What is a perfect (pure) price competition model and what are its assumptions? E

Question

What is a perfect (pure) price competition model and what are its assumptions? Explain in detail how the price competition model is supposed to work, its process and the outcome (this includes many components relating to the quality of goods, the type of ‘playing field’ that production and price competition takes place on, consumer sovereignty, etc.). Does this model hold logically and empirically? Explain. From the heterodox perspective, how does an oligopolistic competitive market work in the real world? Include the assumptions behind this perspective. Does this model hold logically and empirically? Explain. Why does the prevalence and dominance of positive feedbacks support an oligopoly structure over a perfect (pure) price competitive structure (include readings)? Why is it that oligopolistic firms do not compete over price and find it advantageous to collude and fix prices (a recent case involved Procter & Gamble and Unilever, 2011)? Note here that fixing prices is the exact opposite of a perfect price competition model. What is the ‘logic’ of the production system (i.e., M-C-M’ or C-M-C’) from the orthodox and heterodox perspectives and what does this have to do with the structure/organization of our economy? Explain the difference between these two logics. Given the logic of each, what drives the economy forward (i.e. gets it moving) from these perspectives, supply or demand? Explain the process of both.

Explanation / Answer

Question

What is a perfect (pure) price competition model and what are its assumptions?

Answer         

Pure competition is a term that describes a market that has a broad range of competitors who are selling the same products. It is often referred to as perfect competition. The Market prices are determined by consumer demand and no supplier has any influence over the market price, and thus, the suppliers are often referred to as price takers. The primary reason why there are many firms is because there is a low barrier of entry into the business.

            The main assumption of Pure Competition can be discussed as below:

Explain in detail how the price competition model is supposed to work, its process and the outcome (this includes many components relating to the quality of goods, the type of ‘playing field’ that production and price competition takes place on, consumer sovereignty, etc.).

Perfect competition is a model of the market based on the assumption that a large number of firms produce identical goods consumed by a large number of buyers. The model of perfect competition also assumes that it is easy for new firms to enter the market and for existing ones to leave. And finally, it assumes that buyers and sellers have complete information about market conditions. Although, no market fully meets the conditions set out in these assumptions. The purely competitive model provides a benchmark or criteria to evaluate the performance of a market based on the equation

MB = P = MC. The marginal benefit (MB) to the buyer is suggested by the price they are willing and able to pay. The MB to the seller is the marginal revenue (MR) they earn. The marginal cost (MC) reflects the opportunity cost to society.

There is large number of buyers and sellers in the market and each of them buy or sell only a small part of the total products available in the market and hence both the buyer and seller become the price taker and the price is decided by the equilibrium between the demand and supply of the goods in the market. The playing field or the market has no restriction of entry or exit and is neither limited by the government agency barriers. There are free movement of goods and services and even factors of production. Product homogeneity is important as the buyer has to remain indifferent to the brand or firm he buys from. Consumer sovereignty cannot be seen as the consumer has to buy from the available options only.

Does this model hold logically and empirically? Explain.

Very few markets or industries in the real world are perfectly competitive. For example, there are no or very less homogeneous products in the market, if the firm is given the smallest of firms working in manufacturing or services; they try to differentiate their product.

The assumption that producers and consumers act rationally is put to question by behavioural economists. Numerous experiments have demonstrated that decision making often falls short of being rational. Decision making can be biased when consumers and producers are faced with complex situations.

Although unrealistic, it is still a useful model in two respects. Firstly, many primary and commodity markets, such as coffee and tea, exhibit many of the characteristics of perfect competition, such as the number of individual producers that exist, and their inability to influence market price. Secondly, for other markets in manufacturing and services, the model is a useful yardstick by which economists and regulators to evaluate the level of competition that exists in real markets.

From the heterodox perspective, how does an oligopolistic competitive market work in the real world? Include the assumptions behind this perspective. Does this model hold logically and empirically? Explain.

Heterodox economic explains those factors that are part of the process of social provisioning, including the structure and use of resources, the structure and change of social wants, structure of production and the reproduction of the business enterprise, family, state, and other relevant institutions and organizations, and distribution.

The heterodox perspective of oligopoly encompasses the new ways of modelling oligopoly markets/situations: joint-profit maximization, price leadership, limit pricing models, behavioural theory of the firm, and managerial theories of the firms. Oligopoly theory is about maximization-prices under specific conditions; maximization can be either profit or some other maximization. According to the heterodox concept, Oligopoly is of two types:

Pure oligopoly – that have few sellers, the firms are of large sizes and produce homogeneous commodity

Differentiated oligopoly – there are few sellers, the firms are in large size but, the products are heterogeneous in nature.

