Perfectly Competitive And Monopolistically Competitive Markets: A Comparative Analysis

Features of Comparison

There exist different types of market structures in the economic scenarios across the world in real case scenarios. Depending upon the number of buyers and sellers, the demand supply dynamics, the market power in the hands of the buyers and the sellers and the nature of the goods or services sold in the market (Kolmar, 2017). Of the different economic concepts of markets, the two prominent and popular concepts of markets are the perfectly competitive market and the monopolistically competitive market.

Features of the Perfectly Competitive Firms and the Monopolistically Competitive Firms differ significantly in several aspects, which are discussed in the following sections:

Number of sellers in the market- In both perfectly competitive market as well as monopolistically competitive market, there are many sellers or supply side producers.

Types of product in the market- The perfectly competitive firms sell perfectly homogeneous commodities which implies that their commodities do not differ in any aspect like nature, smell, taste and others. However, the products sold by the monopolistically competitive firms are differentiated, at least by the brand names (Azevedo & Gottlieb, 2017).

Price Deciding Power- The perfectly productive firms do not have any price deciding power and are mainly price takers. However, the monopolistically competitive firms, due to the presence of differentiated products, enjoy certain level of price deciding power in the market (Zhelobodko et al., 2012).

Entry and exit barriers- There are no entry or exit barriers in the perfectly competitive market as the firms are free to enter or exit the market without any cost. However, in case of the monopolistically competitive market there remain very low barriers to entry in the market.

In economic concepts, the term equilibrium in the market is the situation at which the demand side and the supply side of the market come to a mutually agreeable situation after interaction with each other (Chaney & Ossa, 2013). Given the differences present in the perfectly competitive and the monopolistically competitive markets, the conditions at which both the markets reach equilibrium are also different, both in case of short run and long run, which are elaborated in the following sections:

In case of the perfectly competitive markets, the firms are price takers and the demand curve faced by the firms are perfectly elastic due to the presence of homogeneous products in the market. This implies that the demand curve, the average revenue curve as well as the marginal curve are all horizontal at a given market price (Baumol & Blinder, 2015).

Equilibrium For the Perfectly Competitive Firms

In the perfectly competitive firms, the equilibrium occurs at the point where the marginal revenue earned from production of one additional unit of output by the firm is equal to the marginal cost of production of that unit of output incurred by the firm, that is, at the equilibrium point:

MR = MC (Nicholson & Snyder, 2014)

Now, in the perfectly competitive market, as MR is equal to the price existing in the market, therefore,

P = MC

In perfectly competitive market, in the short run equilibrium conditions, the firms can earn supernormal profit, normal profit or can also incur loss, depending upon the position of the average cost curve and the AR curve. Here, as AR is above the AC curve, so the firm earns more revenue than its cost, thereby leading to the creation of super-normal profit for the concerned firm in the short run.

As can be seen from the above diagram, in the short run, the perfectly competitive firms can also earn normal profit (a situation of no profit no loss) if the average cost of production is equivalent to the average revenue earned at the point of equilibrium (P=MC).

Thus, it can be asserted that in the short run equilibrium condition, the perfectly competitive firms can enjoy super normal profit, sub normal profit or only normal profit depending upon the position of the average cost and average revenue curves of the firms (Hall & Lieberman, 2012).

Though in the short run equilibrium, there are scopes for the firms to earn super normal profit or loss, however, in the long run the firms only earn normal profit. This is because of the presence of free entry and exit in the perfectly competitive market. In short run, if there is presence of super-normal profit, then more firms enter in the market, thereby increasing the supply and decreasing the price till the normal profit situation is reached. Similarly, if there is loss, then firms start exiting, thereby decreasing the supply, increasing the price and increasing profit level till the normal profit is reached (Rios, McConnell & Brue, 2013). 

Thus, from the above diagram it can be asserted that though there may be presence of super-normal profit, sub-normal profit or just normal profit in the short run equilibrium in the perfectly competitive marker, in the long run the firms in this market earns only normal profit.

As the products in the monopolistically competitive firms are differentiated, therefore each of the firms faces a downward sloping demand schedule. The equilibrium for a monopolistically competitive firm occurs at the point where the MR curve and the MC curve intersects each  other, that is where the cost of production of one additional unit is equal to the revenue earned from that additional unit (Rader, 2014).

