Perfect Competition: Short Run and Long Run Profits Trends

Keywords: perfect competition fads, short run gains, long run profits

This paper is written to critically discuss the next assertion: "If a firm is within perfect competition, it struggles to make supernormal earnings in the long run. Therefore, they should strategize to move from a price taker in a perfect competition situation towards a price manufacturer monopoly situation as part of their corporate strategy. "

This report firstly provides an examination of the overview of perfect competition, including its short-run and long-run profits trends. That is followed by an research of monopoly. Specific information is given out here. And then Strategies for preserving monopoly position is given for recommendations but they might not exactly always helpful. Finally, it extends to the overall final result of this paper.

Table of Contents

1. Introduction

2. Perfect competition

2. 1 The short run and the long run

2. 2 Normal and supernormal profits in a framework of perfect competition

3. Monopoly

4. Strategies for maintaining monopoly position

5. Conclusions

List of References

1. Introduction

This paper is written to critically discuss the next statement: "If a company is at perfect competition, it is unable to make supernormal profits over time. Therefore, they need to strategize to move from a price taker in a perfect competition situation towards a price maker monopoly situation within their corporate strategy. " The range of this paper focuses on the two extremes-perfect competition and monopoly. The writer's insufficient experience in the microeconomic area is apparently main limitation of the report.

2. Perfect competition

Industries are typically divided into four categories in line with the degree of competition that is available between the companies within the industry (Sloman 2005): At one extreme is ideal competition where there are very many firms rivalling. Each firm is so small in accordance with the complete industry that is has no power to effect price. It really is a price taker. On the other extreme is monopoly, where there is merely one firm in the industry, and therefore no competition from within the industry. In the centre come monopolistic competition, which involves quite a lot of firms rivalling and where there is freedom for new firms to type in the industry, and oligopoly, which involves only a few organizations and where entry of new businesses is fixed.

Perfect competition is a theoretical market framework that gives the perfect allocation of resources (Sloman 2005). There are four conditions which have to be satisfied for perfect competition to exist within an industry

1. There has to be many clients and retailers and none of them can be large enough to acquire any influence over the marketplace price

2. There should be perfect knowledge of the marketplace (this implies no advertising is essential)

3. There must be no obstacles to entry - firms will need to have complete flexibility of access and exit

4. The products being sold must be homogenous in nature

If these conditions are fulfilled, then the industry is in perfect competition (Sloman 2005).

Perfect competition was well developed to illustrate that in a few sense it is maximum and in fact represents the end-state. Subsequently, it designed that competition between purchasers and sellers was completed, and neither party can increase energy or income (Steven and Heijdra 2004). Change occurs only when independent parameters change, however the situation becomes how fast and under what circumstances the new equilibrium will be achieved. Competition may not actually direct to a peaceful point out because market makes distinguish earnings and utility maximizing habit with an equilibrium situation that can be, from a public viewpoint, sub-optimal (Steven and Heijdra 2004).

2. 1 The short run and the long run

In the short run, the amount of firms is set. Depending on its costs and earnings, a company might be making large revenue, small profits, no earnings or a reduction; and in the brief run, it may continue to achieve this.

In the long run, however, the amount of profits affects admittance and leave form the industry. if profits are high, new businesses will be seduced in to the industry, whereas if deficits are being made, companies will leave.

2. 2 Normal and supernormal profits in a framework of perfect competition

Normal income is the amount of profit that is just enough to persuade firms in which to stay the industry over time, but not high enough to attract new companies. If significantly less than normal profits are made, businesses will leave the industry in the long run.

Although the talking is about the level of normal profit, used in most cases the speed of profit that decides whether a firm stays on the market or leaves. The rate of profit (r) is the amount of income (T) as a percentage of the amount of capital (K) employed (Sloman 2005). Greater firms will require making a more substantial total revenue to persuade them in which to stay a business. Total normal profit is thus greater on their behalf than for a little firm. The rate of normal earnings will probably be similar.

Supernormal income is any profit above normal earnings. If supernormal profits are created, new companies will be seduced into the industry in the long run. Thus if the industry expands or deals over time will depend on the rate of profit. By natural means, since the time a firm takes to create in business varies from industry to industry, the amount of time before the long run is come to also ranges from industry to industry.

Thereby, in the short-run, it may be possible for a person organization to make supernormal profit. This situation is shown in the diagram below, as the price (average revenue) is above the average cost (AC). As fewer organizations had occurred to enter in the period of high profits, the actual price of a given end result would be higher.

