A Case Study in Perfect Competition

(1)

A Case Study In

A Case Study In Perfect Compe

Perfect Competition

tition::

The U.S. Bicycle Industry

And How Independent Retailers Can Thrive! And How Independent Retailers Can Thrive!

By By Jay Townley Jay Townley Question:

Question: Considering the model of perfect competition and its condition, please argue for orConsidering the model of perfect competition and its condition, please argue for or against this case study’s notion that US

against this case study’s notion that US Bicycle industry is a perfect competition. Further, if it is Bicycle industry is a perfect competition. Further, if it is not anot a perfect com

perfect competition, tpetition, then which hen which market smarket structure woutructure would be the ld be the closest ficlosest fit.t.

Answer:

In economic theory, perfect competition (sometimes called pure competition) describesIn economic theory, perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have the market power to set the price of a markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly com

perfectly competitive mapetitive markets. Still, buyrkets. Still, buyers and sellers in some aers and sellers in some auction-type markeuction-type markets say for commodits say for commoditiesties or some financial assets may approximate the concept. As a Pareto efficient allocation of economic or some financial assets may approximate the concept. As a Pareto efficient allocation of economic resources, perfect competition serves as a natural benchmark against which to contrast other market resources, perfect competition serves as a natural benchmark against which to contrast other market structures.

structures.

Basic structural characteristics



 Infinite buyers and sellersInfinite buyers and sellers – – An An infinite number of consumers with the willingness and ability toinfinite number of consumers with the willingness and ability to

buy the pro

buy the product at a duct at a certain certain price, anprice, and infinite pd infinite producers with roducers with the willithe willingness and ngness and ability to ability to supplysupply the product at a certain price.

the product at a certain price.



 No barriers of entry and exitNo barriers of entry and exit – – No entry and exit barriers makes it extremely easy to enter or No entry and exit barriers makes it extremely easy to enter or

exit a perfectly competitive market. exit a perfectly competitive market.



 Perfect factor mobilityPerfect factor mobility – – In In the long run factors of the long run factors of production are perfectly mobileproduction are perfectly mobile, allowing, allowing

free long term adjustments to changing market conditions. free long term adjustments to changing market conditions.



 Perfect information - All consumers and producers are assumed to have perfect knowledge ofPerfect information - All consumers and producers are assumed to have perfect knowledge of

price, uti

price, utility, quallity, quality and prity and production moduction methods of prodethods of products.ucts.



 Zero transaction costsZero transaction costs - Buyers and sellers do not incur costs in making an exchange of goods in - Buyers and sellers do not incur costs in making an exchange of goods in

a perfectly competitive market. a perfectly competitive market.



 Profit maximization - Firms are assumed to sell where marginal costs meet marginal revenue,Profit maximization - Firms are assumed to sell where marginal costs meet marginal revenue,

where the most profit is generated. where the most profit is generated.



 Homogenous productsHomogenous products - The qualities and characteristics of a market good or service do not - The qualities and characteristics of a market good or service do not

vary between different suppliers. vary between different suppliers.



 Non-increasing returns to scale -Non-increasing returns to scale - The lack of increasing returns to scale (or economies of scale) The lack of increasing returns to scale (or economies of scale)

ensures that there will always be a sufficient number of firms in the industry. ensures that there will always be a sufficient number of firms in the industry.



 Property rights - Well defined property rights determine what may be sold, as well as whatProperty rights - Well defined property rights determine what may be sold, as well as what

rights are conferred on the buyer. rights are conferred on the buyer.



(2)



 No externa No externalities - clities - costs or beneosts or benefits of an afits of an activity do ctivity do not affect not affect third partiesthird parties

In the

In the short run, short run, perfectly-perfectly-competitivcompetitive markets are not e markets are not productively efficieproductively efficient as nt as output will not output will not occuroccur where marginal cost is equal to average cost (MC=AC)

where marginal cost is equal to average cost (MC=AC)

They are allocatively efficient as output will always occur where marginal cost is equal to marginal They are allocatively efficient as output will always occur where marginal cost is equal to marginal revenue (MC=MR)

revenue (MC=MR)

In the long run, perfectly competitive markets are both allocatively and productively efficient In the long run, perfectly competitive markets are both allocatively and productively efficient

