Question

1) Describe Perfect Competition

2) List and explain Pricing Strategies within Perfect Competition

Answer 1

Answer 1)

Perfect competition is a market structure in which the following five criteria are met:

1) All firms sell an identical product;

2) All firms are price takers - they cannot control the market price of their product;

3) All firms have a relatively small market share;

4) Buyers have complete information about the product being sold and the prices charged by each firm; and 5) The industry is characterized by freedom of entry and exit. Perfect competition is sometimes referred to as "pure competition"

Answer2)

In a perfect competition market, the pricing strategy is simple—a firm accepts the market price.

At that point the decision is no longer a pricing decision, but rather a production decision.

The firm will maximize its profits at the point where its marginal cost of production equals the marginal revenue. In a perfectly competitive market, the marginal revenue equals the market price.

At that point the firm has to determine whether or not it can meet its operating costs. If the firm cannot meet its variable costs at the market price, it will likely go out of business. If a firm can meet its variable costs, it will remain in operation during the short run, but unless it can find a way to cover its total operating cost it will go out of business. If a firm can meet its operating costs (which includes ordinary profit) it will remain in business indefinitely.

Of course, these are ideals, and a firm’s specific decisions will rest upon a great deal more information, such as market trends, macroeconomic trends, the degree to which it can actually control costs, innovation, changes in tax policy, and so on.

It also depends on whether a firm can find a method of securing a market share. That is where marketing comes in. If a firm can build brand loyalty, the dynamic changes, at least somewhat. Under those circumstances, the firm may escape the perfect competition of the market and may become a price maker instead of a price taker. Usually firms accomplish this by generating some sort of product differentiation—even if that differentiation is trivial.

To be more precise, a firm will produce to the level where marginal cost equals marginal revenue.

In a perfect competition market, that would occur at the market price. If a firm is able to secure brand loyalty either with or without product differentiation, then the firm will continue to produce at the level where marginal revenue equals marginal cost, but that marginal revenue will no longer equal the market price.