Supply, Demand, Competition
The supply of a
particular product is the quantity of the product that producers are willing to
sell at each of various prices. Supply is thus a relationship between prices
and the quantities offered by producers, who are usually rational people, so we
would expect them to offer more of a product for sale at higher prices and to
offer less of the product at lower prices.
The demand for a
particular product is the quantity that buyers are willing to purchase at each
of various prices. Demand is thus a relationship between prices and the
quantities purchased by buyers, who are rational people too, so we would expect
them to buy more of a product when its price is low and to buy less of the
product when its price is high. This is exactly what happens when the price of
fresh strawberries rises dramatically. People buy other fruit or do without and
reduce their purchases of strawberries. They begin to buy more strawberries
only when prices drop.
Forms of
Competition
A
free-market system implies competition among sellers of products and resources.
Economists recognize four different degrees of competition, ranging from ideal
competition to no competition at all. These are pure competition, monopolistic
competition, oligopoly, and monopoly.
Pure (or
perfect) competition is the complete form of
competition. It is the market situation in which there are many buyers and
sellers of a product, and no single buyer or seller is powerful enough to
affect the price of that product. The above definition includes several important
ideas:
-
there is a demand for a single
product;
-
all sellers offer the same
product for sale;
-
all buyers and sellers know
everything there is to know about the market;
-
the market is not affected by the
actions of any one buyer or seller.
In pure
competition the sellers and buyers must accept the going price. But who or what
determines the price? Actually, everyone does. The price of each product is
determined by the actions of all buyers and all sellers together, through the
forces of supply and demand. It is this interaction of buyers and sellers,
working for their best interest that Adam Smith referred to as the
"invisible hand" of competition.
Neither sellers nor buyers exist in a vacuum. What they do is
interact within a market. And there is always one certain price at which the
quantity of a product that is demanded is exactly equal to the quantity of that
product that is produced. Suppose producers are willing to supply 2 million
bushels of wheat at a price of $5 per bushel and that buyers are willing to purchase 2 million
bushels at a price of $5 per bushel. In other words, supply and demand are in
balance, or in equilibrium, at the price of $5. This is the
"going price" at which producers should sell their 2 million bushels
of wheat. Economists call this price the equilibrium price or market
price. Under pure competition, the market price of any
product is the price at which the quantity demanded is exactly equal to the
quantity supplied.
In theory
and in the real world, market prices are affected by anything that affects
supply and demand. The demand for wheat,
for example, might change if researchers suddenly discovered that it had very
beneficial effects on users' health. Then more wheat would be demanded at every
price. The supply of wheat might change if new
technology permitted the production of greater quantities of wheat from the
same amount of acreage. In that case, producers would be willing to supply more
wheat at each price. Either of these changes would result in a new market
price. Other changes that can affect competitive prices are shifts in buyer
tastes, the development of new products that satisfy old needs, and
fluctuations in income due to inflation or recession. For example, generic or
"no-name" products are now available in supermarkets. Consumers can
satisfy their needs for products ranging from food to drugs to paper products
at a lower cost, with quality comparable to brand name items. Bayer was
recently forced to lower the price of its very popular aspirin because of
competition from generic products.
Pure
competition is only a theoretical concept. Some specific markets may come
close, but no real market totally exhibits perfect competition. Many real
markets, however, are examples of monopolistic competition. Monopolistic
competition is a market situation in which there are many buyers along with
relatively many sellers who differentiate their products
from the products of competitors and it is very easy to enter into this market.
The various products available in a monopolistically competitive
market are very similar in nature, and they are all intended to satisfy the
same need. However, each seller attempts to make its product somewhat different
from the others by providing unique product features — an attention-getting
brand name, unique packaging, or services such as free delivery or a
"lifetime" warranty.
Product
differentiation is a fact of life for the producers of many consumer goods,
from soaps to clothing to personal computers. Actually, monopolistic competition
is characterized by fewer sellers than pure competition, but there are enough
sellers to ensure a highly competitive market. By differentiating its product
from all similar products, the producer obtains some limited control over the
market price of its product.
An oligopoly is a market
situation (or industry) in which there are few sellers (2-8). Generally these
sellers are quite large, and sizable investments are required to enter into
their market. For this reason, oligopolistic industries tend to remain
oligopolistic. Examples of oligopolies are the American
automobile, industrial chemicals, and oil refining industries.
Because
there are few sellers in an oligopoly, each seller has considerable control
over price. At the same time, the market actions of each seller can have a
strong effect on competitors' sales. If one firm reduces its price, the other
firms in the industry usually do the same to retain their market shares. If one
firm raises its price, the others may wait and watch the market for a while, to
see whether their lower price tag gives them a competitive advantage, and then
eventually follow suit. All this wariness usually results in similar prices for
similar products. In the absence of much price competition, product
differentiation becomes the major competitive weapon.
A monopoly is a market
(or industry) with only one seller. Because only one firm is the supplier of a
product, it has complete control over price. However, no firm can set its price
at some astronomical figure just because there is no competition; the firm
would soon find that it had no sales revenue, either. Instead, the firm in a
monopoly position must consider the demand for its product and set the price at
the most profitable level.
The few
monopolies in American business don't have even that much leeway in setting
prices because they are all carefully regulated by government.
Most
monopolies in America are public utilities, such as we
find in electric power distribution. They are permitted to exist because the
public interest is best served by their existence, but they operate under the
scrutiny and control of various state and federal agencies.