In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P=MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for (P=MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a monopoly does not have a supply curve". The abandonment of price taking creates considerable

monopoly does not have a supply curve". The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition.

such as that of monopolistic competition. (In the short run, it is

(In the short run, it is possible for an individual firm to make an econompossible for an individual firm to make an economic profit. This situation is shownic profit. This situation is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C) in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C)

(However, in the long run, economic profit cannot be sustained. The arrival of new firms or expansion of (However, in the long run, economic profit cannot be sustained. The arrival of new firms or expansion of existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (zero economic profit) Its horizontal demand curve will touch its average total cost curve at its lowest (zero economic profit) Its horizontal demand curve will touch its average total cost curve at its lowest point)

(3)

Thus nowadays the dominant intuitive idea of the conditions justifying price taking and thus rendering a Thus nowadays the dominant intuitive idea of the conditions justifying price taking and thus rendering a market perfectly competitive is an amalgam of several different notions, not all present, nor given equal market perfectly competitive is an amalgam of several different notions, not all present, nor given equal weight, in all treatments. Besides product homogeneity and absence of collusion, the notion more

weight, in all treatments. Besides product homogeneity and absence of collusion, the notion more

generally associated with perfect competition is the negligibility of the size of agents, which makes them generally associated with perfect competition is the negligibility of the size of agents, which makes them believe th

believe that they at they can sell can sell as muas much of the gooch of the good as they d as they wish at the wish at the equilibrium equilibrium price but nprice but nothing at othing at a highera higher price (in pa

price (in particular, rticular, firms are dfirms are described escribed as each as each one of theone of them facing m facing a horizontaa horizontal demal demand curve). Hnd curve). However,owever, also widely accepted as part of the notion of perfectly competitive market are perfect information about also widely accepted as part of the notion of perfectly competitive market are perfect information about price distri

price distribution and bution and very quick very quick adjustmeadjustments (whose nts (whose joint operatjoint operation estabion establish the lish the law of one law of one price), to price), to thethe point some

point sometimes of idtimes of identifying entifying perfect comperfect competition wipetition with an essth an essentially entially instantaneoinstantaneous reaching us reaching ofof

equilibrium between supply and demand. Finally, the idea of free entry with free access to technology is equilibrium between supply and demand. Finally, the idea of free entry with free access to technology is also often listed as a characteristic of perfectly competitive markets, probably owing to a difficulty with also often listed as a characteristic of perfectly competitive markets, probably owing to a difficulty with abandoning completely the older conception of free competition. In recent decades it has been

abandoning completely the older conception of free competition. In recent decades it has been

rediscovered that free entry can be a foundation of absence of market power, alternative to negligibility of rediscovered that free entry can be a foundation of absence of market power, alternative to negligibility of agents

agents

Please argue for or against

Please argue for or against this case study’s notion that US Bicycle industry is a perfect competitionthis case study’s notion that US Bicycle industry is a perfect competition The Bicycle industry has been working faster then its own way of age, like in every part of life we had a The Bicycle industry has been working faster then its own way of age, like in every part of life we had a great tendency to have loss or profit but they trying to find a mid-way of success and they tried very fast great tendency to have loss or profit but they trying to find a mid-way of success and they tried very fast in any of market before having a industry we don’t have to take 6 peoples meeting and discussing a great in any of market before having a industry we don’t have to take 6 peoples meeting and discussing a great idea a theory of future and all, this completely spoiling a sight of business, businesses are not started like idea a theory of future and all, this completely spoiling a sight of business, businesses are not started like this, they don’t even explain the surey process, examinations, or any of thing by which this study can this, they don’t even explain the surey process, examinations, or any of thing by which this study can show us that the business is did very innovative ways, they just think that, they can take one economic show us that the business is did very innovative ways, they just think that, they can take one economic way and had to start a business by this way to secure past present and future all the way although the way and had to start a business by this way to secure past present and future all the way although the things been not shown more organized and well planned in whole case they are having a normal business things been not shown more organized and well planned in whole case they are having a normal business with one on one and make a reasonable profit to all the way and loss i

with one on one and make a reasonable profit to all the way and loss i n some of the ways there isn’t anyn some of the ways there isn’t any of the dept needed to explain in it for further that what should the reasons and all the time the argue is of the dept needed to explain in it for further that what should the reasons and all the time the argue is negative on it ...

