Perfect Competition and Market Failure

Perfect competition or perfect market exists when all competitors are too small to influence prices, buyers and sellers are motivated by the need to maximize their profit (income), no barriers to competitors entering or exiting the market exist, and information regarding availability, prices, and quality of goods is shared equally among all buyers and sellers. (perfect competition, n.d.). Perfect competition is rarely seen because of the multiple ways that markets can fail.

Perfect Competition and Market Failure

Perfect competition or perfect market exists when all competitors are too small to influence prices, buyers and sellers are motivated by the need to maximize their profit (income), no barriers to competitors entering or exiting the market exist, and information regarding availability, prices, and quality of goods is shared equally among all buyers and sellers. (perfect competition, n.d.). Perfect competition is rarely seen because of the multiple ways that markets can fail.

Perfect competition requires that all competitors be small enough to exert no individual market power. Market power is "an ability of a firm to adjust or control the market price or volume of production of a product(s) in the market" ("Market Power: Monopoly and Oligopoly", n.d.). Wal-Mart is the classic example of a firm using market power. Wal-Mart owes its success to market power. Sam Walton's success began by purchasing items in large quantities from low cost producers (Sam Walton, n.d.). Purchasing low cost products and large quantities allowed Walton to sell this product - at a low price - longer than his competitors.

Effects of market power can be seen in our current economic downturn. Fear of future money issues has caused consumers to decrease their spending, however, Wal-Mart is able to use market power to weather the storm. Wal-Mart is able to leverage their buying power to undercut competitors and attract consumers seeking to save money. Bustillo and Zimmerman describe Wal-Marts success in this down market:

"On Thursday, after a week of bad news from retailers such as Best Buy Co. and Starbucks Corp., Wal-Mart said earnings for the third quarter rose 9.8% while sales rose 7.5%. At stores open at least a year, sales rose 3%, twice as much as a year before, and far better than nearly every other U.S. retailer" (2008).

Perfect competition requires that both buyers and sellers be motivated to maximize their income. Income is defined as "the surplus remaining after total costs are deducted from total revenue" (profit, n.d.). Arguably, this is the main mission of most businesses, however, non-profit businesses have a completely different mission. Non-profits exist for the betterment of the community; however, betterment of the community is not just for non-profit businesses. Community betterment also affects for profit companies. For example, a factory makes plastic bottles. Hazardous waste is a by-product of the manufacturing process. Factory management must consider the externalities of their waste such as impact on the soil, death of fish in the nearby stream, and poor public opinion that may result. Maximizing profit is their main mission but bettering the community by controlling their waste adds to this mission.

Community betterment also allows companies to create positive public relations. Positive public relations, creates word of mouth advertising, increased customer base, and aid in overcoming cultural barriers. Wal-mart uses community betterment to aid its businesses worldwide. Wal-Mart.com describes one community project "Wal-Mart China contributes to important environmental projects, such as financing the installation of solar panels for 322 households in the Panjiabang Village in Jiaxing Zhejiang Province" (Think about this, n.d.).

Perfect competition requires that no barriers to new competitors entering the market exist. Monopolies create such a barrier. BusinessDictionary.com defines monopoly as a "market situation where one producer (or a group of producers acting in concert) controls supply of a good or service, and where the entry of new producers is prevented or highly restricted" ("monopoly", n.d.). Under a monopoly, size of current competitors gives them increased market power to set prices and production. This increased power can make it very difficult for new companies to enter the market. Let us continue our Wal-Mart example. Wal-Mart has tens of thousands of stores worldwide, supplied by a worldwide wholesale supply chain. Their buying power allows them to undercut potential competitors for weeks, months, or even years. This ability to lower prices and keep them there makes it very difficult for small companies to enter the market.

Perfection competition requires buyers and sellers to have access to all information about information regarding availability, prices, and quality of goods Buyers and sellers use this information to make decisions on products to produce and consume. Companies use this information to decide what products to produce. For example, retailers use buying patterns to decide what products sell better in the spring than in the summer and stock their stores accordingly. Companies can use availability to increase their products value to consumers. Consumers use availability to decide when to buy items and what price to pay. For example, during the Christmas season low supplies of - hard to find - popular toys can result in consumers being willing to pay more for them.

In reality, it is very difficult for perfect competition to exist in the world. Competition, number of competitors, and availability of information makes it more likely for markets to be either oligopoly or monopolies. Investopedia defines oligopoly as "A situation in which a particular market is controlled by a small group of firms" ("Oligopoly", n.d.). Monopoly exists in markets with only a single firm, a group of firms work together, or a firm possesses more than forty five percent of the market ("Market Power: Monopoly and Oligopoly", n.d.).

Perfect competition requires all competitors are too small to influence prices, buyers and sellers are motivated by the need to maximize their profit (income), no barriers to competitors entering or exiting the market exist, and information regarding availability, prices, and quality of goods is shared equally among all buyers and sellers. (perfect competition, n.d.). These requirements make it very difficult for perfect markets to consist in the world.

References

perfect competition. Business Dictionary.com. Retrieved November 30, 2008 from http://www.businessdictionary.com/definition/perfect-competition.html

Market Power: Monopoly and Oligopoly. university-essays.tripod.com. Retrieved November 30, 2008, from http://university-essays.tripod.com/monopoly_oligopoly.html

monopoly. BusinessDictionary.com. Retrieved November 30, 2008, from http://www.businessdictionary.com/definition/monopoly.html

Bustillo, M. and Zimmerman, A. Wal-Mart Flourishes as Economy Turns Sour. Retrieved November 30, 2008 from http://online.wsj.com/article/SB122656558027724083.html

Oligopoly. investopedia.com. Retrieved November 30, 2008, from http://www.investopedia.com/terms/o/oligopoly.asp

Sam Walton. Wikipedia.com. Retrieved November 30, 2008 from http://en.wikipedia.org/wiki/Sam_Walton