Unit 9: Market Structure – Perfect Competition

CONTENTS
Objectives
Introduction
9.1 Assumptions of Perfect Competition 9.2 Price and Output Determination under Perfect Competitive
Firm
9.2.1 Short Run Analysis of a Perfectly Competitive Firm
9.2.2 Long Run Analysis of a Perfectly Competitive Firm
9.2.3 Shut-down Decision
9.2.4 Efficiency of a Firm
9.3 Supply and Demand Together
9.4 Summary
9.5 Keywords

Objectives
 After studying this unit, you will be able to:
 State the assumptions of perfect competition
 Discuss the price and output determination under perfect competition

Introduction
The function of a market is to enable an exchange of goods and services to take place. A market
is any organization whereby buyers and sellers of a good are kept in close touch with each other. It is
precisely in this context that a market has four basic components
(i) consumers
(ii) sellers
(iii) a commodity
(iv) a price.

Price determination is one of the most crucial aspects in microeconomics. Business managers
are expected to make perfect decision based on their knowledge and judgment. Since every economic
activity in the market is measured as per price, it is important to know the concepts and theories related
to pricing under various market forms. Perfect competition is a market structure characterized by a
complete absence of rivalry among the individual firms.

Thus, perfect competition in economic theory has a meaning diametrically opposite to the
everyday use of this term. In practice, businessmen use the world competition as synonymous to rivalry.
In theory, perfect competition implies no rivalry among firms.

9.1 Assumptions of Perfect Competition

In a perfectly competitive market structure there is a large number of buyers and sellers of the
product and each seller and buyer is too small in relation to the market to be able to affect the price of
the product by his or her own actions. This means that a change in the output of a single firm will not
perceptibly affect the market price of the product.

Similarly, each buyer of the product is too small to be able to extract from the seller such things
as quantity discounts and special terms. The model of perfect competition is based on the following
assumptions:
1. Large numbers of sellers and buyers: The industry in perfect competition includes a large
number of firms (and buyers). Each individual firm, however large, supplies only a small
part of the total quantity offered in the market. The buyers are also numerous so that no
monopolistic power can affect the working of the market. Under these conditions each
firm alone cannot affect the price in the market by changing its output.
2. Product homogeneity: The technical characteristics of the product as well as the services
associated with its sale and delivery is identical. There is no way in which a buyer could
differentiate among the products of different firms. If the products were differentiated
the firm would have some discretion in setting its price. This is ruled out in perfect
competition. The assumption of large number of sellers and of product homogeneity
implies that the individual firm in pure competition is a price-taker: its demand curve is
infinitely elastic, indicating that the firm can sell any amount of output at the prevailing
market price.
3. Free entry and exit of firms: There is no barrier to entry or exit from the industry. Entry
or exit may take time but firms have freedom of movement in and out of the industry. If
barriers exist, the number of firms in the industry may be reduced so that each one of
them may acquire power to affect the price in the market.
4. Profit maximization: The goal of all firms is profit maximization. No other goals are
pursued.
5. No government regulation: There is no government intervention in the market (tariffs,
subsidies, rationing of production or demand and so on are ruled out).

The above assumptions are sufficient for the firm to be a price-taker and have an
infinitely elastic demand curve. The market structure in which the above assumptions
are fulfilled is called pure competition. It is different from perfect competition, which
requires the fulfilment of the following additional assumptions.

6. Perfect mobility of factors of production: The factors of production are free to move
from one firm to another throughout the economy. It is also assumed that workers can
move between different jobs. Finally, raw materials and other factors are not
monopolized and labor is not organized.

6. Perfect knowledge: It is assumed that all the sellers and buyers have complete
knowledge of the conditions of the market. This knowledge refers not only to the
prevailing conditions in the current period but in all future periods as well. Information is
free and cost less.
Market Condition
The assumptions of perfect competition imply that a particular relationship exists between the
firm and its market.

Figure 9.2(a) shows the market demand curve for a product. It shows the total amount of this
product demanded by consumers at different prices. It is a normal downward sloping demand curve
showing that for the industry as a whole quantity demanded increases as price falls.

Figure 9.2(b) shows the seller perceived demand curve which is horizontal, i.e., it is perfectly
elastic demand with respect to price. It hits the vertical axis at the current market price, P. Two factors
are stopping the producer from charging a price such as P1 , which is higher than P-perfect knowledge
and homogeneous product. If a higher price is charged, customers would know immediately that a lower
price is available elsewhere, and that the product for sale at the lower price is a perfect substitute for the
more expensive product.

