<2.11.2 PERFECT COMPETITION>

The Internet as Perfectly Competitive Market and How that Affects Customer Loyalty

According to Thomas Friedman, “the Internet offers the closest thing to a perfectly competitive market in the world today.” The key word in the previous quote is like because in reality, no market truly has all the traits that a perfectly competitive market requires. It is more useful as a theory than an actually applicable guide for markets. However, it is quite surprising how many traits that the internet market has that are similar to perfectly competitive markets. Below is a video about perfectly competitive markets and the traits they have.

The internet market possesses the key traits of consumer having perfect information, sellers being price takers, and consumers determining the prices of products. Consumers have perfect information about products because they can easily go online and look up a review of the product, as well as different retailers’ prices for the product. According to a study on UK shoppers habits by Forrester Research, “Some 86% of respondents use ratings and reviews for online purchases and 44% go online before buying products in-store.” As Hsin Hsin Chang and Su Wen Chen wrote, “It is difficult to build customer loyalty in e-commerce transaction primarily because of the low switching costs when competition is only a click away.”  This has implications for the market offline as well. For example, this article from TIME chronicles how the invention of Smartphone Apps that compare prices altered Black Friday forever.

Because consumers have perfect information on product prices, sellers must price their products based on what the price their competition is selling it for. If they set it any higher in attempt to make more of a profit, consumers will just go to their competition, knowing from their ICTs that the competition has a lower price. Therefore, consumers that develop a relationship with brands that become customers literally determine the prices of products.

Evidence of how the internet and the ICTs that service it is a nearly perfectly competitive market can also be seen in the increased church rates of ICTs. The churn rate is the turnover rate of customers for a company (how often customers change their brands or carriers when it comes to phones). Churn rates have been increasing as ICT use has become more prevalent. For example, for Korean mobile telecommunication services, the monthly average customer churn rate rose sharply from 1.3% in the late 1990s (1998–1999) to 3.3% in the early 2000s. Churn rates for the Indonesian telecommunications market are very high as well, with around 10 operators jostling in price wars for subscriber share. With an increased turnover, pinning down customer loyalty can get tricky for companies.

Perfect Competition is a theoretical market scenario where no sellers achieve profit above break-even and every seller is a 'price taker'. Some e-commerce markets are so competitive that their sellers are almost in Perfect Competition.

As e-commerce marketplaces continue to improve the efficiency of transactions bringing more efficient supply from more sellers, the marketplace begins to move towards a perfectly competitive scenario.

An understanding of a perfectly competitive market can help you take control of your business's supply strategy, so you're acting strategically, and looking for opportunities that other suppliers cannot execute on.

When you download this whitepaper, you'll learn:

• Why there is no profit in the long-run if the market is 'too' efficient

• The importance of barriers to entry

• Why you don't want to become a 'price taker'

• Why product selection is the key to long-run profits

• The market supply curve consists of a large number of small firms.

• HOW DOES THIS REDUCE MARKET POWER? If a firm's output is a significant portion of the total market supply (e,g OPEC, in the market for petroleum) then by reducing/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.

• The goods produced by each individual firm are identical (homogenous) in every way. It is not possible to distinguish the product of one producer from that of another. 

• HOW DOES THIS REDUCE MARKET POWER? Well as in the case of Adidas, the Hawkers stall etc they were able to DIFFERENTIATE themselves from their rivals, by offering slightly different styles and varieties and therefore produced HETEROGENOUS products, which gave them a UNIQUENESS that allowed for some loyalty and market power, however, 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.

• Any firm that wishes to enter an industry can do so freely, as there is nothing to prevent it from doing so; similarly, it can also leave the industry freely. In other words, there are no barriers to entry into, and exit from the industry. 

• HOW DOES THIS REDUCE MARKET POWER? One way a firm can establish market power is to limit potential competitors entering the market, giving them more market share and influence, however in this market structure the fact that so many firms exist implies that there are NO such BARRIERS TO ENTRY, thus firms can never establish any dominance and market power.

• Note that this freedom of entry and exit only ONLY APPLIES IN THE LONG RUN, as in the short run firms have fixed factors that prevent them from either entering or exiting. 

• FOR EXAMPLE, It's clear that IB international schools in Hong Kong are very profitable, and this fact should attract more schools to set up, which as a result should increase the supply of competitors and reduce the ability of schools to raise their prices without losing significant numbers of students to rivals, yet this doesn't happen (very quickly anyway) and prices remain high (and rising) and places remain under-provided. BUT WHY? 

• Well due to HIGH BARRIERS TO ENTRY such as the need to get approval from the Gov't, and the large set-up fees, potential entrants are hindered and will possibly reconsider entry meaning existing schools have less competition and can dictate prices somewhat, 

• HOWEVER in contrast the stalls in the wet-market can easily be changed and respond relatively quickly to ensure supply and price are closer to the optimal level. 

• FOR EXAMPLE, if watermelons became very popular at the only stall selling them and they were making a decent profit charging high prices, it would be relatively easy for rival stalls, or even new entrants to also start selling watermelons which would eventually 'compete away' the extra profits' and the price would fall back to a more competitive level. (Also think bubble tea shops), hence they have no market power.

• Resources bought by the firms for production are completely mobile. This means that they can easily and without any cost transferred from one firm to another, or from one industry to another. 

• HOW DOES THIS REDUCE MARKET POWER? As mentioned above in the wet market example, firms that were previously not selling watermelons saw the potential profitability and immediately entered, which implies their factors of production were perfectly mobile and able to switch seamlessly between whatever they were doing previously, however, how realistic is it that a law firm can jump into the market for international schools, if they notice higher earning potential?

• Perfect information means that all firms and all consumers have complete information regarding products, prices, resources and methods of production. 

• HOW DOES THIS REDUCE MARKET POWER? CONSUMER-SIDE: One of the big factors that give a firm market power is the imperfect information that the consumer holds regarding the prevailing prices and quality of goods and their rivals, which is often created through branding and advertising. For example, perfect awareness of an identical substitute for a MacBook would render all BRANDING and ADVERTISING by apple pointless as consumers would not be fooled by the sleek images and their attempts to appear superior. 

• PRODUCER-SIDE: On the producer-side, perfect information about the costs of raw materials, etc, means no single firm is able to get a cost advantage over another and offer a discounted price, furthermore each firm can produce its goods or services at exactly the same rate and with the same production techniques as another one in the market.

• We can see that as the INDIVIDUAL FIRMS HAVE NO MARKET POWER they MUST ACCEPT THE INDUSTRY DETERMINED PRICE, hence they are referred to as 'PRICE TAKERS'. 

• In other words, if they raise their price they will lose ALL quantity demanded, and they have no reason to lower price as they can sell all their output at a higher price anyway.

• 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?

--EXPLAIN WHY FIRMS IN PERFECT COMPETITION IS UNABLE TO SUSTAIN ECONOMIC PROFITS IN THE LONG RUN (DEFINITIONS, ASSUMPTIONS, AND DIAGRAMS NEEDED) [10 MARKS]--

• Explain why a loss-making firm in perfect competition would shut down in the long run.

• Using diagrams, explain why a perfectly competitive firm can make economic (abnormal) profits only in the short run.  

https://www.investopedia.com/ask/answers/05/perfectcompetition.asp