<PERFECT COMPETITION>

--THINK AHEAD/"DO-NOW!"--

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"Now, briefly explain your reasoning for your choices..."

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"Let's get a bit more specific about the defining characteristics of each of these markets..."

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"Now if I told you that a market in which firms have no market power is called 'perfectly competitive,' which of the markets mentioned above would come the closest?"

--DEFINITION--

'PERFECT COMPETITION' as the name suggests, refers to a MARKET STRUCTURE, in which an individual firm has 'NO PRICE SETTING ABILITY' at all. For this statement to be true, the following assumptions need to be made. You can use your own mind to decide how realistic each of these assumptions are.

--ASSUMPTIONS--

"To understand this type of market in action, let's apply the assumptions of the model to the 'ride-hailing market' and see how this impacts the market power of an individual driver."

--LARGE NUMBER OF FIRMS--

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"Can you think why having a large number of buyers and sellers reduces market power?"

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"Not sure?" "Think about what a seller in a market with only a few large suppliers, like OPEC in the market for crude oil (currently supplying 40% of the world's crude oil production), can do to the market price."

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"That's right! If a firm's output is a significant portion of the total market supply (like OPEC in the market for petroleum), then by reducing or increasing supply, they can in fact impact the market price; hence, they would have market power. HOWEVER, in this model, they are so INSIGNIFICANT IN SIZE that their supply decisions have no noticeable impact on market supply; hence, they have no market power.

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--TASK--

Now you are going to apply this to the ride-hailing driver scenario mentioned earlier and 'Explain to what extent a ride-hailing driver works in a perfectly competitive market.'

"A ride-hailing driver operates in a (relatively) perfectly competitive market and thus has no market power, firstly because the ride-hailing market is made up of a huge number of buyers and sellers, in the form of the numerous people who want a taxi at all times of the day and the vast number of drivers who are offering their vehicles for hire on the apps. This fact means that a single driver only has a tiny market share and therefore cannot reduce their services and influence market supply and alter price."

--PRODUCTS ARE IDENTICAL--

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"Can you think why all firms producing identical products ('homogenous goods') reduces market power?"

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"Not sure?" "Think about how Starbucks is able to charge a higher price for coffee compared to McCafe."

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"That's right! As in the case of Nike, they are able to DIFFERENTIATE themselves from their rivals, by offering slightly different styles and varieties and therefore produce HETEROGENOUS products, which gives them a UNIQUENESS that allows for some loyalty and market power; whereas, if the goods are identical, then any attempt to raise the price will result in all demand disappearing to an identical and cheaper rival; hence, they have no market power.

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--TASK--

Now continue to apply this to the ride-hailing driver scenario...

"...furthermore the fact that all cars are identical means..."

--NO ENTRY & EXIT BARRIERS--

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"Can you think why having 'very low barriers to entry and exit' reduces market power?"

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"Not sure?" "Why do you think certain tech and pharmaceutical companies can dictate their prices for many years without anyone challenging them?" "Why is it that when avocados became a popular 'superfood,' they started to be sold at every stall in the wet market?"

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"That's right! In the case of tech firms, they hold intellectual property rights that prevent others from entering and 'competing away' their profits so they can keep prices high; however, in the case of avocados, it would be relatively easy and cheap for rival stalls, or even new entrants, to also start selling avocados, which would eventually 'compete away' the extra profits, and the price would fall back to a more competitive level; hence, they have no market power.

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--TASK--

Now continue to apply this to the ride-hailing driver scenario...

HINT: "Think about what actually happens when there is 'surge pricing.' How do other drivers react?"

"...in addition, the fact that the barriers to entry into the hail-riding market are so low as you only need....means.."

--PERFECT RESOURCE MOBILITY--

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"Can you think why having 'perfect factor mobility' reduces market power?"

HINT: "It's related to the last assumption."

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"Not sure?" "Think about the reason why a viral toy or gadget like Labubu dolls can be replicated so easily and sold on TAOBAO or why bubble tea shops keep popping up everywhere."

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"That's right! Makers of most manufactured goods use machines and labour resources that can easily switch from unpopular products to more popular ones at the 'flip of a switch'; similarly, it's not that difficult for an entrepreneur to obtain bubble tea-making machines, ingredients, and staff; hence, any profits will again be competed away in the future, meaning they have no market power.