The producer is also not undercutting its rivals and charging a price, P2 which is lower than P.
The firm's output is small compared to the industry as a whole and so its entire output can be sold at the
current market price of P. At a price lower than P the firm would not maximize its profit. Thus, over any
feasible range of output, the demand curve for the product of the individual firm is perceived to be
horizontal.

Equilibrium of the Firm

Firms aim to maximize profit and they can be in equilibrium only when they achieve this. For all
firms, profit maximization is achieved when marginal revenue, (MR), equals marginal cost (MC). If
MR>MC, the firm adds more to revenue than it does to costs by increasing output and sales. When this
happens profits will rise.

On the other hand, if MR < MC, the firm adds more to cost than it does to revenue by expanding
output and sales, when this happens , profits will fall. It follows, thus, that the firm is in equilibrium
when MC = MR.

Equilibrium of the Industry

The industry is in long run equilibrium when a price is reached at which all firms are in
equilibrium (producing at the minimum point of their LAC curve and making just normal profits). Under
these conditions there is no further entry or exit of firms in the industry, given the technology and factor
prices. At the market price P, the firms produce at their minimum cost, earning just normal profits. The
firm is in equilibrium because at the level of output Q

LMC = SMC= P = MR
 This equality ensures that the firm maximizes its profit.

At the price P, the industry is in equilibrium because profits are normal and all costs are covered
so that there are no incentives for entry or exit.

Task: Analyze stock market on the basis of the features of perfect market. Do you find it close to
the perfect market?

9.2 Price and Output Determination under Perfect Competitive Firm

9.2.1 Short Run Analysis of a Perfectly Competitive

Firm The aim of a firm is to maximize profits. In the short run some inputs are fixed and these
give rise to fixed costs which have to be incurred whether the firm produces or not. Thus, it pays for the
firm to stay in business in the short run even if it incurs losses. Thus, the best level of output of the firm
in the short run is the one at which the firm maximizes profits or minimizes losses.

This is possible when the marginal revenue (MR) of the firm equals its short run marginal cost
(MC). As long as MR exceeds MC, it pays for the firm to expand output because by doing so the firm
would add more to its total revenue than to its total costs. On the other hand, as long as MC exceeds
MR, it pays for the firm to reduce output because by doing so the firm will reduce its total cost more
than its total revenue. Thus, the best level of output of any firm is the one at which MR=MC.

Caution Since, a perfectly competitive firm faces a horizontal or infinitely, elastic demand curve,
P=MR, so that the condition for the best level of output can be restated as one of which P=MR =MC. This
can be seen in figure diagrammatically and with calculus as follows.

A firm usually wants to produce the output that maximizes its total profits. Total profits (T) are
equal to total revenue (TR) minus total costs (TC). That is,

π = TR–TC 1

where TR and TC are all functions of output (Q).

Taking the first derivative of p with respect to Q and setting it equal to zero gives

D𝜋/dQ = dTR/dQ - dTC/dQ = 0 2

So that

dTR/dQ = dTC/dQ 3

Equation (3) indicates that in order to maximise profits, a firm produces where marginal revenue
(MR) equals marginal cost (MC). Since for a perfectly competitive firm, P is constant and TR = (P).(Q) so
that
dTR/dQ = MR = MC
 The second order condition for profit maximisation requires that the second derivative of p with
respect to Q be negative. That is

D2𝜋/dQ2 = d2(TR)/dQ2 – d2(TC)/dQ2 < 0 4

d2(TR)/dQ2 < d2(TC)/dQ2 5

According to equation (5) the algebraic value of the slope of the MC function must be greater
than the algebraic value of the MR function. Under perfect competition, MR is constant (MR curve is
horizontal). So that equation (5) requires that the MC curve be rising at the point where MR=MC for the
firm to maximize its total profits.

The top panel of Figure 9.3 shows d which is the demand curve for the output of a perfectly
competitive firm. The marginal cost cuts the SATC at its minimum point. The firm is in equilibrium
(maximizes its profits) at the level of output defined by the intersection of the MC and the MR curves
(point E in Figure 9.3).

