Market Structure Research Paper Example | Topics and Well Written Essays - 2250 words

Market Structure - Research Paper Example PERFECT COMPETITION: Firms operating under perfect competition essentially rest upon four primary assumptions, the first of which is that since there are several firms operating under this model the significance of their output from a perspective of the entire industry supply is unimportant which means that such firms do not have the capability to influence the price of the product, therefore, at the market price perfect competition firms are said to experience perfectly elastic demand. Henceforth, this phenomenon postulates that perfect competition firms are price takers (Mankiw, 2011). The second assumption of the model of perfect competition relates to the freedom of entry into the industry or whether there is existence of any barriers to entry or exit. In this scenario, new firms do not face any lack of restrictions if they wish to enter the industry, however, the concept of freedom of entry is said to be applicable in the long-run owing to the period it takes to establish an org anization (Sloman, 2006). A fundamental assumption of the model relates to product homogeneity within the industry, this concept is based upon the idea that all businesses supply products that are identical (Sloman, 2006). Lastly, it is supposed that buyers and sellers have perfect knowledge regarding the market such as price, quality and costs. The profit maximizing output of the firm occurs at the intersection of Marginal Cost and Marginal Revenue where, MC = MR (Sloman, 2006). Therefore, when P = MC firms in perfect competition are economically efficient, where allocative efficiency occurs when consumer as well as producer surplus is at its maximum and productive efficiency occurs because the firm’s equilibrium output in the long-run is established where the businesses’ average cost is the least. The quantity of firms in the short run varies as firms leave or come into the industry, if it is understood that the costs of the firms experience no change the exit of som e firms will lead to generation of abnormal profit or supernormal profit where AR>AC. In the long-run however, the attraction of abnormal profits will cause firms to enter the industry because of no barriers to entry or exit thereby, bringing the state of the market back to equilibrium at a point on the LRAC curve which is the least, causing firms to make normal or zero economic profit such that the long-run equilibrium occurs where P = AR = LRAC = LRMC = MR (Stanlake & Grant, 2000). Due to obvious factors relating to the model of perfect competition it can be concluded that most firms are not audacious in terms of taking risks. The instability of demand therefore, causes perfectly competitive firms to diversify which leads to intra-industry trade and if the condition of elastic demand is fulfilled such exchange of identical commodities on an international scale proves to be beneficial for both the countries and firms involved (Cukrowski & Aksen, 2003). Hypothetically, the economic efficiency of perfectly competitive firms would indicate that government regulation is not required in such a model but in the short-run government intervention might be needed to control prices if firms are generating supernormal profits, however, the primary premise remains that in a perfectly competi