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--TASK--

Now continue to apply this to the ride-hailing driver scenario...

HINT: "Think about what actually happens when the growing incomes of these drivers start to get common knowledge ?"

"...furthermore not only are the barriers of entry low, there are many owners of...."

--PERFECT INFORMATION--

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"Can you think why having 'perfect information' reduces market power?"

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"Not sure?" "Think about why you always buy an iPhone, rather than a Samsung Galaxy." "Is it because you know exactly what you are getting in terms of specs and quality of build and internal parts?" "Do you really know the quality and value for money of ALL competing products out there, in order to make a rational choice to pay?"

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"That's right! Many producers use advertising and consumers' 'bounded rationality' to baffle them with ads and framing bias to manipulate perceptions of quality and charge a premium price. However, if consumers knew everything about all products quality and pricing, then it would be impossible to 'hoodwink' them, as such, they would have no market power.

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--TASK--

Now continue to apply this to the ride-hailing driver scenario...

HINT: "Think about what would happen if a driver announced that he was the safest driver in HK and charged a higher price on the app. Would anyone pay more?"

"...Finally, the fact that thir services are all via the app, all customers can immediately...."

--THINK AHEAD--

"So with 'low barriers to enter and exit,' 'high factor mobility,' and 'perfect information,' what do you think would happen within a shortish space of time if all of a sudden the average price of taxi rides rose or fell significantly?"

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"That's right, you would expect higher prices to quickly attract more drivers and grow the size of the market and lower prices to quickly lower the size of the market. Let's see if we can model this short-run to long-run scenario."

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--SR PROFIT DIAGRAMS--

--A PC firm's AR and MR curves--

"Before we start it's important to understand the following: As individual firms have no market power, they must accept the price determined in the market; hence, they are referred to as 'PRICE TAKERS.'"

Scenario 1: "ECONOMIC. PROFIT in the SR."

"OK let's imagine there is an increase in demand for rideshare services due to a surge in tourism. As demand shifts rightward, the market price rises. In the short run, the number of drivers is fixed because entry is constrained by factors such as the time required to obtain licenses, pass tests, or give notice to existing platforms. These barriers prevent new drivers from entering the industry immediately. As a result, existing drivers will (in accordance with the law of supply) try to increase their hours as they can earn abnormal (economic) profits and greater incomes."

Scenario 2: "LOSSES in the SR"

"Now, imagine there is a sudden decrease in demand for rideshare services due to a sharp decline in tourism. As demand shifts leftward, the market price falls. In the short run, the number of drivers is fixed because exit is constrained by factors such as existing vehicle leases, insurance contracts, etc. These barriers prevent drivers from leaving the industry immediately. As a result, existing drivers reduce their hours slightly and incur abnormal (economic) losses."

--LR PROFIT DIAGRAMS--

Scenario 1: "SR 'ab. profit' => LR 'Normal profit'."

"...However, in the long run, these higher potential earnings attract new drivers who see the chance to earn above their opportunity costs, so they mobilize and reallocate their cars and labor into the market due to the very low barriers to entry. This influx of new drivers at the higher price increases the overall supply of rides, which drives down the price per trip, and as a result, the abnormal profits are gradually competed away until the market settles back at the original price where each driver earns only normal profits."

Scenario 1: "SR 'losses' => LR 'Normal profit'."

"...However, in the long run, drivers are able to better mobilize and reallocate their cars and labor out of the market due to the very low barriers to entry. This exit of drivers decreases the overall supply of rides, which drives up the price per trip, and as a result, the losses gradually disappear until the market settles back at the original price where each driver earns only normal profits."

--A PC firm in LONG-RUN EQUILIBRIUM--

⚠️"So far the ride-hail market looks pretty close to perfectly competitive. HOWEVER, for it to be truly considered 'PERFECT,' we need to add a rather UNREALISTIC assumption about each driver, and that is they have 'IDENTICAL OPPORTUNITY COSTS'

--EFFICIENCY DIAGRAMS--

--ALLOCATIVE EFFICIENCY--

"Previousy we defined (allocative) efficiency as 'the level of output at which total social surplus (cs + ps) is maximised' in other words when production takes place at the socially optimal level where supply (mc) = demand (ar)."