To the left of E profit has not reached its maximum level because each unit of output to the left
of Xe brings revenue greater than its marginal cost. To the right of Xe each additional unit of output costs
more than the revenue earned by its sale so that a loss is made and total profit is reduced.

The fact that a firm is in short run equilibrium does not necessarily mean that it makes excess
Notes profits – whether the firm makes excess profits or losses depends on the level of the ATC at the
short run equilibrium. If the ATC is below the price at equilibrium (Figure 9.4), the firm earns excess
(equal to the area PABE). If, however, the ATC is above the price (Figure 9.5), the firm makes a loss (equal
to the area FPeC).

In the latter case the firm will continue to produce only if it covers its variable costs. Otherwise it
will close down, since by discontinuing its operations the firm is better off: it minimizes its losses. The
point at which the firm covers its variable costs is called "the closing down point". In Figure 9.6 the
closing down point of the firm is denoted by point W. If price falls below Pw the firm does not cover its
variable costs and is better off if it closes down.
 Did u know? All firms in the industry have the same minimum long run average cost.
This, however, does not meant have all firms have the same efficiency.

9.2.2 Long Run Analysis of a Perfectly Competitive Firm

In the long run, all inputs and costs of production are variable and the firm can construct the
optimum or most appropriate scale of plant to produce the best level of output. The best level of output
is one at which price P=LMC equals the long run marginal cost (LMC) of the firm. The optimum scale of
the plant is the one in which short run average total cost (SATC) curve is tangent to the long run average
cost of the firm at the best level of output. If existing firms earn profits, however, more firms enter the
market in the long run. This increases the market supply of the product and results in a lower product
price until all profits are squeezed out. On the other hand, if firms in the market incur losses, some firms
will leave the market in the long run. This reduces the market supply of the product until all firms
remaining in the market just breakeven. Thus, when a competitive market is in long run equilibrium, all
firms produce at the lowest point on their long run average cost (LAC) curve and break-even. This is
shown by point E in Figure 9.7.

The condition for the long run equilibrium of the firm is that the marginal cost be equal to the
price and to the long run average cost.

LMC = AC = P

At equilibrium the short run marginal cost is equal to the long run marginal cost and the short
run average cost is equal to the long run average cost. Thus, given the above equilibrium condition, we
have

SMC = LMC = LAC = SAC P = MR

This implies that at the minimum point of the LAC the corresponding (short run) plant is worked
at its optimal capacity so that minimum of LAC and SAC coincide. On the other point, the LMC cuts the
LAC at its minimum point and the SMC cuts the SAC at its minimum.

Example: For a firm operating in a perfectly competitive market, the following data are
available Price P = AR = MR = 20/ unit

Total cost function is C = 8 + 17Q – 4Q2 + Q3

Let us find out the profit maximizing output and the maximum profit.

Marginal cost will be available if the first derivative of the total cost function is obtained.

Thus,

MC = d(C)/dQ = 17–8Q+3Q2

Maximum profit will be earned when MC and MR are equal:

 20 = 17–8Q+3Q2

Solving this equation gives two values for Q as –1/3 and 3. Obviously, negative output cannot be
produced; hence at Q = 3, the firm will maximize profits. Total revenue will be 60 and total cost 50. The
maximum profit at the output of 3 units is 10.

9.2.3 Shut-down Decision

The supply curve of a competitive firm is its marginal curve. It is that part of the marginal cost
curve which is above the average variable cost curve.

At a price P, the firm is incurring a loss, but it does not shut down because of fixed costs (Figure
9.8). In the short run, a firm knows it must pay these fixed costs regardless of whether or not it produces.
The firm only considers the costs it can save by stopping production and those costs are its variable
costs. As long as a firm is covering its variable costs, it pays to keep on producing. It makes a smaller loss
by producing. If it stopped producing, its loss would be the entire fixed costs.

However, once the price falls below AVC it will pay to shut down (point A). In that case the firm's
loss from producing temporarily and save the variable cost. Thus, the point at which MC = AVC is the
shut-down point (that point at which the firm will gain more by temporarily shutting down than it will by
staying in business. When price falls below the shut-down point, the average variable costs the firm can
save by shutting down exceed the price it would get for selling the good. When price is above AVC, in the
short run, a firm should keep on producing even though it is making a loss. As long as a firm's total
revenue is covering its total variable cost, temporarily producing at a loss is the firm's best strategy
because it is making less of a loss than it would make if it were to shut down.