Long Run Equilibrium

In the short run condition, the monopolistically competitive firms in general, enjoy super normal profit, as the cost of production is less than the revenue earned by the firms

As can be seen from the above diagram that in the short run equilibrium situation, the monopolistically competitive firms enjoy super normal profit. However, this attracts more firms in the market due to the presence of almost no entry barriers. This increases the supply in the market in the long run and the equilibrium changes in the following manner.

Due to the presence of super normal profit and excess capacity in the short run, along with the privilege of low barriers, more sellers enter in the market. The demand also adjusts so as to create normal profit in the long run.

In the long run, the monopolistically competitive firms earn normal profit only with the price getting equal to the average cost of production (Bauer, 2014). 

Productive Efficiency- This type of efficiency is concerned with the optimal method of producing goods and services at the lowest cost in a market.

Allocative Efficiency- This type of efficiency in a market deals with the optimal method of allocation or distribution of goods in the market.

A perfectly competitive firm experiences productive efficiency in the long run as it produces at the point where the price is equal to the marginal cost of production, where the AC is minimum. However, this is not the case with monopolistically competitive firms as they keep price higher than their marginal cost of production (Holmes, Hsu & Lee, 2014).

The perfectly competitive firms, both in short run as well as in long run experiences allocative efficiency as the marginal cost and price are equal, which in its turn maximizes the consumer surplus as well as the producer surplus. However, the monopolistically competitive firms always tend to produce less than the optimum capacity, which implies that allocative efficiency is not present in this kind of market. 

There are different structures of market prevailing in the real economic scenario of the world. One of the most prominent forms of such market types is the oligopoly market. The features of such oligopolistic market are discussed in the following sections:

The oligopolistic markets are characterized by many buyers and the presence of few sellers (Usually not more than 20).

The sellers being few in numbers, each of the sellers enjoy a considerable share of the market. Therefore, each of them have considerable market power, are price makers, and not price takers.

Equilibrium in Monopolistically Competitive Firms

The commodities though of same type are generally differentiated by some attributes, at least the brand names (Fudenberg & Tirole, 2013).

There is presence of the aspect of brand loyalty in the market, which gives rise to the aspect of comparative advantages among the sellers in an oligopolistic market structure.

The competition among the different supply side players in the market may be related to price wars or may also be of non-price types.

The decisions and strategies of one player as well as the profits of one player in this market is influenced by the activities of his fellow suppliers in the market. This indicates towards the presence of mutual interdependence among the supply side players in this type of market (Okuguchi, 2013).

There are considerable barriers to entry or exit present in the oligopolistic market.

Collusion or cartel formation is one of the significant attributes of this type of market as the firms often undertake such activities to avoid price wars, which may have adverse implications on all the firms. Cartel formation, on the other hand, often increases the profitability of the oligopolistic firms (Okuguchi & Szidarovszky, 2012).

As can be seen from the above discussion, the oligopolistic market structure has its unique features. This type of market is not hypothetical like that of the perfectly competitive market structures and the former has extensive presence in the real economic scenarios in the global framework. Oligopolistic market structure is extremely dominant in the highly developed and leading economies across the globe, including that of Australia (Tyers, 2014). Being one of the predominant economies in the world Australia has, over the years, developed to be one of the leading economic and industrial giants and has shown impressive growth trends in many of its industry, which includes the banking industry as well.

The banking industry in Australia, has developed significantly over the years and is currently one of the most robust and sustainable industries in the country as well as an example of success to be inspired from, in the global economic framework. The industry, however, shows the characteristics of an oligopolistic market structure. The banking industry in Australia, though have many supply side players, is primarily dominated by four big players, namely, the Commonwealth Bank, the Westpac Banking Corporation, the Australia and New Zealand Banking Group and the National Bank of Australia (Shamsuddin & Xiang, 2012).

The presence of all other banks are shadowed by the huge domain of operations of these big four banks, which together enjoy huge market share in the country and also have significant activities outside the domestic boundaries of the country (Demirgüç-Kunt & Huizinga, 2013). To be specific, the big four banking giants in the economy of Australia together control more than four fifth of the total banking industry in the market.

Short Run Equilibrium

The four big players in the banking industry have significantly higher domain of operations and enjoy a bigger asset valuation compared to any other bank in the economy of the country. Together they make the oligopolistic character of the banking industry of Australia more prominent (Brämer & Gischer, 2012). The presence of these banks even poses as huge competitive threats to the other banks as well as to the potential entrants in this industry, thereby creating hurdles or entry barriers in the banking industry in the country.

