other firms into the industry by their attractive level of profits. As firms enter, supply will increase and prices and profits will fall.

This rise and fall in profits will continue until all firms in the industry will be earning normal profit, AR=AC. When this occurs, there will be no more incentives for firms to either enter or leave the industry. Thus,the industry will be in long-run equilibrium. Again, the graphical illustration of this situation can be seen in most economics texts.

Well, folks, that is it for now. Next week we will outline another market structure – monopoly. You can begin to read up on this structure based on the headings I gave you in last week’s lesson. We will learn some interesting facts about this market structure, and some common myths will be explained and dismissed. See you then.