Case Study:
Economic Analysis of Agriculture

Irony is the nature of the economics of agriculture; even as many in America still struggle with
hunger, the government has been offering subsidies to the American farmer to artificially raise the price
of produce, in some cases since 1933.
History of Subsidies

Because a typical farmer is so small compared to the entire market for the good he or she offers,
they cannot affect the price of the good, or try to affect the price of good too efficaciously. Instead, they
are referred to as ‘price takers’, who are forced to accept the market price. However, subsidies alter this
economic situation to occasionally illogical results. At the end of World War I, farmers were rewarded by
high prices as the government spent millions to rebuilt war-torn Europe.

In fact, a small farmer who might have been almost forced to sell the farm before the war was in
fact currently quite successful. However, in 1921, the nation fought through a recession as the farm
goods they fervently produced outpaced demand, probably due to Europe’s quick agricultural recovery.
American farmers now suffered, and continued to do so into 1922, where virtually every industry had
recovered except for agriculture. Large lands that had been opened up to feed Europe’s millions pumped
out more and more crops, but prices went lower and lower, and a surplus quickly accumulated that
prevented prosperity.

Rising Anger of Farmers

Farmers could no longer meet the cost of production, and many were forced to leave their
farms. Under neo-classical theory, this could be considered a frictional unemployment situation; as each
farm increases production until it doesn’t take as many to cover the market, some of them should switch
to other tasks.

This ‘message of the market’ was a message of sadness for many farmers. During the Great
Depression, farmers were especially hurt. For example, low dairy prices due to increased production
meant that Midwestern dairy farmers were earning less than ever. Milk, as a highly spoilable good, is a
good example of ‘perfect competition,’ when farmers can only earn the price the market tells them. Even
dairy farm strikes were ineffective, like those as a part of the Farmer’s Holiday Association Strike of 1932
in Wisconsin and Iowa (some of these became violent as milk haulers and milkmen scuffed on the picket
lines).

Since the 1930s

FDR worked to create a national program to guarantee income to farmers by enacting a

significant number of measures to raise prices, beginning with the creation of the Agricultural
Adjustment Administration in May 1933, which began the subsidy system that continues to this day,
even though the AAA was declared unconstitutional in 1936. The AAA measures paid landowners to
leave part of their land fallow.

This did raise farmers’ incomes, but consumers were forced to endure high food prices during
the worse years of the Depression. Subsidies to farmers have been a part of the American agricultural
system ever since. Bill Clinton attempted to reduce payments and increase diversity of crops with the
Freedom to Farm Act in 1994. In 2000, however, the Farm Security and Rural Investment Act restored the
farming subsidies.
 While it is true that some farmers struggle, the government spent $30 billion dollars in subsidies
yearly, even though it is estimated that it would only cost $10 billion dollars in crop insurances and other
measures to bring the poorest farmers in America up to middle class. On May 14, 2002, President Bush
signed a farm subsidy estimated to cost $190 billion dollars over ten years, rekindling a national debate
about subsidies. Today, large commercial farms dominate the agricultural market; 8% dominate 72% of
sales.
Farm policies are sometimes more the product of politics than economics. While security of the
food supply and preservation of small family-owned farms are good goals, wellintentioned programs
might be hugely inefficient. There are cost-effective ways of helping small farmers, including crop
insurance, but today some of these measures are still not used.

Questions
1. Compare the earlier global agricultural scenario with the recent scenario. (as depicted in
the case)
2. Do you agree that agriculture is a perfectly competitive industry? Source:
www.ehow.com

9.2.4 Efficiency of a Firm

Since the price in the market is unique, this implies that all firms in the industry have the same
minimum long run average cost. This, however, does not mean that all firms are of the same size or have
the same efficiency, despite the fact that their LAC is the same in equilibrium. The more efficient firms
employ more productive factors of production and/or able managers. These more efficient factors must
be remunerated of their higher productivity, otherwise they will be bid off by the raw entrants in the
industry. Or, as the price rises in the market the more efficient firms earn a rent which they must pay to
their superior resources.