Not all organizations make supernormal earnings in the brief run. Their profits depend on the positioning of their short run cost curves. Some businesses may be experiencing sub-normal income because their average total costs exceed the current selling price. Other firms may be making normal gains where total revenue equals total cost (i. e. they are at the break-even outcome). Within the diagram below, the firm shown has high short run costs in a way that the ruling selling price is below the average total cost curve. With the profit maximizing degree of output, the company is making an economical damage (or sub-normal profits)

However, this supernormal profit that some businesses made will not last as it'll attract new firms in to the industry (Sloman 2005). The arrival of new firms shifts the supply curve to the right, as shown in the diagram below, and pushes the price down.

The lower price shifts the common revenue curve downwards until all the supernormal earnings has been competed away and the businesses are making just normal income. This long-run equilibrium is shown in the diagram below.

Another drive that shifts the source curve happens when discontinuous changes in the amount of fresh internet marketers (each in front of imperfect understanding of the others' action) enter into the trade. Through this new competition, genuine profits are intensely reduced to a level below the the one that attracts new comers, but they are not sufficiently low to run out any existing organizations. The industry will continue as of this inflated size, and it'll be in equilibrium in the sense that no new organization tends to type in or old business to leave (Robinson 1934).

In a expression, as opposed to a monopoly or oligopoly, it is impossible for a firm in perfect competition to earn supernormal revenue over time, which is to state that a organization cannot make any longer money than is essential to cover its economic costs. If a company is gaining supernormal profit for a while, this will act as a trigger for other companies to enter the market. They will compete with the first organization, driving the marketplace price down until all firms are gaining normal profit, it could be said that supernormal profit is 'competed away'. Alternatively, if companies are making a reduction, then some organizations will leave the industry, decrease the supply and raise the price. Therefore, all organizations can only make normal income in the long run.

3. Monopoly

A monopoly is market structure where there is merely one company/seller for something. Quite simply, the single business is the industry. Accessibility into such a market is restricted credited to high costs or other impediments, which might be economic, interpersonal or political. For instance, a administration can create a monopoly over a business that it needs to regulate, such as electricity. Another reason behind the obstacles against entrance into a monopolistic industry is the fact that oftentimes, one entity has the exclusive protection under the law to an all natural resource. For instance, in Saudi Arabia the federal government has only control over the oil industry. A monopoly may also form when a company has a copyright or patent that helps prevent others from joining the marketplace. Pfizer, for occasion, got a patent on Viagra. Organizations with a monopoly position is a cost maker just because a single firm regulates the total resource in a pure monopoly, with the ability to exert a substantial amount of control over the purchase price by changing the number supplied.

The conventional idea of monopoly was the main area of the field of production outside that of perfect competition, so that it was acknowledged that the monopolist's position was never overall and the elasticity of the demand for his product was always higher than zero. Harrod (1934) uncovers that if products are absolutely homogeneous and advertised by structured exchange is likely to perfect competition to reign. If dissimilarities of design and aspect are possible, each company may be defined as a monopolist of his own goods, but at the mercy of the reaction of his rivals. The degree of monopoly may be measured by the similarities of goods.

Figure: The traditional research of monopoly

Source: Designed from Harrod (1934)

The notation in the figure 2 is given as such: MC is the marginal cost, D is the demand, MR is the marginal revenue, Q is amount, and P is the price. Harrod (1934) mentioned that the volume of result (number 2) is determined by the intersection between the marginal revenue curve, derived from the demand curve, and the marginal cost, but the price M P is identified by the demand curve.

According to Robinson (1933), the demand curve imposes after the seller a cost problem for his product comparatively to the horizontal one from the perfect competition. However, the monopolist decision about the purchase price and the output depends upon the elasticity of the curve and upon its position relative to the cost curve for his product. In that circumstance, earnings may be bigger, perhaps by increasing the price and providing less, perhaps by minimizing it and advertising more. The positioning and elasticity of the demand curve for the merchandise of anybody retailer depend in large part upon the option of competing products and prices that are requested them.

Since there are barriers to the accessibility of new companies, the supernormal gains produced from the monopoly will not be competed away over time. The only difference, therefore, between short-run and long-run equilibrium is that in the long run the company will produce where MR = long-run MC.

