The basic characteristics of perfectly competitive market are, that several companies operate at the same time (which means no entry and exit barriers) and products are identical. Such competition leads the supply and demand, to determine the price of the product (firm is a price taker). Perfect competition cannot exist, because it demonstrates a perfectly elastic demand curve, for a firm in the market (no change in price whatever units are sold). The curve below shows the graphical demonstration of Perfectly Competitive Market. Perfect competition usually exists in market for unbranded goods usually, such as eatables.
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This above figure gives a long run equilibrium position of perfectly competitive market (showing a firm, making normal profit). In case, a firm modifies its product and gains a competitive advantage, it can be abnormally profitable but only in short term, unless the product is copied by the competitors or new entrants are attracted by the product. This brings such changes to the diagram for a short period of time.
Such as if a firm introduces a pen with spy camera video recorder, audio recorder and Usb memory in it. These new features will differentiate it from others products for a small period of time, unless copied or a similar product is introduced by its competitors. The 2nd figure shows the short term abnormal profit earned by a firm for the innovation of that exclusive pen.
Another market system is known as a monopoly. When, in a market, one firm is the only supplier of a certain product, or two large producers agree to sell a product at a certain price (firm becomes price maker), a monopoly occurs. Mergers and takeovers can also result in the formation of monopolies. Monopolies use different methods, such as predatory pricing strategies, to keep the competition at a dead level in the market. To prevent a monopoly from occurring, deregulation takes place. Deregulation reduces barriers of entry for the firms, to enter into a certain market. This is a way through which governments are able to create competition in the markets, to remove monopolies and provide people with low priced goods. The deregulatory authority in the UK is known as “Monopolies and Merger Commission”. Monopoly can also lead to inefficiency, because the producer is not much concerned about the cost of production, since consumer is bound to pay any price charged to them. Sewage disposal is generally a monopoly of local government bodies.
Railway in India is a Government monopoly.
An oligopoly refers to such industry which is dominated by few large producers. This refers to the concept of concentration ratio which explains that 3 to 4 (small number of large businesses) firms hold the power for most of the sales in the market. There are high barriers of entry into this market and prices are almost stable because firm’s behaviours are dependant on their rival’s strategies accordingly. Mostly non-price competition is seen in this market. The automobile industry is one of the best examples of oligopolistic competition all over the world.
The figure explains that demand curve in an oligopoly is not straight. If a firm raises price, the competitors will not follow the trend, but if a firms lowers a price to gain competitive advantage, its rivals will do the same to avoid the loss of market share.
The theory of contestable markets was developed by William J. Baumol, John Panzar and Robert Willig (1982). This theory describes a market in which there are few companies which operate like competitors to avoid the threat of new entrants. There are no barriers to the entry or exit from this kind of market, but still artificial barriers might be created by the firms which already exist, such as the use of predatory pricing strategy. It is easier for the existing firms to gain competitive advantage by improving their efficiency to kick out new competitors entering the market. In such markets firm can benefit by identifying area of higher added value and exploiting them. There are no sunk costs in this market.
In 1993, the airlines industry in the EU was dominated by the 15 National carriers (which were states owned and states- sponsored) such as Air Italia (Italy), Aer Lingus (Ireland), British Airways (UK), Air France (France), Lufthansa (Germany) and etc. This market can be said as a natural monopoly because of high cost of planes and their maintenance which was considered to be affordable only by the governments. Secondly were the barriers erected by the government that to travel between two destinations it was only possible to have one of the either airline (the airline of the departing country or the other of the country to arrive) such as to travel between Ireland and Italy a passenger could only make a choice between Aer Lingus or Air Italia. Therefore to travel long distances people were bound to use these Air lines and pay whatever price that was charged. This market deregulated, partially in 1987 and completely in 1997 along with the competiton faced by the railway networks.
Deregulation removed the barriers of entry in the market. Still in 1998, 75% of the total market of air travellers was held by the Flag- carriers. Later in 2001, the Pie below shows the market position.
45% shows the proportion of other low cost air lines. Rest are the national carriers with their market share (Lufthansa 12%, British Airways 11%, Air France 8% and others).
Market was enlarged in 2004, by the joining of 10 more countries to EU which as a whole had a population of about 70m. Europe in that era enjoyed the period of economic growth and development which lead to rise in real incomes of people, encouraging people to use more air travel.
All this raised competition and now in 2010, there are more airlines operating in markets. This competition has eroded the dominance of National carriers and market share has migrated towards more efficient and low cost air lines. This is because low cost airlines charge an average fare, which is only 3% (approximately) of the average monthly wage EU industrial wage. The diagram below shows how increase in supply (new entrants in airline industry), drive a fall in price and increase in demand for the people using flights for journey.
The new and lower cost airlines these days are Flybe, Easy Jet, GO, Ryanair and etcâ€¦These firms keep prices low by using smaller airports, using less value added such as no distribution of food during fights, making sales through internet and etc. For example, Easy Jet makes 90% of its sales through internet. There are 280 airports in Europe of which just over 100 now have a low-cost service.
Though high cost itself is a very big hurdle to enter the market, but still to avoid any chances for entering or survival of new competitors, existing firms use hubs as barriers of entries now a days. Different airlines use their market power to reduce their marginal cost at these hubs such as reduction in landing fees, maintenance fee and other expenses. The domination of a specific airline at a hub forces the airport faculty to give them some competitive advantages.
A few examples are given below:
Ryanair (London Stansted airport) and
Flybe (Southampton, Birmingham, Manchester and Belfast)
The national carriers also dominate a few hubs such as:
Heathrow: British Airways
Paris Charles De Gaulle: Air France
Government intervenes and keeps a view of the market to maintain competition and intervenes when necessary, Such as Government intervened and crossed – border between airlines to merge such as Ryanair and Buzz, Easy Jet and GO to maintain competition. The attraction to these companies from mergers was gaining market power and share (dominance), economies of scale and gaining pricing powers which might lead to monopoly formation in future. If these mergers take place the figure below shows how firms can exercise their market power to set price.
Firms can set a price below market equilibrium, to make it difficult for competitors to survive.
This can also erect high barriers for a new organisation to enter the market.
This way the merger companies can benefit from a long term monopoly formation.