Question

Markets are separated into two broad categories based on their level of competition. On the one hand there are perfectly competitive markets and on the other hand, there are all other market structures which are grouped under imperfect competition. Markets under imperfect competition are generally described by fewer firms with each firm having some degree of market power depending on the number of firms in the market. Discuss the fundamental differences between perfect competition and imperfect competition (include a discussion of marginal revenue). In addition, discuss how the degree of market power effects the welfare of producers, consumers, and society. 20 Points

Answer 1

Perfect competition is a hypothetical market where there are a large number of buyers and sellers selling homogenous goods. Whereas imperfect has few sellers and buyers selling slightly differentiated or heterogeneous products. In the former, we assume perfect knowledge and no non-price competition like advertising and sales promotion as they sell homogenous goods. Whereas in the latter due to heterogeneous products there is not only imperfect information but also high non-price cost for advertising and sales promotion especially in monopolistic. Perfect has no barriers to entry and exit whereas imperfect has barriers to entry and exit, especially in a monopoly.

Perfect competition is a price maker that has to take price as given in the market whereas imperfect is not a complete price taker as a monopoly is a price maker. Imperfect has relatively low per-unit cost due to economies of scale whereas in perfect the per-unit cost is high as has very few economies of scale. Allocative and productive efficiency can be seen in perfect as the price is equal to marginal cost but imperfect is inefficient in allocation and production as the price is set above marginal cost. The profit maximization rule for the markets is MR=MC but in perfect due to the price taking ability P=MR=MC.

As a perfect competition has no market power and controls it has a horizontal marginal revenue curve that is P=MR=AR=DEMAND.In the imperfect, the marginal revenue is downward sloping as for every additional unit of output it will have to lower its price.

As the perfect competition operates at equilibrium it maximizes the consumer and producer surplus whereas in imperfect the target is always to increase the producer surplus hence price being greater than marginal cost. Therefore when consumer surplus loss is greater than gain in producer surplus it gives rise to deadweight loss to society in the imperfect, especially monopoly.

Perfect competition examples revolve around internet providers, local fish traders whereas for imperfect we have restaurants and pubs for monopolistic and railways for monopoly.