Thursday, May 19, 2011

Econ for statists 6: Perfect competition

From my earlier discussion, Why inequality is good, part 3, I explained why a "perfectly competitive" market can happen although it is very rare. I wrote there,
In most cases, perfect competition does not exist, but in a few cases, it does. For perfect competition to occur, ALL these five factors should be present at the same time: (a) homogeneous product, (b) many sellers of a particular product, (c) many buyers of that product, (d) perfect information, and (e) free entry and exit of firms.

Take tomatoes. The small, rounded, red cherry tomatoes are different from small, not rounded (maybe flattened, oblong, etc.) tomatoes, are different from medium-size rounded tomatoes, are different from medium-size, not rounded green tomatoes, are different from large-size rounded tomatoes, are different from large, seedless tomatoes, are different from large, few seeds tomatoes, and so on.

Here, there are heterogeneous products among tomatoes alone. If we talk of perfect competition, then comparison should only be on homogenous, similar or same product in terms of quality and characteristics. Once you introduce a different product, say a different type of tomato, then one factor of perfect competition – the homogenous product criteria – is immediately violated.

 Thus, the real world is characterized more by monopolistic competition, not perfect competition, because it is very easy to create a mini-monopoly in each sector and sub-sector. The different qualities and characteristics of tomatoes mentioned above would constitute a mini-monopoly in the production and trading of tomatoes. 

 A few products would qualify under perfect competition, somehow, like petroleum products. Whether the gasoline is sold by a Shell gas station or Chevron or Total or Petron or PTT or any other gas stations, we assume that it is of same quality. A really homogenous product. There are many gas station sellers, there are many motorists, and the prices by different gas stations are generally the same, there is perfect information. Free entry and exit, however, can be affected by government regulations and politics. Not all gas stations that want to enter a certain city may be granted business permit if the Mayor or an influential Councilor there owns one or more gas stations already, as this will adversely affect their business.

This graph will further illustrate a "perfectly competitive" market.

The graph on the left represents the market, the one on the right represents a single or representative firm. A perfectly competitive market, zero product or service differentiation that will introduce a "slightly different" product to the consumers, would have just one price. Any firm who will sell at a higher price will not be able to sell anything, all other things being equal.

A firm's location can affect this situation and will in effect, introduce service differentiation. All firms sell at P105 per kilo (tilapia, milkfish, chicken feet, etc.) but they are at least 100 meters away from a big residential condominium or village. One firm will sell at P106 (or higher) per kilo but it is just in the ground floor (or across the street) of the condo, so this "more expensive" firm will still be able to sell at a price higher than the prevailing market price.

The lesson for statists and price interventionists here, is that if most or all firms that supply a particular product in a given area or community have the same or almost-the-same price, it does not automatically mean "price collusion" or cartelization among them. Rather, it can be due to the existence of a perfect (or near-perfect) competition market for that particular product. Thus, government intervention and additional regulations in this case are totally unnecessary.

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