The presence of big four baking enterprises in the economy of Australia, apart from the creation of entry barriers in the market also shows some other prominent characteristics of an oligopolistic market structure in terms of the economic concepts. Due to the presence of huge number of players in the demand side, which not only includes the population of the country but also includes clientele in the international markets, each of these four banks enjoy significantly huge share of the market in this industry. The presence of brand loyalty is also one of the significant factors in the banking industry in the concerned country. The word of mouth and goodwill aspects, in general heavily influence the banking industry. The four big banks also have earned significant goodwill over the years, which have contributed significantly to their long term sustainability and privilege of enjoying huge shares of clientele. This, on its turn, shows the presence of another important attributes of the oligopolistic market structure in the banking industry of the concerned country.

Another important aspect of oligopoly is the interdependence of the rival firms in the market. In an oligopolistic market structure, the activities and decisions of one firm does not only influence the profits and prospects of the firm only but also the profits of the rival firms as well (Dalton et al., 2014). This trait is also visible in the banking industry of the concerned industry as the big four banks and their activities have huge implications on each other. Due to the presence of market power and price decisive capabilities, the firms in the oligopolistic market have the capabilities of earning super-normal profits, even in the long run. The oligopolistic markets, in general, also have kinked demand curve 

These traits are also present in the banking sector of the country as these four banks work towards maximizing their own profits, even at the cost of sacrificing the welfare of the citizens of the country, which in turn has given rise to dissatisfaction among the clientele.

Long Run Equilibrium

From the above discussion, it can be asserted that the banking industry in one of the biggest economies in the global framework, the Australian economy, is primarily of oligopolistic in nature, in spite of presence of many small players. The big four banks majorly dominates the industry, with lion’s share of the market under their control. 

Of the leading economies in the global framework, one of the most significant one is the economy of Australia. Australia has shown significant development in an overall level over the years with the economy prospering hugely in different aspects. This increasing prosperity of the country can be highly attributed to the increase in the industrial and commercial aspects of the same, which has helped the country to become one of the centers of attraction for global population (Plumb, Kent & Bishop, 2013).

This immense economic scopes of prosperity has also led to increase in the population of the country, especially in the commercially and economically active urban zones like Sydney or Melbourne or others. However, this has also led to an issue of concern, which has increased with time. This is the concerning problem of affordability of housing in the country, which is elaborated in the following sections:

In the last few decades, the housing market in the country has seen immense dynamics, with the demand continuously increasing in the same. Much of this increased demand has been due to the increase in the pressure of population, which has been a byproduct of the economic success of the country. This has in its turn led to the creation of affordability issues in the housing sector of the country.

Empirical evidences suggest that over the years, there has been a considerable increase in the share of population who have been spending more than 30% of their total gross income on accommodation in the country. The lower middle class and the lower income sector has been the worst hit as affording housings, especially in the urban areas of the country has been becoming almost impossible for them. 

The primary demand side factors influencing the initiation of the concerning problem of housing affordability are as follows:

Increasing demand for housing- With the increase in the economic and commercial prospects of the country, the pressure of excessive demand for housing is felt, especially in the urban zones of the country.

Easy credit availability- To increase their commercial prospects the banks in the country, over the years, have facilitated easy availability of credits which in turn have fueled investment in the housing sector.

Productive and Allocative Efficiencies

Investment demand- Housing being one of the form of asset building, has been immensely in demand among the investors in the country. With the speculation that the prices of these housing would not fall, residential investment has increased considerably (Gurran & Phibbs, 2013).

Foreign ownership- The economy of the country prospering hugely, immigration has increased considerably in Australia, which in turn has led to increase in the demand for housing as well as ownership of housing by the immigrants coming from other countries.

With the problem of affordability becoming a national issue, addressing the issue has become one of the most crucial responsibilities for the Australian government. The problem can be solved only by measures, which can help in reducing the prices of the dwellings. These measures primary include supply side tools.

The government has already imposed capping on the credits which the investors can avail for investing in the housing sector. Other measures which can be taken and has been taken to some extent are the strategies to increase the number of budget housings across the countries, such that the lower middle class finds it within their capability to afford housings in their area of interest and are not compelled to move to the suburbs (Jacobs, 2015). 

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