Thus, rents of more efficient factors become costs for the individual firm, and hence the LAC of
the more efficient firm shifts upwards as the market price rises, even if the factor prices for the industry
as a whole remain constant as the industry expands. In this situation, the LAC of the old, more efficient
firms must be redrawn so as to be tangent at the higher market price. The LMC of the old firms is not
affected by the rents occurring to its more productive factors. It will be shifted only if the prices of
factors for the industry in general increase.

Thus, the more efficient firms will be in equilibrium, producing that output at which the redrawn
LAC is at its minimum (at which point the LAC is cut by the initial LMC given that factor prices remain
constant). Under these conditions, with the superior, more productive resources properly costed at their
opportunity cost, all firms have the same unit cost in their long run equilibrium.

In Figure 9.9, at the initial price Po the second firm was not in the industry as it could not cover
its costs at that price. At the new price P1 , firm B enters the industry, making just normal profits. The
established firm A earns rents which are imputed costs, so that its LAC shifts upward and it reaches a
new long run equilibrium producing a higher level of output (Q2).
Supply and Demand Together

The following three conditions exhibit how adjustment is likely to take place in the firm and in
the market under different situations.

Market Response to an Increase in Demand

Faced with an increase in demand which it sees as an increase in price and hence profits, a
competitive firm will respond by increasing output (from A to B) in order to maximize profit (Figure 9.10).
As all firms increase output and as new firms enter, price will fall until all profit is competed away. Thus
the long run supply curve will be perfectly elastic as is SLR in (a). The final equilibrium will be at the
original price but a higher output. The original firms return to their original output (A) but since there are
more firms in the market the market output increases to (C).

Market Response to a Technological Improvement

 A technological improvement will shift AC and MC curves down, creating short run profits. As
existing firms expand output and as new firms enter, these profits will be competed away until the price
has once again fallen to equal average total costs (initially point B in the short run) and ultimately point C
in the long run (Figure 9.11).

Market with Specialized Inputs Response to a Decrease in Demand

Faced with a decrease in demand which it sees as fall in price and hence profit, a competitive
firm will respond by decreasing output in order to minimize losses. Firm output and market output will
fall. Figure 9.12 is the market response: as all firms decrease output, the demand for specialized inputs
will fall, causing the firm's cost in (a) to fall from AC0 to AC1 . The long run equilibrium price will be lower
than the original price, and the long run supply curve SLR will be upward sloping, rather than perfectly
elastic.

Caselet:
The Stock Market

The stock market is very close to a perfect competitive market. The price of a stock usually is
determined by the market forces of demand and supply of the stock and individual buyers and sellers of
the stock have little effect on price (they are pricetakers). Resources are mobile as stock is bought and
sold frequently. Information about prices and quantities is readily available. Funds flow into stocks and
resources flow into uses in which the rate of return.
Thus, stock prices provide the signal for efficient allocation of investment in the economy.
However, imperfections occur here also though the stock market is very close to a perfect competition,
for example, sale of huge amount of stocks by a large corporation will certainly affect (depress) the price
of its stocks.

Case Study:
Perfect Competition

The U.S. Bicycle Industry (In words of J Townley) I had an epiphany, as in a sudden insight into
reality, in May at a meeting where a long time friend in the industry offered the opinion that the U.S.
bicycle industry is in a classic state of perfect competition.

My immediate response was "...that sounds like a good thing!" My friend, who went back to
graduate school after working in a bike shop, for a major component manufacturer and prominent
bicycle brand quickly responded with "...no, you don't understand." He went on to explain that when he
studied economics in graduate school he became aware of perfect competition which is a term of art in
economics for the most competitive market imaginable - one where the companies and businesses
realize the bare minimum profit necessary to keep them in business.

At the time we were in a meeting together with six other people from the bicycle industry - and
the room went silent for a time. As the group started to discuss the notion of perfect competition it
became apparent that no one strongly disagreed, and in fact there seemed to be more agreement than
not that our industry was indeed in perfect competition.

We ended our meeting, and went our separate ways, but the concept of perfect competition
stayed with me, kind of like the dull pain of a toothache. When I got back to my office I did a search on
the web and found quite a lot about this subject. Here is a summary of what I learned.

Perfect competition according to economists, is the most competitive market imaginable. In the
real world, it is rare, and there are even some economists that feel it may not even exist in its purest (I
take this as worst) form. The example of a market in perfect competition that is referenced by those
economists that believe it does exist - is agriculture.

