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Economic Analysis

THE ECONOMIC OF COMPETITION


Underlying Questions
1.1 In what ways do competitions affect the decisions and actions of a particular firm?
According to Gabay, B.G. (2008) competition is always part of human activities and
motivations. Competition can make wonders in the economy. The best in human activity like the
best record in 100-meter dash in the sports Olympics can be brought out in a spirit of
competition. The best shoes can be produced in the market of there is fair competition among the
shoe-producers. Fair competition can make wonder both in human activities and in the market
system. Needless to say, perverted and unbridled competition can lead to undesirable ends.
Fajardo, F.A. (1990) stated in his book that economists make distinction between pure and
perfect competition. A market is said to be perfectly competitive if it contains all the
characteristics of pure competition plus an additional characteristics such as consumers, owners
and firms in the market have knowledge of present and future prices and costs, while, pure
competition if there is a large number of sellers and buyers of the commodity each too small to
affect the price of the commodity, the outputs of the firms in the market are homogeneous
(products of seller are exactly alike in all respects to the product of any other seller) and there is
freedom of entry into and exit from the industry.
Now, subject to certain limitations, most economists agree that a purely competitive economy
will lead to the most efficient allocation of resources. A competitive price economy will tend to
allocate the fixed supplies of resources available to society in such a way as to maximize
consumer satisfaction.
First, because of the presence of competition, firms would be forced to produce those goods
consumers wanted most. In addition, prices charged by firms under pure competition would be
reasonable to both the producers and consumers. Second, the presence of competition forces
firms to use the most efficient or least cost, methods in the production of these goods. Firms
under pure competition cannot afford to produce goods of inferior quality. Consumers will shift
to producers who will produce better quality goods or services assuming the presence of
competitive pricing.
A final appealing feature of a purely competitive economy is that the highly efficient
allocation resources which it fosters come about because businesses and resource suppliers freely
seek to further their own self-interests. This means that the invisible hand theory is at work in a
competitive economy, businesses employ resources until extra or marginal costs of production
equal the price of the production. This not only maximizes the profits of individual producers but
simultaneously results in a pattern of resource allocation which satisfies the consumers.
1.2 Is it true that competition promotes consumer welfare?
I believe that competition promotes consumer welfare, let me first cite the consumers
perspective view. If there are competitions in the market, consumers are able to choose among

Otic, Jonathan F. 2015

Economic Analysis
the products available in the market, as I have cited above, that consumers will be able to be
provided with quality goods since producers are challenged with the competition that takes place
in the market world.
As an economist view, competition can give changes to the small fry in the market wherein
the flow of economic profit doesnt only received by 2, 3 or even few people who are
monopolizing the industry.
1. Because there is perfect knowledge, there is no information failure and knowledge is
shared evenly between all participants.
2. There are no barriers to entry, so existing firms cannot derive any monopoly power.
3. Only normal profits made, so producers just cover their opportunity cost.
4. There is no need to spend money on advertising, because there is perfect knowledge and
firms can sell all they can produce. In addition, selling unbranded goods makes it hard to
construct an effective advertising campaign.
5. There is maximum possible:
o

Consumer surplus

Economic welfare

6. There is maximum allocative and productive efficiency:


o

Equilibrium will occur where P = MC, hence allocative efficiency.

In the long run equilibrium will occur at output where MC = ATC, which is
productive efficiency.

7. There is also maximum choice for consumers.

Otic, Jonathan F. 2015

Economic Analysis

Moreover, it is very timely that the House of Representatives passed the Philippine Fair
Competition Act of 2014, by which, it breaks the monopolies in the country.
2. It is utopian to try to break up monopolies into even a few effectively competing units,
because the basic cause of monopoly is the law of decreasing cost with mass production, and in
any case, a few competitors are not enough to duplicate the pricing patterns of perfect
competition. What are the Pros and Cons?
As we all know there is a tendency for a monopolist to maximize profits and being the
only one in the market, a monopolist would not think too much of consumers welfare. So let us
analyze the issue in both Pros and Cons;

Advantages according to Economists;


Monopoly avoids duplication and hence wastage of resources.

A monopoly enjoys economics of scale as it is the only supplier of product or service in


the market. The benefits can be passed on to the consumers.

Due to the fact that monopolies make lot of profits, it can be used for research and
development and to maintain their status as a monopoly.

Monopolies may use price discrimination which benefits the economically weaker
sections of the society. For example, Indian railways provide discounts to students travelling
through its network.

Monopolies can afford to invest in latest technology and machinery in order to be


efficient and to avoid competition.

Otic, Jonathan F. 2015

Economic Analysis
Disadvantages;

Poor level of service.


