Perfect Competition: Defining Features Video Lecture | Economics for JAMB

The first market structure we're going
to examine is a perfectly competitive
market.
Let's talk about the characteristics a
perfectly competitive markets
to determine what distinguishes them
from other markets.
But before we do, that we should talk
about what a market is.
A market is nothing more than an
institutional arrangement
in which buyers and sellers exchange
goods and services.
These markets may be centralized - in
which all trade takes place in one
central location
as in the case of the New York Stock
Exchange or in the
case of commodity markets such as the
auction market
depicted here for tobacco. Trade could
also take place
in a decentralized manner in which
buyers and sellers can be
in many different locations. One example of
this
is the rental real estate market where each
home is a little bit different and is
located in different areas. If you want
to visit rental properties you have to
travel around a bit,
especially if you are not sure which
part the country you wish to live in.
eBay is another example of an
extremely
decentralized virtual market in which
buyers and sellers can be located in
any country (as long as they have internet
access).
What makes a market perfectly
competitive, though,
are four basic conditions. Those
conditions are:
- that the product is standardized,
- that buyers and sellers have full
information,
- that there are no transaction costs
associated with participation in the
market,
and that all buyers and sellers are
effectively
price takers - that no buyer seller can
affect the market price.
Let's talk about each of these
conditions in a bit more detail.
When we say that a product is
standardized, what we mean is that
buyers of the good don't care who they
buy it from.
For example, if you buy agricultural
products, such as a given type of corn,
you don't really care or generally know
which farmer produced the corn
as long as it's a type that you want to
buy and its equally fresh, or at least
as fresh as other goods that are being
sold. So you don't really care about the
brand-name associated with it. In fact there
often is no
brand-name if you look too many in the
aisles from the grocery store, especially for fresh
fruits and vegetables
you generally don't see the names of the
farmers that actually produce these goods
Things like rebar,
2x4's and quarter-inch
exterior plywood
are standardized products in which
everyone producing them essentially
produces the same commodity.
Buyers and sellers don't care who
they buy them from as long as they meet
industry standards. That would be another
example me standardized product. Stocks
and other financial instruments are also
standardized.
If you buy a share of AT&T stock or
any other stock
one share of common stock is
equivalent to any other
share of common stock. From the
holders' standpoint it doesn't matter
which particular shares they hold.
Now there are some markets, though.
were goods, in fact most markets, in
which goods are differentiated.
Once again, the rental real estate market
is one where the product is
differentiated. There's a big difference
between living in a
trailer
and living in a mansion. For example, the
market for cars is also one
which is not standardized. Each model of car,
and there are many different
variations within each model, has
different features and characteristics.
There's a big difference between driving
a sports car
and driving a minivan. There is also quite a
bit of variation in the market for
cooked meals. Each restaurant
or food provider provides a very
different service. Here's an example of
I've
dozens of providers of food at the New
York State Fair.
The next condition
of a perfectly competitive market is
that buyers and sellers have
full information. Specifically this means
full information about the
characteristics of the product
and information about the prices that
are available elsewhere.
Full information doesn't always hold
about either of these.
Let's look at some examples. In the
1950's one toy that was being
sold was
something called a uranium detector kit
in which parents would buy
kits containing samples of
uranium ore and geiger counters
and parents or other children would
hide radioactive materials in the home
and then
the lucky child would go out and find
them using this Geiger counter.
Parents who bought this were probably
not fully aware of the risk.
Nor, for that matter, was the
company selling it
was probably not fully aware of the risk
associated with
uranium and with radiation. Somewhere
around the same time,
shoe stores sometimes had x-ray machines
where you would try on a pair of shoes,
slip them into those little notches in
the bottom,
and then an x-ray would be taken of your
foot. These machines generated a fairly
large amount of radiation and putting
the
potential shoe buyers at risk but also
putting
the she sellers at even greater risk.
Another way in which we don't have
for information is over alternative
prices.
