Perfect Competition and Real Estate Agencies

Topics: Economics, Microeconomics, Real estate Pages: 5 (1422 words) Published: April 11, 2008

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 – 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 – in this case a real estate agency – 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...
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