In a perfectly competitive market condition, because of the presence of a large number of buyers and sellers, there is no rivalry existing among them. Since no seller or buyer is able to dominate market price under perfect competition is determined by the operation of demand and supply. Therefore, the action and interaction among the forces of demand and supply can be said to influence the price in the short run in a perfectly competitive market (Narayan, 1997). Normally prices will be fixed at a point where the forces of supply and demand are maintained at an equilibrium position. The equilibrium position is bound to change by a shift in supply and demand factors. The shift in demand is subject to the marginal utility of supply to the buyers. On the other hand, the shift in supply is influenced by the cost of production. Therefore the factors of marginal demand and marginal supply are the factors that determine the prices in the short run. Because the product is identical to many competitors the firm cannot charge a price that is higher than that of the competitor. Examples of perfect competition include producers of some agricultural products such as wheat, corn, egg farmers, and secondary sellers like textbook sellers, unskilled labor, and online auction sites (Murrraylax.org, 2009). In these industries, there is a large number of sellers and consumers where no single seller or user has any control over the price and the forces of demand and supply determine the price level in the short run.
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Under monopolistic or imperfect competition there are a large number of small sellers. These sellers deal in differentiated products which are close substitutes to others. Product differentiation is one of the important aspects of imperfect competition. Under a monopolistic market structure, the firm becomes a ‘price-makers as against a perfect competition in which the firm acts as a ‘price-taker. It is for the firm to fix a price for its products so that the price fixed fetches the firm the maximum of profit (Narayan, 1997). There are three independent variables that act upon the prices of products in a monopolistic structure namely the price, output, and selling costs. In the short run, since the seller who is selling a differentiated product has a number of rivals, he can operate within a limited range within which the seller would be able to have control over the product he deals with. With a small decrease in prices, the seller would be able to attract more customers who can be managed with the output the seller can generate. The price reduction can be achieved by reducing the selling costs. The competition among the firms is based on quality, price, and marketing and quality can be achieved by firms with better design, reliability, and ease of access. Banks, radio stations, firms selling clothing or jewelry, frozen foods, apparel stores are typical examples of monopolistic competition where there are no entry or exit barriers and the firms compete with each other with the product differentiation and quality as the main aspects of competition (mccd.edu, n.d.). Airline companies are one of the examples of imperfect competition where service quality influences the pricing in the short run. Similarly, in the case of banks, the product differentiation is in the form of service quality and financial products.
mccd.edu, n.d. Monopolistic Competition – Chapter 11. Web.
Murrraylax.org, 2009. Introduction to Microeconomics – Perfect Competition. Web.
Narayan, B.N., 1997. Essence of Managerial Economics and Management Science. India: Anmol Publications Pvt Ltd.