By considering certifiable markets and their results, economists have identified a number of market attributes that if present leads to positive results and if missing leads to negative or even unattractive results. In the event that all these attributes are present, a market would be regarded to be a perfect market and vice versa. However, in the real world, there is nothing like a perfect market (Chapman, 2004, p. 2). In order for a market to be considered perfect, it must have certain attributes. First, it must serve a large number of buyers and sellers and none of them should be in a position to affect the volume of sales and prices (Ashby, 2014, p. 40).
Second, buyers should be aware of the market and have access to it at no extra cost. In addition, they should be aware of the available products, their attributes, and advantages and disadvantages of acquiring them. Third, there should be a freedom of entry for both buyers and sellers. Fourth, sellers should not be in a position to influence supply. Lastly, the benefits and costs of the product should only be enjoyed and incurred by the buyers and sellers only (Ashby, 2014, p. 40).
As already been mentioned, a perfect market does not exist in the real world. However, there are fairly a number of markets that come somewhat close, for instance, agricultural commodity markets (McConnell & Brue, 2004, p. 45). The focus of this essay will be on the commodity and non-commodity markets. Commodities are basically goods that are impossible to tell apart and are sold by many sellers and purchased by many consumers. Therefore, commodity markets are markets that come quite close to a perfect market (Ashby, 2014, p. 149). On the other hand, non-commodity markets are markets that deal with distinguishable products and represent the imperfect markets. The suppliers in the non-commodity markets usually apply product differentiation strategy and marketing to enhance their market power. For this reason, the same product may be differentiated by adding some features (Ashby, 2014, p. 190).
Generally, consumers dictate market dynamics, example, if consumer demand is high, the market will respond by increasing supply and vice versa (Dilt, 2004, p. 2). The market response process entails six fundamental stages. To understand the market response dynamics, market-level diagrams have to be constructed (Ashby, 2014, p. 167). Figure 1 and 2 demonstrates how individual demand curves and supply curves can be used to derive a market demand curve and market supply curves respectively. The two figures show that when more buyers and suppliers enter into the market, the market demand and supply curve shifts. Decrease in demand or supply will shift the aggregate demand or supply curve in the opposite direction (Dilt, 2004, p. 3).
The three individual supply curves are the portion of the suppliers’ marginal cost curve that lies above their average variable cost curve. In the real commodity market, the number of suppliers and buyers are very many. For this reason, the market demand and supply curves are highly compressed (Chapman, 2004, p. 6).
Figure 3 shows the cost structure of a representative supplier and the market equilibrium. The long-term market equilibrium satisfies three conditions, that is, demand and supply equals, the suppliers are maximizing their profits, and the profits made by the suppliers are enough to guarantee their sustainability. It is important to note that at the long-run equilibrium P=AR-MR=MC=ATC=LRATC (McConnell & Brue, 2004, p. 99).
An increase in commodity demand shifts the market demand to the right as shown in figure 4. This represents the first step. Q’ units of the product will be available at the prevailing price. Since demand is positively correlated with price, the suppliers will increase their price to p1 in order to equate the new demand and supply. As the price increases, a number of buyers will react by reducing their demand (Q’ to Q1). This represents the second step (McConnell & Brue, 2004, p. 100).
At the same time, suppliers will increase supply along the individual marginal cost curve and as a group along the aggregate supply curve. The increase in supply is due to the fact that individual suppliers normally maximize profit when they operate on their marginal cost curve at the prevailing price level. Suppliers cannot increase supply without increasing prices. Increase in supply without price increment means the marginal cost will surpass marginal revenue for the entire product. This is the reality of the individual supplier’s cost structure. This marks step 3 (McConnell & Brue, 2004, p. 100; Ashby, 2014, p. 175).
The shaded area represents the economic profit made by the supplier. The profit normally attracts new entrants and this will shift the supply curve to the right as shown in figure 5. This represents step 4. The increase of new entrants will force the existing suppliers to lower their prices so as to arouse demand and, therefore, link supply and demand. This represents step 5 (McConnell & Brue, 2004, p. 101).
The entry of new suppliers will go on as long as the market is profitable. However, the profit will shrink due to the falling prices. The suppliers will respond by lowering the marginal cost curve so as to avoid making losses. This is well illustrated in figure 6 and represents step 6 (McConnell & Brue, 2004, p. 102).
Entries and exits may leave the long-run equilibrium with zero economic profit. This means the market cannot withstand any increase in costs. Therefore, the cost has to be passed to the consumers. The figure 7 shows what happens when the marginal cost curve rise because of increased cost. Any rise in cost curves is matched by a rise in the aggregate supply curve (McConnell & Brue, 2004, p. 104).
At the prevailing price P0, increase in cost prompts suppliers to reduce output. They attempt to do away with all the units whose marginal cost exceeds marginal revenue (McConnell & Brue, 2004, p. 105). If the prices were to remain the same, the volumes will fall to quantity Q’. However, as the quantity falls, the suppliers are forced to increase prices to P1 to equate supply and demand. Since the demand curve is slopping, the price increase is higher than the cost.