--EFFICIENCY IN THE SR--

"What do you notice about the efficiency levels of a profit maximising or loss-minimising PC firm?"

"...what about in the long run?"

"...so what can we conclude about efficiency in PC?"

--THINK AHEAD--

"You are often asked to compare and contrast market structures, and it is often the case that perfect competition is considered the most desirable. Besides some of the unrealistic asumptions can you think of any negatives?"

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--EVALUATION--

--'THE GOOD----

ALWAYS ALLOCATIVLY EFFICIENT as the profit max quantity is always where MC=AR, hence maximising social surplus w/o DWL.
LOW PRICES FOR CONSUMERS in the LR, once abnormal profits are competed away, the price falls.
NO INEFFICIENT FIRMS as all high cost producers are forced to leave the market.
Responds to consumer tastes in LR.

--THE BAD--

UNREALISTIC ASSUMPTIONS, in the first place.
FIRMS ARE TOO SMALL TO TAKE ADVANTAGE OF ECONOMIES OF SCALE, which means they are unable to lower their average costs, which in turn leaves less chance of a price reduction for consumers.
LACK OF PRODUCT VARIETY, as all goods are homogenous.
UNABLE TO ENGAGE IN R&D to make new products as they are unable to make any abnormal profits.

--ASSESSMENT--

WWW.EDULASTIC.COM

--THINK AHEAD/"DO-NOW!"--

To understand what makes a market 'perfectly competitive,' it is much easier to first identify those characteristics of an 'imperfectly competitive' market and compare; so let's look at the market power ('price-setting ability') of international schools in Hong Kong!"

Ask yourself:

"Are there loads and loads of similar schools available?"

"Are each school exactly the same (e.g., location, facilities, programs, etc.)?"

"Is it really easy to enter and set up a school?"

"Are school buildings and qualified teachers readily available?"

"Can parents accurately judge the?"

"Ask yourself this about your school: Do they operate in a market of hundreds of small schools that produce exactly the same product, such as qualifications, facilities, and location, that consumers all know are identical in quality, that can't get any competitive advantage over their rivals; that produce exactly the amount of units that maximize your profits, which is just enough to stop them from leaving and doing your second highest-paying job, and you can sell out at the market price every day."

"Do you have any market power?"

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"No! If they raise their price, they will lose all their customers to a rival, and lowering their price would be irrational, as they can sell out at the market price."

--TASK--

Summarise

"Now, explain your reasoning for your choices in terms of...."

"Are there loads and loads of similar schools available?"

"Are each school exactly the same (e.g., location, facilities, programs, etc.)?"

"Are there many barriers to entering and setting up a new school?"

"Are school buildings and qualified teachers readily available?"

"Can parents accurately judge the?"

--TO SHUTDOWN OR NOT?--

We have just seen that firms can be making losses in the SR and in many cases, they have fixed costs that must be repaid regardless of whether they shut down now or remain open until they can exit the market after paying off these obligations in the LR.
So do they simply shut down? Have you ever seen a shop that is usually empty remain open? Why do you think this is? Surely they are losing money right?

--THINK AHEAD--

"So clearly in the short run during instances of 'surge pricing' (due to a rise in demand), currently ride-hail drivers (e.g., Uber drivers) can earn abnormal profits, but what eventually happens to these extra profits?"

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"That's right! All the other drivers who were not willing to provide their services at the lower prices see the higher rewards on offer on the app (perfect info) and then quickly 'mobilise' their factors and offer their services (low barriers to entry), increasing supply, and eventually 'competing away' the higher surge pricing, resulting in a fall in price."

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--ALLOCATIVE--

ALLOCATIVE EFFICIENCY occurs when firms produce the particular combination of goods and services that consumers mostly prefer. This is also known as the 'SOCIALLY OPTIMAL' level where supply (MC) = demand (AR)

--PRODUCTIVE--

PRODUCTIVE EFFICIENCY occurs when production takes place at the LOWEST POSSIBLE AVERAGE COST (ATC). This occurs where the ATC = MC.

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