LECTURE 11

Title: Perfect Competition in Bulk Shipping 1.0 OBJECTIVE

1.1 To explain the theory of perfect competition 1.2 To explain the application of theory of perfect

competition to bulk shipping. 2.0 INTRODUCTION

2.1 Bulk ships only sails when there is cargo booked for it. 2.2 Cargo booking is by bidding process eg. at Baltic

Exchange. 2.3 Freight rate for the carriage of good is determine on the

basis of the lowest offer made by the potential shipowner/carrier.

2.4 Hence bulk ships operate following demand and supply,….

2.5 …..thus close to the condition of perfect competition,….

2.6 …..where the economic of certain commercial operation is not influenced by any other factors except demand and supply.

2.7 Please note that the theory applicable to liners shipping is of non-perfect competition.

3.0 THEORIES ON PERFECT COMPETITION

3.1 There are few assumption for the industry/company to operate within a perfect competition environment, as folows….

3.2 …..first there is large number of sellers ( shipowners) and buyers (shippers)……

3.3 …..second the cargo is homogeneous, that is it must be bulk and not bulk and liners combined…..

3.4 …..third there is free entry and exit of firms within the market,…..

3.5 …..fourth there is no government interference in the market environment,…..

3.6 …..fifth there is perfect mobility of factor of production,…..

3.7 …..sixth shipowners and shippers have perfect knowledge of the condition of the market.

3.8 There can be two types of condition for perfect competition, namely…..

3.9 …..first the short run equilibrium,….. 3.10 …..second the long rub equilibrium. 3.11 For the short run equilibrium the firm is in perfect

competition when is capable of maximising profit given by total revenue (TR) minus total cost (TC).

3.12 Please note from previous lecture that the plot of cost and revenue ( R ) with quantity ( Q ) is a straight line through (0,0) with a positive gradient,……

3.13 …..as compared to a bell shape of R against Q for non-perfect competition where is complies with the idea of marginal revenue,…..

3.14 …..Non-perfect competition maximise profit by obtaining additional profit from the next quantity sold.

3.15 The marginal revenue curve for perfect competition is a horizontal line at the price being charged.

3.16 The cost curves for the perfect competition is the same as those for non-perfect competition whereit comprises of two component; fixed and variable,…..

3.17 ……and the short term average cost (SATC) and the short term marginal cost (SMC) are the same as those for non-perfect competition, …..

3.18 …..where SMC cuts SATC at the later’s miniumum point.

3.19 The plot for MR and MC for perfect competition is as follows:

3.20 The shaded area is the maximised profit when the firm is in equilibrium.

3.21 For the long run equilibrium the shape of the curves are the same as for short run,…..

3.22 ….but the long run average cost LATC curves is enveloping many SATC curves, as below

3.23 Note that free entry in the long run environment allows increase of production affecting the SATC,…..

3.24 …..thus shifting the supply curve to the right. 3.25 Price will also fall,….. 3.26 …..and finally comes to an equilibrium point where the

firm is actually operating at the bottom of the LATC and LMC.

3.27 At this point the price is at P where the P line is horizontal and tangential to the minimum point of LAC.

4.0 DEMAND CHARACTERISTIC OF BULK SHIPPING

4.1 Demand for bulk shipping is actually coming from major oil company.

4.2 In the short run demand is inelastic,….. 4.3 ……that is change in price will have no significant

effect to the quantity demanded. 4.4 The main reason for inelasticity is due to no real

substitute for bulk shipping. 4.5 The shape of demand curve in bulk shipping (oil

market) is as follows.

4.6 …..which is called the ‘cobweb’ demand curve. 4.7 It shown the impact of price elasticity to expactation. 4.8 R1 to R5 are series of different price regions. 4.9 Within each region price may move without setting off

short term future price expectation. 4.10 R1 and R5 satisfy the normal demand curve

requirement; a straight line with a negative gradient. 4.11 At any time the whole market may be, in total,

operating in one of the region. 4.12 When there is an excess in demand, the demand curve

shift to the right. 4.13 In reply supply curve also shift to the right. 4.14 The critical point is at I where the supply curve is

cutting the demand curve at its tips b and b’. 4.15 Too excessive demand can create shock just because

shipowners ‘expect’ that there is excess profit. 4.16 Depending on the severity of the ‘shock’ created by the

demand curve the price will normally fluctuate between b and b’.

4.17 If the ‘shock’ is too great increase in price will result in the acquisition of new tonnage.

4.18 This thus shift the supply curve further to the right,….. 4.19 ……while at the same time demand has actually

relatively shrinked, and thus shifted to the left. 4.20 The situation becomes irreversible and demand moves

down along the dotted path until total collapse of demand curve.

4.21 (This for example may occur when shippers withdraw from the market).

4.22 Total collapse end at f, which is the lowest level of price.

4.23 The market will recover again step by step. 4.24 First with the supply at g level corresponding to price f. 4.25 Then demand increase from g to h, requiring I number

of ships.

4.26 Excess supply will force price to fall to j. 4.27 Shipowners will become discourage and supply curve

shift to the left and tonnage drops to k. 4.28 The same process will repeat as before until total

collapse again. 4.29 This explain why rate for the carriage of bulk cargo

fluctuates and the fluctuation is in a cyclical way. 5.0 CLOSING

5.1 Bulk shipping operates according to demand and supply.

5.2 The exact demand curve is ‘cobweb’ type. 5.3 Fluctuation in rate for the carriage of bulk cargo is at its

extreme when the market totally collapsed.