Still another area in which we don't have
perfect information is
in the market for health care. If you go to a
surgeon who recommends that you have a
particular type of surgery, or a particular
medical procedure,
if you trust that physician or that
surgeon you're probably not going to
shop around for the lowest bidder on that.
One side affect of this is that we see a
lot of price dispersion.
This chart here depicts the dispersion
between the lowest and the highest
prices last year
in the greater San Francisco Bay
Area
and we see there's a fairly large
difference between the low price and high
price procedures where the
high-priced ones are sometimes ten times
as much as
the lower price procedures. There are
some markets where we come close to
having perfect information.
Agricultural markets are probably one of
the better examples
where buyers and sellers know the
current prices.
Similarly in stock markets price
information is transmitted
almost immediately to anyone
participating in the market.
The next condition is that there be no
cost to engaging in transactions. In the
market this means that there's no cost
to participating in the market for
either
buyers or sellers of the good. Let's
consider just a few simple example of
this.
if you open a roadside honey stand,
the cost of this is basically the cost of
this cart
and the jars and the cooler
are perhaps a little cash
jar for people to put the money in. It's
not quite no transaction costs, but the
costs are relatively low.
Similarly, in less-developed countries
there are often bazaars where it doesn't
really cost very much to set up a
stand in
the community commons. Similarly, if you
want to become
are a subway busker, such as Heidi Kole
depicted here
(by the way , she has a very interesting book
called The Subway Diaries) than
the main cost would be the cost of your
guitar and equipment.
So, in some markets, we don't ever have
any market with no transaction cost
but there's some others where the cost
of entry is so low as to effectively not
serve as a barrier
On the other hand there are some
significant transaction costs and
in many markets, for example, if you want
to build a nuclear power plant you're
going to be spending several hundreds of
millions of dollars
Such as the cost spent constructing the
Nine Mile One
nuclear power plant in Oswego or
similarly if you want to shop at Sam's
Club
or BJ's or Costco you have to pay an
annual membership fee,
which does serve as a cost of engaging
in these transactions.
In other cases there is an explicit charge
for entering the market as a seller.
For example, if you want to operate a
taxi cab in New York City
you have to have a taxi medallion, and
you can't legally operate a taxi cab in
New York without
a medallion. The current cost of these
medallions is approximately
a million dollars. So the cost of entry is
is non-trivial
The last condition is that buyers and
sellers
are effectively price takers. What this
means in practice
is each buyer and seller has to be so
small relative to the market
that they're not able to affect the
market price.
One example is in the market for
agricultural products again
where if you're a farmer growing cotton
it doesn't matter whether you sell five
bushels of cotton
or five thousand bushels cotton. That's such
a small share of the overall market for
cotton that it's not going to affect the market
price.
Similarly, in most financial markets there are a
few buyers or sellers that are large enough
to affect the price on the stock.
In the market for Facebook stock other
than Mark Zuckerberg
there's probably not going to be many
people whose sales would be large enough
to significantly influence
the price for the stock. So we've
noted though that there really aren't many
markets that meet all the conditions. In
fact. agricultural markets
and some financial markets are the only
ones that come pretty close.
So, the question then is why are we
spending our time
analyzing a market structure that
doesn't seem to really fit
any real world markets perfectly well.
Well there's a few reasons for that. One
is that
even though we don't have many perfectly
competitive markets, there are some
markets where the predictions of the
model of perfect competition
allows us to explain pricing behavior
fairly well,
so that we can understand using the tools
of perfect competition
why prices will rise or fall or why the
quantity produced and sold will rise or
fall.
Another reason is that perfect
competition is a somewhat
easier to understand than other markets
because we don't have to worry about the
actions of rival firms. Each individual
firms is making decisions independently and
that makes it
easier to analyze. Similarly, each individual
buyer is making decisions independently
which makes it easier to analyze the
behavior of buyers. Furthermore, there's
going to be certain
efficiency properties that will be seen very
shortly about perfect competition
and they'll serve as a benchmark against
which
other market structures can be compared