Competition is ... competition, so what makes perfect competition different from all other forms
or kinds of competition? According to economists - because it is so competitive that any individual buyer
or seller has a negligible impact on the market price. Products are homogeneous, or composed of parts
that are all of the same kind. Product and pricing information is also perfect in that everyone, including
the ultimate purchaser knows everything about the products, including the best prices available in the
market.

In a market in perfect competition everybody is a price taker, producing and selling essentially
identical products and each seller has little or no effect on market price, and is unable to sell any output
at a price greater than the market price.

Firms earn only normal profit, or the bare minimum profit necessary to keep them in business.
 If firms do earn more than normal profit, which is called excess profit, the absence of barriers to
entry mean that other firms will enter the market and drive the price level down until there are only
normal profits to be made. Manufacturing output will be maximized and price minimized.

This sounds very familiar to me - and I am sure you can also relate to real world examples of the
U.S. bicycle industry as you read through this explanation of perfect competition.

Component manufacturers scramble to get the latest designs and functionality to market in a
timely fashion. Bicycle suppliers struggle mightily to craft and specify bicycle products that have more
value than the competition and sweat over the timing and dealer programs to introduce them. Bicycle
retailers lose sleep over how much to commit for and what to bring to market - and whether to become
a concept store or remain independent, and which suppliers to do business with.

And with all this activity, no buyer or seller has a negligible impact on the market price, and
everybody in the channel of trade is a price taker, earning the bare minimum profit necessary to stay in
business.

Last year and this season are good examples. In 2005 we had our best year ever for the sale of
high-end road 700c bicycles selling above $1,000. And in 2005 the typical bike shop lost 5 margin points
on the sale of new bicycles, continuing an unfortunate trend of losing money on the sale of new bicycles
that has plagued our channel of trade for over a decade.

High-profit bike shops, while they performed much better than the typical shop, also came in
just below their cost of doing business on the sale of new bicycles in 2005, the first actual loss for high-
profit shop on the sale of new bicycles in a decade.

Despite the continuing, and apparently growing losses on the sale of new bicycle, the U.S.
bicycle industry posted one of its best years for apparent market consumption in 2005 - second only to
the record set in 2000. 2006 started off well enough, but now as we enter the 3rd quarter of the year,
some bicycle brands are reporting overstocks from last season, and retailers are reporting some 2006
models already are out of stock as the brands introduce and start to deliver 2007 models.

History does matter, and in economics, path dependence refers to the way in which apparently
insignificant events and choices can have huge consequences for the development of a market or an
economy. In the case of the specialty bicycle retail channel of trade, the collective choice not to adopt
Uniform Product Codes, or UPC's has come back to blind the industry again, and again over the last
twenty five to thirty years.

The seemingly insignificant, competitive based choice of not adopting UPC's has made bar
coding technology, and the full power of its inventory and sales tracking efficiency uniformly unavailable
across all levels of our channel of trade, making real channel efficiency impossible.

Simply stated - brands and manufactures don't know what is selling at retail and retailers have
little or no input or influence on what is reordered and manufactured to refill the supply pipeline. As
most economists will tell you...where we have been in the past determines where we are now, and
where we can go in the future. This, in turn, leads to the importance of information.
 Economic and channel efficiency is likely to be greatest when information is comprehensive,
accurate, and readily and cheaply available.

As evidenced by the specialty bicycle retail channels recurring pattern of having too much or not
enough, many of the problems facing economies and markets arise from making decisions without all
the information that is needed.

Currently our channel of trade operates on the premise that if a brand or company can acquire
or gather more information than its competitors it is a good thing. However, economists will tell you that
asymmetric information, when one channel player knows more than the other channel players, can be a
serious source of inefficiency and market failure. Uncertainty can also impose large economic costs.

The power of the Internet has greatly increased the availability of certain information. However,
even with all its information power, there are specialty bicycle retail channel inefficiencies, like not
knowing what is actually selling at retail, that the Internet will not be able to solve. Accordingly,
uncertainty - literally not knowing, will remain a huge source of specialty bicycle retail channel
inefficiency.

And this inefficiency makes our channels blindness complete. Potentially the most useful
information, about what will happen in the future...or the ability to more accurately forecast future
demand, replenishment, inventory and sales will simply never be available under our channels current
state of perfect competition.