(4)

Market

Market structure

structure (Oligopoly)

(Oligopoly)

As per my perceptions, the closet market structure fit is Oligopoly, As per my perceptions, the closet market structure fit is Oligopoly,

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Oligopolies can result from various forms of collusion which reduce competition and lead (oligopolists). Oligopolies can result from various forms of collusion which reduce competition and lead to higher costs for

to higher costs for consumersconsumers

With few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one With few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm therefore influence and are influenced by the decisions of other firms. Strategic planning by

firm therefore influence and are influenced by the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants oligopolists needs to take into account the likely responses of the other market participants

(5)

Characteristics

Profit maximization conditions Profit maximization conditions An oligopoly maximizes profits An oligopoly maximizes profits Ability to set price

Ability to set price

Oligopolies are price setters rather than price takers Oligopolies are price setters rather than price takers Entry and exit

Entry and exit

Barriers to entry are high The most important barriers are economies of scale, patents, access to Barriers to entry are high The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to

destroy nascent firms. Additional sources of barriers to entry often result entry often result from government regulationfrom government regulation favoring existing firms making it difficult for new f

favoring existing firms making it difficult for new f irms to enter the marketirms to enter the market Number of firms

Number of firms "Few"

"Few" – – a "handful" of sellers there are so few firms that the actions of one firm can influence the a "handful" of sellers there are so few firms that the actions of one firm can influence the actions of the other firms

actions of the other firms

Long run profits Long run profits

Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.

entering market to capture excess profits. Product differentiation

Product differentiation

Product may be homogeneous (steel) or differentiated (automobiles) Product may be homogeneous (steel) or differentiated (automobiles) Perfect knowledge

Perfect knowledge

Assumptions about perfect knowledge vary but the knowledge of various economic factors can be Assumptions about perfect knowledge vary but the knowledge of various economic factors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price, cost and product quality.

to price, cost and product quality. Interdependence

Interdependence

The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must anticipate a firm's countermoves. It is very much like a game of chess or pool in which a player must anticipate a

(6)

whole sequence of moves and countermoves in determining how to achieve his or her objectives. For whole sequence of moves and countermoves in determining how to achieve his or her objectives. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price incre

price increase, it ase, it may wamay want to know wnt to know whether othehether other firms will r firms will also incalso increase prices rease prices or hold exor hold existing priceisting pricess constant. This high degree of interdependence and need to be aware of what other firms are doing or constant. This high degree of interdependence and need to be aware of what other firms are doing or might do is to be contrasted with lack of interdependence in other market structures. In a perfectly might do is to be contrasted with lack of interdependence in other market structures. In a perfectly competitive (PC) market there is zero interdependence because no firm is large enough to affect market competitive (PC) market there is zero interdependence because no firm is large enough to affect market price. All

price. All firms in a firms in a PC maPC market are pricrket are price takers, e takers, as curreas current market nt market selling priselling price can ce can be followebe followedd predictably

predictably to maxto maximize shoimize short-term profits. rt-term profits. In a moIn a monopoly, thenopoly, there are no re are no competitors competitors to be concto be concernederned about. In a monopolistically-competitive market, each firm's effects on market conditions is so negligible about. In a monopolistically-competitive market, each firm's effects on market conditions is so negligible as to be safely ignored by competitors.

as to be safely ignored by competitors. Non-Price Competition

Non-Price Competition

Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of non-price competition.

(7)

Modeling

There is no single model describing the operation of an oligopolistic market. The variety and complexity There is no single model describing the operation of an oligopolistic market. The variety and complexity of the models is because you can have two to 10 firms competing on the basis of price, quantity,

of the models is because you can have two to 10 firms competing on the basis of price, quantity, technological innovations, marketing, advertising and reputation. Fortunately, there are a series of technological innovations, marketing, advertising and reputation. Fortunately, there are a series of

simplified models that attempt to describe market behavior by considering certain circumstances. Some of simplified models that attempt to describe market behavior by considering certain circumstances. Some of the better-known models are the dominant firm model, the Cournot-Nash model, the Bertrand model and the better-known models are the dominant firm model, the Cournot-Nash model, the Bertrand model and the kinked demand model