7 Perfect Competition
7.1 an Introduction to market structures
Over the next four chapters, we will learn about a variety of market structures. There are a couple of things you should be aware of:
- The cost calculations are the same regardless of the market structure. There can be structural differences from one structure to another, but this will be captured within the problem.
- It is very tough to find a market or firm that exists in a single market structure. Instead, we should think about the characteristics and the impact each has. Further, the market structures exist on a spectrum, so we will be concerned with the changes in outcome based on the changes in the characteristics from one market structure to another.
We will have a total of four market structures:
- Perfect competition
- Monopolistic competition
- Oligopoly
- Monopoly.
The main characteristics we will study are:
- Are individual firms price takers or price searchers?
- Are there barriers to entry that firms face to enter the market or barriers to exit that firms have to pay to leave the market?
- How many firms are there in the market?
The following flowchart summarizes the markets:
The four market structures can be thought of as a spectrum like the one shown below.
7.2 An Introduction to perfect competition
From: Openstax: Principles of Microeconomics (Chapter 8.1)
Firms are in perfect competition when the following conditions occur: (1) many firms produce identical products;(2) many buyers are available to buy the product, and many sellers are available to sell the product; (3) sellers and buyers have all relevant information to make rational decisions about the product that they are buying and selling; and (4) firms can enter and leave the market without any restrictions—in other words, there is free entry and exit into and out of the market.
A perfectly competitive firm is known as a price taker, because the pressure of competing firms forces it to accept the prevailing equilibrium price in the market. If a firm in a perfectly competitive market raises the price of its product by so much as a penny, it will lose all of its sales to competitors. When a wheat grower, as we discussed in the Bring It Home feature, wants to know the going price of wheat, he or she has to check on the computer or listen to the radio. Supply and demand in the entire market solely determine the market price, not the individual farmer. A perfectly competitive firm must be a very small player in the overall market, so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market.
A perfectly competitive market is a hypothetical extreme; however, producers in a number of industries do face many competitor firms selling highly similar goods, in which case they must often act as price takers. Economists often use agricultural markets as an example. The same crops that different farmers grow are largely interchangeable. According to the Unite