Perfect Competition And Real Estate Agencies

Introduction

Real estate agencies in Brisbane are dealt with on a daily basis. The focal point of this paper is to analyse firstly to what extent Brisbane real estate agencies match the characteristics of a perfectly competitive industry. Secondly it will examine the pros and cons of the industry in relation to welfare implications using producer and consumer surplus concepts. This paper will not state which market structure real estate agencies fall under, it is just to what extent the agencies fit into a perfectly competitive industry.

Real Estate Industry

There are many papers which argue what market structure real estate agencies fall under. Coiacetto (2006, 1, Online) argues “that it is not necessarily a competitive industry and, in some instances, can be highly oligopolistic.”

GAO (2005, 8, Online) says the industry does have competitive attributes but these are based on non-price variables such as such as quality, reputation, or level of service, than on price.

Entry into the real estate industry is almost free (Goolsbee, 2005, Online) and there are many agencies that operate within the industry. The products sold by real estate agencies are not homogenous products (Coiacetto, 2006, Online). Each product is as unique as the next, in terms of its location, features, building and financing.

When prices increase, the quantity decrease (Graph 1) and new firms enter the market in order to make economic profits. However this does not mean the real estate agents or brokers earn more money. On the contrary, the prices they charge may increase, but the number of houses each sell do not change (Goolsbee, 2005, Online). From this it is evident that the price of products in the real estate market is not affected by the entry of new firms.

Perfect Competition

A perfectly competitive market is based on a model of perfect competition. For a market to fall under this model it must have a number of firms, homogeneous products, and easy exit and entry levels into the market (McTaggart, 1992).

In relation to the real estate agencies it is clear that it fits two of the three characteristics mentioned above. Entry into real estate agencies is very easy - with limited restraints and there are a number of firms in the industry.

The price of the real estate products are no affected by the entry or exit of firms into the market. Therefore real estate agencies would be most likely to fall under long-run supply curves вЂ" more specifically a constant-cost industry. The graphical interpretation of this supply curve is illustrated on Graph 2.

Under perfect competition, a firm can make only one decision and that is the amount of quantity output that is needed to maximise profit. The graph above illustrates the activities of an individual firm вЂ" in this case a real estate agency вЂ" in relation to an increase in price. The increased price is taken and quantity increases from Q1 to Q2. If the new price is above the SRATV then firms will go from making normal economic profit to an economic profit.

Graph 3 constructs the effect on the industry as a whole, when prices increase. The demand in the industry increases equilibrium price and firms earn above normal economic profit, thus attracting more businesses into the industry. This causes an increase in supply (S1 to S2) and establishing equilibrium price E3. Now all firms earn zero economic profit, which stops new firms entering the market (Layton, 2005, 195). As house prices increases, demand decreases (Graph 1), which in turn increases the competition to gain more clients. Under this theory real estate agencies would make roughly the same amount in areas where prices have not amplified (Goolsbee, 2005, Online).

Competition and Welfare Implications

Allocative efficiency refers to the amount the consumer is willing to pay in relation to the cost of production for a product. If the marginal cost is greater than the market price the consumer is better off having the seller produce an extra unit, who in turn can sell it for a price, higher than the market price which is either equal too or below the consumers price. In other words, allocative efficiency deals with making mutually beneficial trades (Lee, 2005, Online).

Productive efficiency is associated with the technological efficiency. That is producing maximum outputs at minimum costs (Lee, 2005, Online). Under the theory pursuing maximised profits gives firms an incentive to reduce costs. However if lack of competition produces slack and inadequate production, society will incur welfare losses (Walker, 2006, Online).

Consumer welfare is illustrated when productive and allocative efficiencies are established within competing producers. The surplus equated the price paid for the product and the willingness to pay that amount, this gives a direct connection between consumer welfare and consumer surplus. As consumer welfare is enhanced, consumer surplus is maximized (The Skeptical Regulator, 2003, Online)

Two implications have been derived from this model using Graph 4. Importantly market price of a product must equate marginal cost of the product, therefore creating equilibrium for all producers. As explained in allocative efficiency if market price is greater than marginal cost for a seller, profits can be made by producing an extra unit that is a positive margin of sale. Therefore seller will expand output at marginal