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What are the differences between the long-run equilibrium of a perfectly competitive firm and the long-run equilibrium of a monopolistically competitive firm Compare the productive and allocative efficiency of monopolistic competition and perfect competition.
In answering this question, as a minimum, you need to
(b) What are the characteristics of an oligopoly market Choose an Australian industry that represents oligopoly. Justify your example by relating them to the characteristics of oligopoly market.
As a minimum, you should
(c) How can Australia address the housing affordability crisis
In answering this question, you need to
The assignment discusses some basic microeconomic concepts such as market structure and basic demand supply phenomenon. In the first part a comparative analysis is made between perfectly competitive market and monopolistically competitive market. Main features of these two types of market, short run and long run equilibrium situations are briefly discussed. Finally, productive and allocative efficiency in these two forms of market are analyzed. In the second part, characteristics of oligopoly market and prevalence of oligopoly in the Australian banking industry is discussed with help of practical and reliable data. In the third part of the assignment, housing affordability crisis in Australia is discussed in view of demand and supply side factors playing major role in the housing market.
Perfectly competitive market is a type of market where numerous buyers and sellers participates and exchange a homogenous good (Kirzner, 2015). Followings are the key characteristics of a perfectly competitive market
As the name suggest monopolistically competitive market is a combination of monopoly and perfectly competitive market. In the monopolistically competitive market there are many sellers selling a differentiated product (Rios, McConnell & Brue, 2013 ). Competition exists among different brands while owner of each brand has a monopoly power over its own brand. The key features of monopolistically competitive markets are as follows
Short run
Short run is defined as a time where firm can change their production level by changing variable factors like labor and inputs but cannot change fixed factors like capital or machinery. The perfectly competitive firm is a price taker. The demand curve in the market is a horizontal straight line. Because of fixed price, the marginal revenue curve coincides with average revenue curve. The marginal cost curve is in its usual shape of U (Kolmar, 2017). Two equilibrium conditions of perfectly competition are
In the short run, competitive firm can enjoy either a profit or a loss. Profit is when price is above the average cost. In contrast, losses occur when equilibrium price is below the average cost. Figure 1 and figure 2 describe the situation of supernormal profit and loss respectively in a competitive market.
In the long run the situation is different. In the long run firms enjoy only normal profit. Because of free entry or exit of firms, any supernormal profit or loss reduced to normal profit. The adjustment mechanism is described in figure 3.
Suppose in the short run competitive price is set at P. Since, price is above the average total cost firm is enjoying positive profit. Because of profit, new firms are attracted in the industry. When new firms enter in the industry the industry supply increase shifting the industry supply curve to the right. The increased supply reduces price from P to P1. Firms continue to enter in the industry unless profit is reduced to the normal level (Baumol & Blinder, 2015). In times of loss, firms leave the industry reducing industry supply. This increases price and again normal profit is achieved.
Short run
The monopolistically competitive firm in the short run maximize its profit or minimizes loss by choosing equilibrium quantity corresponding to a point where marginal revenue equals marginal cost. An economic profit is earned if market price is above the average cost. The firms incur a loss if price is below the average cost.
In the monopolistically competitive industry, there are low barriers to entry or exit. If firms are enjoying economic profit then new firms enter in the industry and profit reduces. However, because of differentiated products, demand curve is not perfectly elastic and hence price in the long run does mot equalize with minimum point of average cost. With entry of new firms, there is a leftward shift of the individual demand curve making demand more elastic. This continues until the tangency point between demand curve and average cost curve achieved. As compared to perfect competition, a lower quantity is produced and a comparatively high price is charged. The firms operate at the falling part of average cost and therefore have excess capacity.
Productive efficiency is said to be achieved when production is done without any waste of resources. This corresponds to the choice of production point on the production possibility frontier. For a firm productive efficiency is achieved when equilibrium quantity is supplied at price equals minimum average cost.
Allocative efficiency refers to the choice of a socially preferred production point among all the feasible points along production possibility curve.
. For a perfectly competitive industry the mechanism of free entry or exit in the market ensures price equalizes with minimum average cost. In the perfectly competitive market output is produced at lowest average cost and hence productive efficiency is achieved.
Price of a good reflects the social benefits derived from the good and marginal cost represent social cost of for producing the good. Price in the competitive market equals to the marginal cost (Cabral, 2017). This in turn ensures social benefit of the good is in line with social cost of production. Therefore, allocative efficiency is achieved.
As mentioned earlier productive efficiency is achieved when all the resources in the market are used efficiently. Productive efficiency is achieved when price of the product equalizes to minimum average cost or marginal production cost. The monopolistically competitive firm operates to the left of minimum average total cost and has excess capacity in the long run. Firm in a monopolistically competitive market always charges price that exceeds its marginal cost (Baqaee & Farhi, 2017). This mean productive efficiency can never be achieved.