However, if the barriers to the entrance of new organizations are not total, and when the monopolist is making large supernormal profits, there may be a danger over time of potential rivals breaking in to the industry. In such instances, the monopolist may keep its price down and in that way deliberately limit the size of its profits in order not to draw in new entrants (Sloman 2005). This practice is known as limit prices (Sloman 2005).

In the following Figure, two AC curves are drawn: one for the monopolist and one for a potential entrant. The monopolist, being set up, has less AC curve. The new entrant, if it's to compete effectively with the monopolist, must ask for the same price or less one. Thus provided the monopolist will not raise price above P1, the other company, struggling to make supernormal earnings, will not be attracted into the industry.

AC for new entrant

AC for monopolist




P1 may well be below the monopolist's short-run profit-maximizing price, but the monopolist may would prefer to limit its price to P1 to protect its long-run income from damage by competition. Fear of government intervention to suppress the monopolist's techniques may have an identical restraining effect on the purchase price that the monopolist charges.

Consumers are prepared to buy more goods if the price level is lower than the one identified under monopoly, however the conditions of imperfect competition imposes limitations over the marketplace mechanism to bring in more organizations to compete and reduce the price level. Companies invest in product differentiation to avoid your competition of new entrants, so the level of sales is based upon the method where his product differs from opponents' product. Differently, under perfect competition, a producer may shift in one sector to another, but the volume of sales never will depend, as under imperfect competition, after product differentiation. The producer, in perfect competition, is actually a part of the market in which many others are producing the identical good. The sales can vary greatly over a wide range without changing the price, so they may be as large or as small as he pleases without the necessity of changing his product (Robinson, 1933).

The differentiation is an essential requirement but its deviation may refer to the quality of the merchandise - complex changes, new designs, or better materials; it may mean a new package or container; it may suggest more quick or courteous service, a seperate location (Robinson, 1933).

If economies of size is completely absent when the demand goes up the inflow of new producers will continue, leading to a continuous decrease in the end result of existing companies and a continuing increase in the elasticities with their demand before latter becomes infinite and prices will equal average cost. There the activity will minimize. However, each company will have reduced his productivity to this amount that he has completely lost his hold over the marketplace (Kaldor, 1935).

The role of the economies of range is exhibited by Kaldor (1935) as a device that reinforces imperfect competition. Thus, if there is not really a sufficiently great demand to create one product by using an optimal size, the developer may still utilize his seed fully by producing several products, alternatively than creating a smaller, sub-optimal seed or leaving his existing plant under-employed. Matching to Kahn (1935), how big is a firm depends on two sets of factors: a) the complex conditions of creation, as portrayed by its cost curve; and b) the degree of imperfection of competition, as expressed by the demand curve because of its product.

The question about market integration can be examined using the explanation of Harrod (1931), therefore the firms, in order to keep up their market electricity, may require a license from some controlling power, or the existing companies may be so strong they are able to repel new competition having a price war. They may even resort to violence to avoid fresh rivals from showing up on the industry. In such cases, no level of high revenue will be sufficiently enough to tempt new companies into the trade, and the supply of enterprise compared to that trade is perfectly inelastic at the existing amount. For such industry, any level of profits is normal and the word ceases to truly have a valid software.

In a world where all business people are alike there would be a consistent rate of profit in all companies in the long period. In the real world entrepreneurship is no more homogenous than land in real life. It really is socially appealing to reroute entrepreneurs from industries in which the firms are obviously larger than the average for industry all together, and to catch the attention of them into companies where company are naturally below the common in size. Where in fact the firms are already in a natural way large under conditions of laissez-faire it is in the interests of world that they must be yet bigger; where they are already in a natural way small it is interest of contemporary society that should be yet smaller. As a result, deals which require unconventional personal capability or special qualifications, including the power to command a sizable amount of capital for the initial investment, will generally have a high level of profits; trades that happen to be easy to type in will have less level (Robinson 1934 and Kahn 1935).

4. Approaches for retaining monopoly position

As stated in the last areas, it is impossible for a firm in perfect competition to earn supernormal earnings in the long run, but possible in a monopoly situation. For a company to shoot for or maintain its monopoly position, there has to be barriers to entry of new organizations (Sloman 2005). Barriers also exist under oligopoly, however in the situation of monopoly they need to be high enough to block the entrance of new firms. Barriers can be of various forms.

