Introduction
Market structure refers to the features of a market that define the nature and performance of the consumers and firms in the market. The major features that specify a market are the number of buyers and sellers, the objectives of the firms in the short run and long run, the entry and exit barriers, the nature of a product and the relationship between the firms in the market. The main market structures are perfect competition, monopoly, monopolistic and oligopoly.
Perfect Competition
This is a market structure characterised by; a large number of sellers and buyers, the firms produce a homogenous product, entry and exit to the market is unrestricted, there is perfect information ...view middle of the document...
An increase in price by any producer results to a shift of consumers to other firms who sell it at the market price. A litre of milk costs on average $1.5 and any seller who sells higher will record little or no sells until the price comes down.
The Effect of Entry and Exit on Profitability of Firms in the Long-Run
We assume that all firms have access to technology and input market of factors of production. Entry into the market relies on the profitability of firms already existing in the market. If firms in market are making profits, other firms will have incentive to enter. This will increase the number of firms in the market, quantity of goods produced will increase and so will the quantity supplied. The prices in the market will reduce leading to a decline in profits. If firms are making losses, some firms will exit the market, the quantity produced will fall, this will cause a rise prices and profits. At the end of the entry and exit process firms remaining in the market will be making zero economic profits i.e. the price of the good matches the average total cost of production.
The Effect of Price Elasticity of Demand on Price Determination
Price elasticity of demand is the change of the quantity demanded brought about by changes in the price of that good. Under perfect competition, the market has a downward sloping demand curve. The single firm has a horizontal demand curve that is perfectly elastic. The price elasticity of demand for the single firm is perfectly elastic. If the firm increases it price beyond the market price, it will lose all its customers to its competitors. The firm will make zero sales hence total revenue will be zero. The firm will not sell below market price, as this will have zero effect on the market. Since the firm can sell all its output at the market price, it takes the price determined by market i.e. price determined by interaction of forces of demand and supply.
Role of Government in Determination of Prices
Perfectly competitive market lack barriers of entry and exit; therefore, there is no government intervention in the market. Thus, the government has no role to play in the market, as it does not control the forces of demand and supply in the market. The government ensures that there is favourable environment for business to prosper.
Effect of International Trade
Trade opens entry of goods from foreign countries into an existing perfect competitive market. The market is open to entry for any firm, if existing firms are making profits, foreign firms will be attracted. Investment of foreign...