Allocative efficiency means production choice that maximizes social benefits. This happens when price equals to the marginal benefit that in turn should be equal to social cost or marginal production cost. Since in the monopolistically competitive market price is well above its marginal cost allocative efficiency cannot be attained.
Oligopoly market is characterized as a market where there are few either seller selling differentiated or homogenous product. The few sellers in the market devices significant control. This type of market lies between monopolistic competition and monopoly (Ciliberto, Murry & Tamer, 2016). Few sellers having control over market prices dominate the market.
The basic characteristics of oligopoly market is given as follows
Few seller: In the oligopoly market, there are few sellers in the market. There are many buyers. As few sellers serve many buyers, each seller has a considerable control over price of their product and enjoys a significant share of the market (Belleflamme & Peitz, 2015).
Interdependence among firms: The strategic interdependence among firms is a key feature of this market. Each firm observe the strategy of others and then decide its own strategy. Firms always remain aware of their competitor’s strategy. When one firm makes any change in the price or its promotional strategy then other firms have to take some equivalent strategy to remain in the competition.
Advertising: In order to capture a higher share in the market, firms advertise their product for promoting own brand. The firms design advertisements, modify it to broaden their customer strength (Nicholson & Snyder, 2014). Advertisement by the firms intensify competition in the market.
Competition: Because of small number of sellers, there are high competition among sellers. Action taken by one firm has considerable impact on its rival firms. For example, if one firm reduces price of its product to increase sales, others do the same and this ultimately results in a price war in the market.
Barriers to entry or exit: The firms do not face any barriers in times of leaving the industry. However to enter in the market firm often faces barriers. The barriers can exist in the form of the patent, government license, benefits of economies of scale by the existing large firms, complex technology and requirement of high capital (Georgantzís & Attanasi, 2016). Often government favors the existing firms and this create a natural barrier to entry.
Lack of Uniformity: The firms are not uniform in size. Some firms are large while some are small.
Oligopoly and its type
Pure oligopoly: When oligopolistic firms sell a homogenous product then the market is known as a pure oligopoly.
Differentiated or imperfect oligopoly: In this form of market, firms sells a differentiated product.
Collusive oligopoly: In collusive oligopoly, firms operating in the industry cooperate to determine output, price, or both. Firms often form a cartel and decides price output decision in industry.
When oligopolistic firms in the industry compete with each other then it is known as non-collusive oligopoly.
Kinked demand curve is one of the important feature of oligopolistic market. The demand curve has two parts. In one part, demand is elastic in nature while in other part demand is inelastic. The kink occurs at the juncture. Competition among the oligopoly firms often taken form of price war when firms compete in terms of prices. However, price war always occurs at the elastic part of the demand curve.
Markets that are identified as an oligopoly market are distinguished with a few sellers selling identical but slightly differentiated product. The oligopoly markets usually have high entry barriers. Behavior of the individual firm is subject to the predicted behavior of its competitive firms. The Australian Banking industry resembles the characteristics of oligopoly market (Booth & Whelan, 2014). The Australian banking system is an example of oligopoly. There are four major banks dominating Australian banking industry. These are National Australian Bank, Westpac, Commonwealth Bank and the Australian and New Zealand Banking Group.
For a nation, it is not very surprising for its banking sector to be oligopoly. Given the nature of banking industry and its way of lending, scale economies and retail margins make it inevitable for oligopoly structure to prevail oligopoly in the banking sector. Australia is not the not only industry having oligopoly in the banking industry. In Norway and Finland, the three largest banks captures a market share of 84% and 85% respectively. There are high entry barriers in the Australian banking industry. The entry barriers are not only in form of regulatory and capital requirement but also because of the high market power of the four big banks in the industry (Bhasin, 2015). The market power of existing big four banks are considered as the biggest barriers for new entrants in the industry. Entry of new firms with high dominance of incumbents involve considerable amount of cost and risk. Although the four major, banks are regarded as technically separated units, studies revealed that majority of the shareholders and some members of board are same. These members include big international banks, fund managers like HSBC, Citibank, JP Morgan Chase. The following table shows the share in the four major banks
Herfindahl-Hirschman Index (HHI) is one common determinant of existing competitive level in the industry. It shows size of the firm relative to the industry and the extent of competition. Based on HHI index measure it is seen that banking industry in Australia is becoming more and more concentrated (Joshi et al., 2013). The increasing concentration in the banking sector has resulted from Westpac’s acquisition of St. George Bank Limited and CBA’s acquisition of Western Australia Bank in 2008
Politicians are supposed to oppose oligopolies in the nation. However, in case of Australian Banks the success of an oligopoly structure receive support from nation’s politicians. The finance spoke person Andrew Robb in 2103 supported oligopoly structure and suggested that state should help to form oligopoly structure. The oligopoly structure is believed to bring innovation and increase international competitiveness (Selmier, 2016). The political support is not limited to politicians only but is extended to the central bank.
