Perfect competition and monopoly

The key conditions for the perfect competition are a s follows:

1. There are many buzzers and sellers in the market, each of which is small relative to the market.
2. each firm in the market produces a identical product
3. buyers and sellers have perfect information
4. there are no transaction costs
5. there is free entry into and exit from the market

Taken together, the first four assumptions imply that no single firm can influence the price of the product. The fact that there are many small firms, each selling an identical product, means that customers view the products of all firms in the market as the perfect substitutes. Because there is perfect information, consumers know the quality and price of each firm’s product. There are no transaction costs (such as the cost traveling to a store); if one firm charged a slightly higher price than the other firms, customers would not shop at that firm but instead would purchase from a firm charging a lower price. Thus, in a perfectly competitive market all firms charge the same price for the good, and this price is determined by the interaction of all buyers and sellers in the market.

The assumption of free entry and exit simply implies that additional firms can enter the market if economic profits are being earned, and firms are free to leave the market if they are sustaining losses. This assumption implies that in the long run, firms operating in a perfectly competitive market earn zero economic profits.

One classic example of perfectly competitive market is agriculture. There are many farmers and ranchers, and each is so small relative to the market that he or she has no perceptible impact on the prices of corn, wheat, pork or beef. Agricultural products tend to be homogeneous; there is little difference between corn produced by farmer Jones and corn produced by farmer Smith. The retail mail-order market for computer software and computer memory chips also is close to perfect competition. A quick look at the back of a computer magazine reveals that there are hundreds of mail-order computer product retailers, each selling identical brands of software packages and memory chips and charging the same price for a given product.The reason there is so little price variation is that if one mail-order firm charged a higher price than the competitor, consumers would purchase from another retailer.

Monopoly
A market structure in which a single firm serves an entire market for a good that has no close substitutes.

MONOPOLY POWER
In determining whether a market is characterized by monopoly, it is important to specify the relevant market for the product. For example, utility companies are local monopolies in that only one utility offers service to a given neighborhood. To be sure, there are almost as many utility companies as there are cities in the world, but the utilities do not directly compete against one another for customers. The substitutes for electric services in a given city are poor and, short of moving to a different city, customers must pay the prices for local utility services or go without electricity. It is in this sense that a utility company is a monopoly in the local market for utility services.

When one thinks of a monopoly, one usually envisions a very large firm. This needn’t be the case, however; the relevant consideration is whether there are other firms selling close substitutes for the good in a given market. For example, a gas station located in a small town that is several hundred miles from another gas station is a monopolist in that town. In a large town there typically are many gas stations and the markets for gasoline is not characterized by monopoly.

The fact that a firm is the sole seller of a good in a market clearly gives that firm greater market power than it would have if it competed against other firms for costumers. A monopolist does not have unlimited power, however. In summary, the monopolist is restricted by consumers to choose only those price-quantity combinations along the market demand curve. The monopolist can choose a price or a quantity, but not both. The monopolist can sell higher quantities only by lowering the price. If the price is too high consumers may choose to buy nothing at all.