Goverment policy and perfect competetion

Essay by shityUniversity, Bachelor'sB, March 2005

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How efficient the economy is operating largely depends on the level of the competition in the market. Level of competition in economic theory is divided into three different categories, named the perfect competition, monopolistic competition, oligopoly and monopoly. Barriers of entry is one of the key points to distinguish the difference between the levels, thus it is, to a certain extent, the authorities' main task to keep the entry barriers low, where the market can operate efficiently, but it does not mean the monopolistic market structure is always inefficient. This essay will compare both form of structures and discuss the competition policies and the importance of lowering the barriers of entry. It refers to the work of Anderton, Sloman, Hanson and other economists.

Perfect competition in a market consists of many small firms selling identical products and services. Because there are so many firms involved, it makes no difference to the buyer where he/she purchases from.

Demand is perfectly elastic and the firm is price taker - since the companies individually produce a very small percentage of the total industry output, they have no influence on the market price. They can only accept the prevailing market price. In order to maximise its profit, the firm will produce at a quantity where marginal cost equals marginal revenue, i.e. the price. Although in the short run, if the price is higher or lower than average cost, there will be a supernormal profit or an economic loss accordingly, because of complete freedom of costless entry and exit for firms and all producers' and consumers' perfect knowledge of the market, either of them will be eliminated by competition, leaving no incentive for firms to either enter or quit the market. And the long run equilibrium under perfect competition keeps market price at the level...