No consumer sovereignty.
Consumers may be charged high prices for low quality of goods and services.
Lack of competition may lead to low quality and out dated goods and services.

3. Is it true that oil product is under oligopolistic industry? How the price of oil rises and falls
nowadays?
Oligopolies are classified either pure or differentiated. If products produced by the various firms
are identical pure oligopoly is present. Thus, oil as a product is considered under oligopolistic
industry.
Main factors that affect the price
1. Fundamental factor. The fundamental factor of oil price determination is demand and
supply like other type of products. Demand and supply of oil products change according to
situation and circumstances. In any market situation, imbalance between demand and supply
can affect prices. For instance, in the case of more demand than supply (undersupply), the
price is likely to rise. The variables which result in imbalance between demand and supply
include: Economic growth is the factor that positively corresponds with the price of oil.
When the economy grows, oil demand in our daily lives as well as demand to cope with
economy expansion will increase. If the worlds production is unable to meet the growth, the
price of oil is definitely on a rise. In an opposite vein, the price of oil will decrease if the
economy growth is minimal in the light of oversupply of oil. It is noted that the world
economy growth rate in every region must be taken into consideration. Weather Seasonal
change is another factor which causes the imbalance between oil demand and production.
Especially, the consumption patterns in Europe and the USA are clearly dictated by the
season. That is, in winter, the demand of heating oil (mainly diesel and fuel oil) is higher than
other types of oil. Normally, the oil traders start to increase inventory of heating oil in the
fourth quarter of the year to prepare for the winter at the beginning of the year. As a result,
the price of oil tends to increase during the said period. In addition, the demand is sensitive to
the coldness. The colder it gets, the higher the demand is. Due to the fears of the oil shortage,
the consumers increase their oil inventories which also results in an oversupply and may
affect the price as well. Meanwhile, summer is the driving season for the western countries,
starting in the third quarter of the year or around July. Given that the demand of gasoline is
higher than other types, its price tends to increase in the second quarter of the year. In sum,
the weather is another fundamental factor which contributes to the changing demand and
supply and the price of oil. OPECs production capacity If the production is not in line with
the demand, the price of oil will be affected as witnessed by the price skyrocketing during the
past world oil crises. Thus the countries with high reserves and production capacity have
strong negotiating power for prices. Most of the producers are Organization of Petroleum
Exporting Countries or OPEC which currently has 11 members i.e. Algeria, Indonesia, Iran,
Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE and Venezuela. OPEC can manage
and control production to meet the consumption. If the production of the member is too high

Otic, Jonathan F. 2015

Economic Analysis
or too low, the price will be accordingly affected. For instance, the growing and prolonged
strike of oil workers in Nigeria can have consequences in decreasing production and rising
prices. Policy of OPEC The policy set by OPEC also impacts demand and supply of oil
market at great length. As, the worlds largest oil producers and reserves, the OPECs
announcement to increase or lower the production level, unavoidably triggers the oil price.
As a major news, each OPECs meeting is always in the spotlight. Oil reserves of worlds
major consumers Typically, each country has to reserve oil for energy stability and security.
Large consumer has to maintain the right inventory level just to sufficiently meet the demand
in order to reduce the expense. The sufficient oil inventory will lessen the worry in the supply
shortage. The price is likely to be softened. In the meantime, when the demand exceeds the
forecast, the inventory then decreases as the consumption rises and results in undersupply.
Under such scenario, the price will then adjust upward. As a result, the large consumer such
as the USA or European countries, have paid a particular attention to the oil inventory.
Alternative energy The discovery and technology development to exploit other alternative
energy sources such as natural gas, coal and nuclear and others to substitute oil at
competitive prices and efficiently meet the consumers need, will decrease the demand and
price of oil. As long as the technology and development is still limited, the price of oil will
fluctuate and depend on the imbalance between demand and supply. Nevertheless, the world
oil crisis alerts the people who suffer from the oil price to accelerate their plan to develop
other alternative fuels. If alternative fuel can be developed to replace oil, the equilibrium
between demand and supply will then take place.
2. Sentimental factors. The oil market is naturally more sensitive to news than other
market. The sentiment of oil traders is the key factor to drive oil price to quickly respond to
the news. The political and economy movement in any region can impact the world oil price.
Particularly, in unordinary situation e.g. major war, the price is quite volatile. The news about
the major oil producers and users in the world especially in the Middle East, North Sea and
the USA, etc predominantly impacts oil market more than the news about other regions.
Therefore, monitoring unrest political situation, strike, coup detat, assassination of political
leaders of OPEC countries or the decision of international organization which influences
international politics, is thus critical. These news all affect the price adjustment due to the
concern and worry despite the fact the production and export volume still remain unchanged.
3. Technical factor. To trade oil product in the market, apart from monitoring news and
movement according to fundamental factors of oil market, the traders require information,
statistic as well as average price record or history of the oil products to determine the price of
today. This information also affects the decision of oil sale and purchase as well as poses an
indirect impact of price level. Especially, the impact is greater in the future market which has
a larger trading volume larger than the real existing volume in the market. The trading is
mostly speculated for profit making. At present, there are five major future markets: New
York Mercantile Exchange (NYMEX), New York, USA; International Petroleum Exchange
(IPE), London, UK; Singapore Monetary Exchange (SGX), Singapore; Tokyo Commodity
Exchange (TOCOM), Japan; and Shanghai Futures Exchange, China.
4. Miscellaneous Factor Foreign exchange The oil is traded internationally and sold in US
dollar. Therefore, the value change of foreign currency when compared with US dollar, affect
the price of oil. When US dollar devalues, the price of imported crude and finished products
will be cheaper when calculated in local currency. Conversely, the price when calculated in
US dollar, will be higher. The stronger US dollar will also result in lower oil price.