At 2014, the Banking industry in Australia is regulated lightly. The policymakers in Australia looked around the experience of financial crisis in different nation in the last five years and learn from these countries.
Like any other industry, concentration in the banking sector reduces level of competition leading to high price. High rate of interest is often considered as a by-product of increased competition. In times of global financial crisis, the strong financial sector help Australia to escape from recessionary impact of the crisis. The market power help the banks to grab a high profit. The high profit reduces all the incentive of the banks to act in different manner unless there are some external pressure. The sources of external pressures are intervention by the government, action groups and competition from credit unions or mutual banks.
The major capital cities in Australia has experienced a hike in the property price since 1998. The biggest price increase have seen in Sydney and Melbourne with property price raising at the rate of 105% and 95% respectively from 2009 (Birrell & McCloskey, 2016). The exceptionally high price of housing combined with a low growth of wages. The low interest rate encourages household to borrow and consequently leading to high debt. The household debt becomes 130% of GDP. This results in unsustainable growth of property. A report on Housing affordability crisis suggested that the average price of houses in capital cities in Australia almost equal to average incomes for over seven years. Some factors contributing to housing affordability crisis are as follows
High income
With rise in productivity and high earnings from export, average income of the household and wealth level have increased. Households are willing to spend part of the increased income and their wealth. This has improved the quality of housing. During this time, the demand for holiday homes particularly those located in coastal region (Nicholls, 2014). As oppose to the increased demand there are limited responses from the supply side.
There has been a decrease in the average size of the household. There are different reasons for decreasing size of household. These include later marriage, growing incidence of divorce and separation and fewer children. This lead to an increase in housing demand for a given population. Australia has a relatively high population growth as an advanced economy (aph.gov.au, 2017). High immigration to Australia is a significant contributor to high population growth. The increased population increases the demand for housing.
The rising trend of rents increases desire of the renters to purchase their own house in place of living in rented house.
The standard interest rate on home loan has significantly declined from middle of 1990 to early 2000 (Butlin, 2013). This increases the availability of funds to finance purchase of new house and hence, raises demand.
To address housing affordability crisis government has undertaken several policies. In the federal budget a considerable amount of funds are allotted to provide some facilities to those willing to buy houses (Gurran & Phibbs, 2013). Some of these policies are discussed below
This policy allows the first home buyers to use superannuation savings as deposit. The household then can match this contribution of savings as superannuation. The policy is an appropriate solution to bridge the deposit gap.
Fed has declared a policy that exempted retirees from some of the superannuation limits or rules to boost supply of housing. To encourage downsizing of houses the retirees are allowed for exemption of stamp duty in case of purchase of small house and provide tax breaks on profit derived from the sales of their existing house (ampcapital.com.au, 2017).
To increase supply of houses government has released some of its commonwealth land such as defense land.
Government has taken a more stringent measure for overseas buyers. The present indicators show the foreign buyers constitute around 10 to 15 percent of housing demand in the nation with demand concentrating in some areas.
This corresponds to construction of social housing. The measure potentially introduces a bond aggregator that involves sourcing large capital amounts from bond market and use the money to offer long term loans at a low interest rate.
To address the issue of rising house price and ongoing housing affordability crisis the supply of housing should be matched with its demand. The supply side solution should involve overcoming three major challenges in this area.
The first is finding suitable land for building houses. Access to land is one of the major constraint in the housing supply. Use of land to its full extent help to reduce standard housing cost. The citywide mapping and other inventory exercise reveal many opportunities.
Cities need to eliminate barriers in building houses. A governance structure needs to be developed to represent all the stakeholders. The actual execution of houses should be rationalized.
To increases supply of housing the construction industry needs to be developed. The low productivity of construction industry can be partially blamed on different external factors such including building codes, the process of permitting and fluctuation in demand.
Building houses in not the only supply side solution to the housing affordability problem. Despite increasing number of houses the problem of low affordability remains. Therefore, supplying houses at an affordable price is a more relevant solution. For this, incentives should be provided to house developers to offer house at reasonable price (theconversation.com, 2017). Other supply side solution includes reducing infrastructure cost to go with housing, leasing more land to builders and relaxation of stringent regulation.
Austin, P. M., Gurran, N., & Whitehead, C. M. (2014). Planning and affordable housing in Australia, New Zealand and England: common culture; different mechanisms. Journal of Housing and the Built Environment, 29(3), 455-472.
Australian housing affordability crisis – can government policies fix the problem?. (2017). Ampcapital.com.au. Retrieved 22 December 2017, from http://www.ampcapital.com.au/article-detail?alias=/site-assets/articles/latest-news/australian-housing-affordability-crisis
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Solutions beyond supply to the housing affordability problem. (2017). The Conversation. Retrieved 22 December 2017, from https://theconversation.com/solutions-beyond-supply-to-the-housing-affordability-problem-67536
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