Economies of Level. In case a monopoly experiences substantive economies of size, the industry might not exactly be able to support several developer (Sloman 2005). In Figure below, D1 symbolizes the industry demand curve, and hence the demand curve for the company under monopoly. The monopolist can gain supernormal revenue at any productivity between points a and b. if there have been two organizations, each charging the same price and providing half the industry end result, they would both face the demand curve D2. There is no price that could allow them to hide costs.








It is particularly likely if the market is small. Although market could support more than one firm a new entrant is unlikely to be able o set up on a very large range. Thus a monopolist already experiencing economies of scale can charge a price below the cost of the new entrant and drive it out of business. If, however, the new entrant is a firm already established in another industry, it may be able to endure this competition.

Product differentiation and brand commitment. If a firm produces a obviously differentiated product, where in fact the consumer associates the product with the brand, it'll be very hard for a new firm to break into that market (Sloman 2005). This barrier can occur even although market is potentially big enough for just two firms each attaining all the available economies of scale. Quite simply, the condition for the new organization is not in having the ability to produce at low enough costs, however in having the ability to create a product sufficiently attractive to consumers who are faithful to the familiar brand.

Lower costs for an established firm. A recognised monopoly will probably have developed specific development and marketing skill (Sloman 2005). It really is more likely to understand the most effective techniques and the most dependable and/or cheapest suppliers. It is likely to get access to cheaper finance. It really is thus operating on a lesser cost curve. New firms would therefore think it is hard to contend and would be more likely to lose any price battle.

Ownership of, or control over, key inputs. If a company governs the supply of vital inputs, it can refuse usage of these inputs to potential rivals (Sloman 2005). On a world size, the de Beers company has a monopoly in fine diamonds because all precious stone suppliers market their gemstones through de Beers.

Ownership of, or control over, wholesale or retail outlets. Similarly, if a firm controls the stores through which the merchandise must be sold, it can prevent potential competitors from gaining access to consumers (Sloman 2005). For example, Birds Eyeball Wall's used to provide freezers absolve to shops on the problem that they stocked only Wall's glaciers cream in them.

Legal protection. The firm's monopoly position may be shielded by patents on essential techniques, by copyright, by various types of licensing and by tariffs and other trade restrictions to keep out international opponents (Sloman 2005). Types of monopolies shielded by patents include most new medicines developed by pharmaceutical companies, Microsoft's Glass windows operating systems and agro-chemical companies, such as Monsanto, with various genetically revised plant types and pesticides.

Mergers and takeovers. The monopolist can put in a takeover bid for new entrant. The large threat of takeover may discourage new entrants (Sloman 2005).

Aggressive tactics. A recognised monopolist often will sustain losses for longer than a new entrant. Thus it can begin a price warfare, mount massive advertising campaigns, offer a nice-looking after-sales service, add new brands to compete with new entrants, and so on.

Intimidation. The monopolist may holiday resort to various forms of harassment, legal or unlawful, to drive a new entrant out of business.

However, to gain or maintain monopoly position is actually a very difficult process. In real life, in simple fact, in many industries of the economy marketplaces are best identified by the word oligopoly-where a few companies dominate the majority of the market and the industry is highly concentrated (tutor2u. net (n. d. )). In the duopoly two organizations dominate the marketplace although there could be many smaller players on the market (teacher2u. net (n. d. )).

5. Conclusions

Perfect competition and monopoly are in reality two extremes when dividing the companies based on the degree of competition that prevails between the companies within the industry. It really is impossible for a company in perfect competition to earn supernormal revenue over time, which is to state that a organization cannot make any more money than is essential to pay its monetary costs. If a firm is generating supernormal profit for a while, this will become a result in for other firms to enter the market. They will compete with the first company, driving the marketplace price down until all organizations are getting normal profit, it could be said that supernormal earnings is 'competed away'. Alternatively, if businesses are making a reduction, then some organizations will leave the industry, reduce the supply and boost the price. Therefore, all businesses can only just make normal profit in the long run.

Due to the high obstacles to the entry of new organizations, the supernormal profits derived from the monopoly will not be competed away over time. However, if the obstacles to the entry of new companies aren't total, of course, if the monopolist is making very large supernormal profits, there may be a danger in the long run of potential competitors breaking in to the industry. In real world, in many sectors of the overall economy market segments are best identified by the term oligopoly-where a few suppliers dominate the majority of the market and the industry is highly concentrated. Hence lots of the companies' striving for monopoly position could only lead to the oligopoly position alternatively than monopoly position, because in the end, it is a free market.

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