¶ … Firm, Labor Markets, and Imperfect Information
Economics
Perfect Competition and Monopolistic Competition
A perfectly competitive market does not have barriers to entry or exit and is characterized by many producers and many consumers, all of whom are price takers -- a term that means the suppliers and the buyers cannot effect the price as they do not have market power ("Competitive Markets," 2014). Monopolistic competitive markets are do have some barriers to entry and exit. Consumers can find substitutes for all of the goods in a competitive market, whereas high product differentiation is seen in a monopolistic competitive market ("Competitive Markets," 2014). Indeed, one of the reasons that a firm can achieve a monopoly for a product is that the business has been successful in its efforts to differentiate a product, as perceived by its customers. The ability of a business to make profits in the long-run is referred to as the elasticity of demand. Perfectly competitive and monopolistic competitive markets both demonstrate elasticity of demand in the long-run ("Competitive Markets," 2014). That is to say that consumers in both markets are sensitive to price, so that the demand for products decrease if the prices rise ("Competitive Markets," 2014).
A small difference in elasticity between the two types of competition does exist. Consider that in a perfectly competitive, the demand curves are perfectly elastic: an incremental price increase causes the demand for a product to cease ("Competitive Markets," 2014). In contrast, demand curves are not perfectly elastic in monopolistic competition. Businesses have market power in monopolistic competition, which means that these firms can raise their prices and not see all of their customers vanish ("Competitive Markets," 2014). A perfectly competitive market is perfectly efficient. What this means is that the profit of any firm in a competitive market cannot increase without reducing the profit of another ("Competitive Markets," 2014). This is because consumers can select substitute products without loosing any advantage or without having to pay more for the substitute good. Suppliers cannot determine the price of a product or service because the market dictates the price in a competitive market.
Cost, Profit, and Production
When prices fall, consumers will generally buy more of a good or service; this is reflected in a downward sloping demand curve ("Zero Profit Equilibrium," 2014). Alternately, an upward sloping supply curve represents the willingness of producers to sell less goods or services when prices fall ("Zero Profit Equilibrium," 2014). Market equilibrium is the represented by the intersection of these two curves -- and it is considered to be the optimal outcome for all actors in the market ("Zero Profit Equilibrium," 2014). In a monopolistic market, output is lower than it is in a competitive market, and the prices in the monopolistic market are also higher ("Zero Profit Equilibrium," 2014). This creates what is known as deadweight loss or a welfare loss for society ("Zero Profit Equilibrium," 2014). This is a primary reason why monopolies generally do not create the best situations for societies.
Businesses try to maximize revenue while simultaneously minimizing costs. This requires a business to keep an eye on changes in both revenue and costs, which is referred to as "looking at the margin" ("Zero Profit Equilibrium," 2014). That is to say that the businesses scrutinize marginal revenue -- changes in revenue -- and marginal costs -- changes in costs, for every unit produced ("Zero Profit Equilibrium," 2014). The relationship that is pivotal to profit maximization is this: If the increase in revenue is larger than the increase in costs, then producing more of the goods or services will still raise the price ("Zero Profit Equilibrium," 2014). This relationship will continue until the marginal revenue (MR) equals the marginal cost (MC) ("Zero Profit Equilibrium," 2014). Another way of showing profit maximizing is: MR=MC ("Zero Profit Equilibrium," 2014). All other things remaining the same, it will be easier to create profit in the short-term rather than over the long-term. Indeed, economic theory suggests that firms cannot be profitable over the long-term. However, what is referred to as profitability is not accounting profitability, but this is just the difference between total costs and total revenue -- or explicit costs that generate an increase in debt or an outflow of money ("Zero Profit Equilibrium," 2014). On the other hand, economic profit is total revenue minus total costs, which means that it includes implicit costs ("Zero Profit Equilibrium," 2014). So in addition to opportunity costs, economic profit also must account for the effort, money, and time that an owner invests in a business ("Zero Profit Equilibrium,"...
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