The best example of perfect competition that I have heard recently is in my own
backyard...Madison Wisconsin, one of the best specialty bicycle retail markets in the country. As most of
the industry knows there are two Trek company stores in Madison, and one of them, located on the East
side has been identified as the company's flagship store. Erik's Bike Shop is a successful multi-store
retailer headquartered in the MinneapolisSt. Paul Minnesota market. Erik's established a store in
Madison several seasons ago, and carries Specialized, as what I understand is its marquee brand.

Several weeks ago, according to the buzz among bicycle dealers, Specialized announced to its
dealers in Madison that Erik's will open a second store, reportedly directly across the street from the
Trek flagship store on the city's East side.

By the way, both the Trek flagship and the new Erik's that will carry Specialized are both in direct
competition with an established bicycle dealer that has carried both the Trek and Specialized brands for
many years - and is just one-mile away!

To make this market situation even more "perfect," the Trek flagship and new Erik's store Notes
are located almost within sight of a large new Dick's Sporting Goods that opened last year.

This is, I suggest to you, much more than just two brand competitors going head-to-head in one
of the best specialty bicycle markets in the country. It is also a clear example of perfect competition at its
best, or should I say worst.

The most competitive market imaginable...where output will be maximized and price minimized.
Consumers, particularly adult enthusiast cyclists have been and will continue to be the clear beneficiaries
of this most competitive of markets.
 The retailers, including the two backed by deep pocket bicycle brands, will beat on each other
and will become more efficient to survive, and as a result prices in the market will be kept surprised.
Keep in mind that in a state of perfect competition a firm that earns excess profits will experience other
firms entering the market and driving the price level down until there are only normal profits to be made
- the bare minimum profit necessary to keep them in business.

All of the retailers in this scenario, when it comes to full fruition, including those backed by the
big brands, will still only have a negligible impact on the market, including the market pricing.

This all raises the question - at least in my mind, of the big guy that was there first, Trek Bicycle,
erecting or creating some type of barrier to entry. I am sure they will think about such a thing - and they
may actually try several potential barriers to another new store, which might very well also be a brand
"concept," entering their geography, and market space.

At the end of the day...there is no real barrier to entry that can be put in place, or actually exists
for that matter, because the largest brand seller in our channel of trade still doesn't have enough mass or
leverage to dominate through a monopoly, and I am not talking about the board game.

Most markets exhibit some form of imperfect or monopolistic competition. There are fewer
firms in this imperfect competition than in a perfectly competitive market and each can to some degree
create barriers to entry. Such barriers would allow the existing firms to earn some degree of excess
profits without a new entrant being able to compete to bring prices down.

So far, the consolidation in the U.S. specialty bicycle retail channel of trade hasn't reached a
point where there are a small enough number of brands and /or manufacturers with enough product
differentiation to allow the creating of barriers to market entry. The number of bike shops has kept
falling over the last seven years, but here again, no retail organization has grown to the point that it can
create barriers to market entry.

And what about the current independent bicycle retailer that has been in the market the
longest? He is clearly at a dangerous place, but is the only one of the players who can break away from
the state of perfect competition that has a strangle hold on the rest of the industry and the specialty
bicycle retail channel of trade.

By the way, this retailer was made aware in advance by the brands, first that the Trek flagship
store was going in a mile from him, and next that Erik's Bike Shop was going to locate a new store within
about the same distance from him. He has reacted by remodeling the interior of his current location. I
have not spoken with this particular retailer since the news about the location for the new Erik's store,
but I have E-mailed, and when I do talk to him, here is what I am going to suggest.

1. Hyper-differentiate your store. This is a term coined by Mike Basch, former CEO of YaYa! Bike,
and it means differentiate your store totally from any other bike shop or bicycle retailer in your market
so that you stand out as the brand in your market. It will be important to keep the adult enthusiast
cyclists that are now customers - but the key will be crafting and marketing features and benefits to
retain them as clients for life.

The battle between the two big bicycle brands is going to test the "loyalty" of the adult
enthusiasts in the market - but their loyalty is a question of personal attachment, relationships and the
deal they got most recently, so there is marketing room for the independent to establish client loyalty
programs and establish ongoing communications so the relationship is maintained and strengthened.
Items 7, 8 and 9 discussed below become very important here.

