Read the requirement carefully Essay Example | Topics and Well Written Essays - 1500 words

Read the requirement carefully - Essay Example The difference in the products and the way in which firms compete is also discussed. The assumptions that hold for the perfect market are also explained and highlighted. A perfectly competitive market is the one in which the market forces work without any hindrance. This means that the demand and supply interact to determine the price which is accepted by all the other firms. This market is only a theoretical one based on assumptions and it tells us that how a markets should respond to the changes in demand and supply. The perfect market is nonexistent in our real world like all the other perfect things but it is important to understand it. This is because the perfect market structure can be used to compare the other markets and their responses to changes in different situations. (Goshit & Mai-Lafia, 2009) Firstly, let us consider the case of equilibrium in a perfect market. The supply and demand will become equal at some point and that point will be considered as the equilibrium poi nt of the market. The following drawing shows a perfect market at equilibrium. The forces of supply and demand fix the price at $5. (Goshit & Mai-Lafia, 2009) Now, like all the other markets, the perfect markets also faces demand and supply shocks to which it reacts accordingly. Mostly the market responds to changes in demand as the consumer is considered sovereign. Let us now consider the case where the consumer demand increases. This may be due to any reason but let us suppose that it is due to an increase in the price of a substitute. The market will shift accordingly. The following drawing shows how. (Archambault, 2008) The increase in demand will result in extra demand at the same price. This will create a shortage of the product. The supply will react accordingly and there will be a movement along the supply curve. This will lead to a new equilibrium at a higher price and a higher quantity. This is because the consumers were willing to pay more for the good and thus the market forces reacted and short run equilibrium was attained. This increase in demand will also add to the consumer and producer surplus which is the area between the two graphs. These two refer to the difference between the amount that the consumer or the producer expects and the price. (Krugman and Wells, 2008, p.71-72) The long run response of the market will be different. The long run equilibrium of a market is when the marginal cost becomes equal to the lowest of average total cost (ATC). This equilibrium will be disturbed by the increase in demand. The firms will now charge a higher price than their marginal costs and thus their average revenue will exceed their average total costs. The firms will be earning an abnormal profit. (Peck, 2006) The following graphs show the disturbance. As a result of the abnormal profit, new firms will enter the industry to make profit for themselves. This will cause the supply to increase. This increased supply will push the prices downwards back to n ormal with a higher amount of goods traded than before. The long run equilibrium will be attained and the market will return back to normal. (Burnette, 2012) The following graph shows the effect of new firms entering the market. Perfect markets differ from the markets we see daily. There are assumptions that need to be considered. The first one is that there are many sellers in the market, which means that the competition is intense. Secondly,