Otic, Jonathan F. 2015

Economic Analysis
Furthermore, the fluctuation of foreign exchange will make it more difficult for traders to
compare the price of oil in each market.
4. Importance of knowing price elasticity before a firm decides on price adjustment
Price elasticity of demand refers to the relationship between the price of a product and the quantity of
the product that is demanded by consumers.
A product's demand is said to be elastic if, when the price goes up, revenues go down. If the price
goes up and revenues go up, then demand is inelastic.
For a firm, this is very important information. If a manager, owner, or any businessman knows the
elasticity of the demand for his firm's product, he will be able to know whether to raise or lower
prices. This is surely a very important decision for any manager to make.

1. Charles G. Lipsey says, that elasticity of demand is the rate of the percentage change in
demand to the percentage change in price.
2. K. E. Boulding says that elasticity of demand measures the responsiveness of demand to
change in price.
3. A. K. Chairncross says that the elasticity of demand for a commodity is the rate at which
quantity bought changes as the price changes.
Degrees of price elasticity
1. Perfectly elastic demand
Demand is perfectly elastic when small change in price bring big change in demand. A small decrease in price leads
to big increase in demand. A small rise in price by sellers reduces the demand to zero. It is infinite elasticity of
demand. The elasticity of demand can be determined through slope of demand curve. When demand is perfectly
elastic the demand curve will be horizontal straight line.

Price

Demand

$10

5 kg

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Otic, Jonathan F. 2015

Economic Analysis

2. Perfectly inelastic demand


Inelastic demand means that there is no change in demand whether the price increases or decreases. The elasticity of
demand is equal to zero. The demand curve will be straight vertical line. Perfectly inelastic demand is important
theory rather than in practice. Anyhow demand of a commodity like salt may be perfectly inelastic for many
consumers.
Price

Demand

$10

5 kg

Unitary elastic demand

Otic, Jonathan F. 2015

Economic Analysis
When rate of change in demand is equal to the change in price the demand is called unitary elastic. The numerical
value of unitary elastic demand is 1. Marshal says it elasticity being equal to unity. The demand curve, in this case,
will be rectangular hyperbola.
Price

Demand

$10

5 kg

10

3. Relatively elastic demand


The demand is relatively elastic when it is more than one. The in quantity demand is more than change in price. The
numerical value of relatively elastic demand lies between one and infinity. According to Marshal such elasticity is
called greater than unity. The demand curve for relatively elastic demand is sloping. This concept has practical
importance. Demand for many commodities is more elastic.

Price

Demand

$10

5 kg

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Otic, Jonathan F. 2015

Economic Analysis

4. Relatively inelastic demand


The demand is relatively inelastic when it is between zero and one. The rate of change in quantity demand is less
than change in price. Marshal call it elasticity is less than unity. The demand curve for relatively inelastic demand is
rapidly sloping. This demand is important in practical life.

Price

Demand

$10

5 kg

Otic, Jonathan F. 2015

Economic Analysis
REFERENCES
BOOKS
Fajardo, F. R. Economic Development Revised Edition. Text Book 1990
Gabay, B.K.G. et al, Economics Concepts and Principles ( Agrarian Reform and Taxation) 2006
Gaudencio, G. V. Principles of Economics 2008

INTERNET
http://www.cci.gov.in/May2011/Advocacy/essay2012/jyoti.pdf
http://www.managedstudy.com/micro/elasticity-of-demand.htm
https://mrphillipsibgeog.wikispaces.com/file/view/Oil+Prices.pdf
http://www.enotes.com/homework-help/discuss-importance-elasticity-demand-and-its-146187

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Otic, Jonathan F. 2015