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Studying for a test? Prepare with these 3 lessons on Forms of competition.
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In pretty much all of the videos so far we've been assuming an economic ideal, and that economic ideal is perfect competition. And perfect competition is exactly what you think it is, competition. But what I want to do in this video is think about it in a little bit more exact terms, in terms of what are the ground rules we need to have to really have this ideal perfect competition. It's important to realize that there's very few markets that are truly perfectly competitive. And those that are are very good for consumers, but there are that get very close to being perfectly competitive. And if we have time, we will discuss those in this video. Now, to be perfectly competitive, you have to have many competitors. So one of the first stipulations is many players. And they need to be competing for the kind of the same buyer and kind of offering the same thing. And so they need to have identical products. Remember, we're talking about an economic ideal here. There's very few markets where the product is absolutely identical or the service is absolutely identical, but we're talking about an economic ideal over here. The next condition you need is no barriers to entry. So, if at any given moment it looks attractive for other people to go into that market, other people will go into that market and there's nothing that's really going to stop them. If the firms that are already in the market are making an economic profit that means that it's good. It's a good option for people to do. You can do better in this market than your opportunity costs, and so people will enter into that market. And in order for this market to be perfectly competitive, we can't have any barriers, nothing stopping those people. On top of that, there can be no advantage for established firms. No advantage for existing firms. So once someone jumps into the fray and, assuming that they are somewhat competent, they are going to be able to compete on kind of equal terms with the people that are already there. And then the last one, and this is important, is that you have to have really good price information. That the buyers and the sellers all have to know about each other's prices. The buyers need to know all the prices so that they can really do good comparison shopping, and the sellers need to know everyone's prices so that they can really match prices really well. So good price information. Now, there are many different types of markets that somewhat approximate perfect competition. There are very few that are completely purely perfect competition. But one of them that does come to mind, one of them that does definitely come to mind is the US airline industry. And the US airlines-- We can think about these different bullet points, how closely it matches it. There are definitely many different airlines. They don't offer identical products. I'm sure the airlines would not agree. They would say that they're differentiating on their service and what type of food they give or, I guess, don't give to you, or how much they're charging for the baggage check-in and all the rest. But for most consumers, they're just like, look, I just want an economy class ticket from San Francisco to New York, and they view them as almost identical products. So the airline industry does pretty well on this first point. No barriers to entry? Well, there are some barriers to entry in the airline industry. You need a few billion dollars that you need to either find or borrow or whatever, so that you can buy the capital so you can start operating planes. Or, I guess you could rent the planes. But, either way, you need a lot of capital to get into this business. You need access to airport terminals that you'll have to lease and landing rights and all the rest. So there are some barriers to entry. But for the most part, at least in the United States, if you are a US operator-- so there are some barriers to entry, especially for foreign operators. But if you are a US operator and you have the capital you will be able to be the next Virgin America or Southwest Airlines or JetBlue. So there are some barriers to entry, but they are low. It's not like the government is saying that no one else can start a new airlines. No advantage for existing airlines? Yeah. That's somewhat true. If I start a new airlines tomorrow and it's offering comparable rates and comparable service, I could imagine people would be willing to take this airlines. So the airline industry seems pretty good there. And good price information-- and this is why the airline industry definitely came to my mind, because I can't imagine an industry where you have better price information that at least now, after the internet came about-- than in the airline industry you want a flight from San Francisco to New York, you go to any of these travel sites, Orbits, Kayak, Expedia, whatever you want to go to. And you get all of the flights listed for you and they're listed by price. They consort them by price. And you can actually pick-- and it's known that people do this-- they pick a flight that might be $500 or $600, but they can compare based on a few pennies or even a few dollars. So there's extremely good price information. And, obviously, the sellers have all of their IT systems, the airlines have all their IT systems to keep track of where airline prices are going as well. So the air travel industry, like most industries, is not absolutely perfect competition, but it gets pretty close to perfect competition. And you even see that in the real world, is that it's very hard for the airlines to make really a lot of profit, whether you're talking about accounting profit or even economic profit. And you can see that from this supply and demand curve right over here. So on this axis, the horizontal axis, this is the quantity. This is a measure of the quantity of kind of airline service. And we're measuring it in billions of seat miles per week, and I know that sounds like a strange thing. But really, we're just saying, OK, in a given week tell me all of the seats that are in use, and multiply those number of seats-- so the seat miles in a given week. The number of seats times the miles or the average miles per seat in a given week, and that gives you how much air travel. This is a measure of air travel in, let's say, in the US in that week. And on this axis, this is the price. This is price per, and this should actually say price per seat mile. And, of course, you have your supply curve right over here. This is your supply curve. At first, to start providing those first few miles. The airlines are willing to do that relatively inexpensively. Maybe they're finding that from the most obvious airports that maybe the landing rights are cheaper or it's cheaper to lease things, or whatever. But as they start running more and more and more routes, maybe between smaller and smaller cities, maybe smaller and less efficient planes, it starts to become more and more expensive for them to supply those incremental miles. And obviously, on the demand side, if air travel is very, very expensive, very few people are going to want to travel. There is going to be very little travel that happens. If it's very cheap, many people are going to want to travel. Now, let's say that this is where the market is right now. Obviously, we have an equilibrium price right over there. And then we have an equilibrium quantity of seat miles. But let's say that the price level in order for the players to actually have an economic profit is over here. So it is right over here. So this is the price needed for zero economic profit, or you could say for neutral economic profit. Or you could even say for normal profit, for economic profit to be equal to zero. So at that point, if that is the price, then the firms that are offering airline travels, they're kind of neutral between shutting down and continuing to offer service. But notice, the way I've drawn it here that is substantially lower than the current equilibrium price. So what this is saying is since the current equilibrium price is a good bit higher than this, or it's just higher at all, these firms in the market right now are generating economic profit, definitely positive economic profit. So what's happening? If there is positive economic profit, that means that there's an incentive for other firms to enter into this industry. So what's going to happen is this is going to be the supply curve right at that moment. But as soon as another carrier realizes that they can, or any of the carriers realize they can offer more-- it doesn't even have to be new carriers entering. It could be existing carriers just offering, maybe buying more planes or offering more routes. Then maybe a little bit later the supply curve shifts like this. The supply curve shifts like that. And then this would be our new equilibrium price. But we're still making economic profit because our new equilibrium price is still higher than the price needed for zero economic profit. So still more people will continue to enter. And so then you might have a new supply curve that looks like this. And now this is our new equilibrium price. And notice what's happening. We're traveling down to the right along the demand curve. As more supply comes on, we are obviously increasing the quantity and the price is going down. But still, the equilibrium price is higher than this line right over here. So even more people will enter, until we get to that point right over there. And at that point, now the equilibrium price is the price at which all of the players are having zero economic profit. And there's no incentive for more people to enter into it, because then the equilibrium price will go down, or they're, essentially right now economic profit is zero. So everyone is neutral in this scenario. So I want to leave you there. This is what happens with perfect competition. That there's no barriers to entry and more people go in and in and in, the price goes down, the quantity will go up in this scenario. But what I want to do in the next video is to think about what if we didn't have perfect competition. And especially, what happens if we have something like, I don't know, something like a monopoly.