The assumptions of an oligopolistic market are:

The model does have an empirical value, as heterodox economists extend their theory to examining issues associated with the process of social provisioning, such as racism, gender, and ideologies and myths. And believe that the choice the buyer faces involves issues of ethical values and social philosophy and the historical aspects of human existence.

Why does the prevalence and dominance of positive feedbacks support an oligopoly structure over a perfect (pure) price competitive structure

The positive feedback is a feature of oligopoly as in a pure competition, the products are homogenous, and that is that they cannot be differentiated from each other. The buyer remains indifferent to the firm or the company from which it is buying the product. Whereas in an oligopoly where there are only a few firms that control the market retaining the customer is very important and hence each firm values the response or feedback of the consumer.

Pure competitive products are of daily use and a minimal increase in its price does not affect its market much, the firms in the pure competition are Price taker and hence they do not believe in customisation or feedback.

Why is it that oligopolistic firms do not compete over price and find it advantageous to collude and fix prices (a recent case involved Procter & Gamble and Unilever, 2011)? Note here that fixing prices is the exact opposite of a perfect price competition model.

Firms in an oligopoly may collude to set a price or output level for a market in order to maximize industry profits. When sellers in the market decide price together and the prevailing price is fixed according to two or more firms together in unison it is known as price fixing.

The phenomena of price fixing can be studied by the example of Procter & Gamble and Unilever, 2011. Unilever has had a strong, unmatched foothold in The organizational success in executing this objective successfully is evident in the detergent market.

P&G entered the market in a direct competitor with Unilever and has been using price wars, as well as aggressive advertising campaigns, to whittle away at Unilever's market share. The cost of this strategy in the short run has been pressures endured by both company's operating margins and bottom-line financial results. However, P&G believes in accepting losses today in order to make profit from potential future gains. Strategically, the market was essentially flooded by P&G with their products as an attempt to drive prices below Unilever's marginal costs. P&G has been modestly successful in obtaining control of some additional market share in India over time, as Unilever has given up their once 90% market share held since 2004.

Each company has a strategy of either pricing competitively (i.e., high prices) or engaging in a price war (i.e., low prices). It is optimal move for one player to set high prices while the other is priced low, but both players actually want to set low prices. P&G continued to price their products at the low price while Unilever prices competitively.

In reality, both companies act in a somewhat surprising manner by following the strategy of rigorous price cutting. Both the companies set a decided price which inhibited the smaller firms to compete in the market the small players in this market have no viable alternative means of competing for any length of time in a scenario where the major players are engaged in a price war due to their limited capital to draw on. Both Unilever and P&G had to face a fine for price fixing.

What is the ‘logic’ of the production system (i.e., M-C-M’ or C-M-C’) from the orthodox and heterodox perspectives and what does this have to do with the structure/organization of our economy? Explain the difference between these two logics. Given the logic of each, what drives the economy forward (i.e. gets it moving) from these perspectives, supply or demand? Explain the process of both.

Marx says that capital's starting point is with the circulation of commodities. The ultimate product of this commodity circulation is money. C-M-C (commodities transformed into money which is transformed back into commodities) is the direct form of circulation. In this case we sell commodities in order to buy more, and money acts as a kind of middle-man. However, there is also another form,

M-C-M. In this case, we buy in order to sell; money is capital. The first phase transforms money into a commodity, the second transforms a commodity into money. Ultimately, then, we exchange money for money.

Comparing C-M-C and M-C-M. They are similar in that both have M-C and C-M phases, involving commodities and money, and buyers and sellers. However, in the case of C-M-C, the final product is a use-value, and thus gets spent once and for all. There is no "reflux" of money because it is lost in exchange for the product bought. In M-C-M the seller gets his money back again; the money is not spent, but rather advanced. This reflux of money occurs regardless of whether a profit is made, by the nature of the process. Use-value is the purpose of C-M-C, while exchange-value is the purpose of M-C-M. Money is indistinguishable, and it seems absurd to exchange it for itself. It is distinguishable only in amount. Thus, in M-C-M what really occurs is M-C-M', where M' = M + excess. This excess is called surplus-value. The original value adds to itself and converts the surplus value to capital.

Since M-C-M is buying in order to sell, the cycle is endless. Both M and M' have the "same vocation, to approach, by quantitative increase, as near as possible to absolute in wealth." In the end, money is again the starting point, and from M' we go to M'' and so on. Thus, the possessor of money becomes the capitalist. He is a capitalist in so far as the increase of wealth is the sole force behind his actions—in this role he is "capital personified and endowed with consciousness and a will." His aim is boundless enrichment. M-C-M' is the general formula for capital, as it appears in the sphere of circulation.

The C-M- C approach is supply driven the consumer pays for one commodity which the seller pays for the next whereas in the M-C-M’ approach, the M’ or the money excessive of the money that was already circulating in the market can be put to various uses and the economy can be demand driven.

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