2. Market to and really welcome casual cyclists, women, minorities, baby boomers seniors -
everyone that is now underserved by all-the-other bike shops and concept stores. This is a key strategy
for growth. It involves a product selection that will give all the non-enthusiast adults a truly enjoyable
bicycle riding experience while not forgetting about the kids. Proactive market outreach in the form of
demographics within zip codes and direct-response is essential, along with a formal referralmarketing
program to drive word-of-mouth.

3. Focus totally on the consumer. Our channel of trade is now very product focused, and we
think everyone that walks in the door is also product focused. This is a false premise. Shoppers, all
shoppers are looking for an enjoyable experience, and that experience includes focusing on their wants
and needs, while making them comfortable in the store. Adult enthusiast cyclists want and seek out
product orientation, but also appreciate a more enjoyable experience. Casual cyclists and non-cyclists,
where the growth potential is, are seeking the shopping experience and want to be comfortable with
and develop a relationship with a consultant who's expert advice about bicycle products will best meet
their wants and needs.

4. Educate your whole organization to focus totally on shoppers and customers. Because of the
current product focus of our channel of trade, we don't educate our employees about the vital
importance of focusing totally on the shopper, and not making any snap judgments about who a cyclist
or customer is, or isn't. Hiring and educating customer service naturals is way more important than in-
depth product knowledge. Educating them to really listen to shoppers and customers wants and needs is
vital to building lasting, lifetime relationships.

5. Make it all about them and an extraordinary shopping experience. There is no retail selling
today - everything a retailer does, everything retail employees do is marketing. The whole store, and the
whole attitude has to make it all about them from the parking lot to the windows to the front door to
the greeting - through making the bicycle buying process easy and fun, and the whole visit to the store
extraordinary. Making it all about them and providing an extraordinary shopping experience is the path
to increased transaction values and increased close rates.

6. Make your store the brand. Work with, stock and sell products that will provide the features
and value your customers want and need, and the margins and inventory turns you need to grow your
business. Present a uniform brand image in everything you do and that your staff does and says - one
outward brand face. And develop and promote formal word-of-mouth customer referral programs to
leverage your store brand in the market.

7. Create individual client solutions. You and your staff - your whole store, your brand and the
shopping experience you provide are for one purpose. To create individual solutions for your customers
wants and needs. In doing so you will create clients for life.

8. Become an efficient database manager. Educate your staff to the importance to your business
of utilizing all the features built into to your computerized point of sale system and any other retail
shopping systems you incorporate into your retail process and shopping experience. The uniform entry
of shopper, customer and Notes client information is as important to your business as a uniform and
consistent new bicycle assembly process and check list.

9. Become an efficient direct-response marketer. Staying connected to prospects, shoppers,

customers and clients utilizing a regular direct-response marketing plan, is essential to growing the
number of transactions generated by the business, and it is reliant upon a clean and current database.
10. Follow the Phillips Rule of never ever selling anything in your retail store below your cost of doing
business. This will lead to consistently earning excess profits.

All ten of these suggestions together create the foundation for a new level of specialty bicycle
retailing that changes the paradigm and has the potential to take the retailers that follow it out from
under the state of perfect competition that the rest of the channel of trade is trapped in. Question
Comment on the suggestions made by the writer. Source: http://www.jaytownley.com/the-bicycle-
industry-competition?page=4 9.4

Summary

 In theory, perfect competition implies no rivalry among firms.

 In a perfectly competitive market structure there is a large number of buyers and sellers
of the product and the product is homogeneous.
 There is free mobility of factors of production and the buyers and sellers have perfect
knowledge of the market.
 In the short run the best level of output of the firm is the one at which the firm
maximises profits or minimizes losses. This is possible at P = MR = MC. The point at
which the firm covers its variable costs is called "the closing down point".
 In long run the best level of output is one at which price P=LMC. At equilibrium the short
run marginal cost is equal to the long run marginal cost and the short run average cost is
equal to the long run average cost. Thus, given the above equilibrium condition, we have

SMC = LMC = LAC = SAC P = MR

9.5 Keywords

Equilibrium: Condition when the firm has no tendency either to increase or to contract its
output.
Minimum price: Price at which the sellers refuse to supply the goods at all and store it with
themselves.
Perfect competition: A market structure characterized by a complete absence of rivalry among
the individual firms.
Profit: Difference between total revenue and total cost
Market period: A very short period in which the supply is fixed, that is no adjustment can take
place in supply conditions.