The firm reduces supplies from q0 to q1 to minimize losses. At q1 the marginal cost is at a high price level. This means the high cost is passed to the consumers, but that is not good enough because of the negative economic profit. The negative economic profit will force some firms out of the business. However, the negative economic profit will only persist until many suppliers have exited the industry. The exit reduces supply and, therefore, prices increase to P2 (McConnell & Brue, 2004, p. 106; Ashby, 2014, p. 177).
The drop in the cost structure is matched by a corresponding drop in the aggregate supply curve. At the prevailing price PO, supply will increase as long as the marginal revenue is above the marginal cost. If the prices were to remain the same, supply will increase to Q’. However, additional increases in supply will force the price down to P1 to equate demand and supply. As the prices go down, the firms reduce supply from q1 to q0. This ensures that firms operate on the marginal cost curve at the prevailing price level. An additional supply from the new entrants is able to offset the reduction in supply (McConnell & Brue, 2004, p. 107; Ashby, 2014, p. 17).
As already been mentioned, non commodity markets are markets dealing with different versions of products. Non-commodity products can be created through product differentiation. Some of the most common non-commodity products include shoes, cars and aircrafts among others. For instance, there are a wide variety of shoes and each has unique characteristics. Non-commodity products give consumers unmatched opportunities for commodities that not only suit their pockets, thanks to different product varieties, but also suit their diverse tastes and preferences (Ashby, 2014, p. 190).
Using product differentiation, a firm can create a market niche and, therefore, can influence the price of its product. However, this does not mean the suppliers can totally control both market prices and volumes. What they can do is set prices and let the market determine the volumes and vice versa. All in all, the objective of the suppliers do not change in both commodity and non-commodity market, that is, profit maximization (Kotler & Armstrong, 2001, p. 66; Ashby, 2014, p. 191).
By reducing supply, the firm can create an artificial shortage that would push the price up and vice versa, hence the demand curve slopes to the right (Tomlinson, nb, p. 2). However, in the case of many competing commodities, the slope is relatively gentle. An attempt to push prices up would lead to loss of sales to the rivals. On the contrary, few competing products would have a steep demand curve. This is because firms have a considerable power over market niche (Ashby, 2014, p. 191; McConnell & Brue, 2004, p. 110).
Figure 8 shows a typical scenario of a firm that has created very little demand for its product to guarantee sustainability. The AR line represents the highest price that would be paid for competing products. On the other hand, the LRATC represents the lowest average cost that would be paid for similar competing product. It can be seen that at each level, the AR is exceeded by LRATC. Negative economic profit cannot be avoided in this case. In free market economies, losses are as significant as profits. Normally, losses are as a result of wastefulness. As a result, they can be avoided through efficient use of scarce resources (Ashby, 2014, p. 197).
Figure 9 shows an efficient/profitable supplier of a non-commodity product. So long as a section of the AR curve lies above the LRATC, there is a possibility of making some profit. Maximum profit is realized where the resource (represented by ATC curve) and the supply (Q*) fulfill two conditions. First, MR=MC. Second, ATC= LRATC. The shaded area is the maximum economic profit. Efficiency can also be achieved when the firm operates at the lowest average cost per unit. In other words, the firm is operating at the bottom of the ATC curve. In addition, efficiency can be achieved when the bottom of the ATC curve is at the bottom of the LRATC (Ashby, 2014, p. 197). In a country where resources are scarce, all the three conditions are vital. They can be achieved when firms face horizontal demand curve, and this can only take place in commodity markets. Nonetheless, non-commodity market can also achieve efficiency, but they tend to be rather productively inefficient. This implies that they only operate with the first two conditions (where MC=MR and ATC= LRATC (McConnell & Brue, 2004, p. 112).
Optimal “allocative efficiency” call for the prevailing price to equal marginal cost (P=MC). However, this cannot be achieved in non-commodity market. Hence, non-commodity firms do not supply socially-optimal volumes and, in so doing, slows down the general standard of living (Ashby, 2014, p. 199).
Economists have identified a number of market attributes that if present leads to positive results and if missing leads to unfair outcome. These attributes are used to classify markets as either perfect or imperfect. Commodity markets are close representative of perfect markets, whereas non-commodity markets represent imperfect markets. Commodity markets are basically markets selling goods that are impossible to tell apart and have so many buyers and sellers. In other words, there is freedom of entry. Buyers and sellers in this market have no influence over volume of sales and prices.
On the other hand, non-commodity markets are markets that deal with different versions of products or simply distinguishable products. Profit maximization in commodity market depends on consumer demand, supplies and production cost. In addition, market equilibrium in the commodity market is represented by P=AR-MR=MC=ATC=LRATC. On the contrary, profit maximization in non-commodity market is hinged on efficient utilization of resources. Maximum profit is realized where the resource (normally represented by ATC curve) and the supply (Q) fulfill two conditions. First, MR=MC. Second, ATC= LRATC. Efficiency can also be achieved when the firm operates at the lowest average cost per unit. It is usually very difficult to meet the above three conditions in countries where resources are very scarce.
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