Competitive market structure

The competitiveness of a market refers to the extent to which firms have power to influence the terms on which their production is realized and the product is sold (for instance, the market prices). The less power firms have to influence these terms on their market, the more competitive that market is. The extreme form of competitiveness occurs when each firm has zero market power. In this case, firms perceive themselves as having no power to influence the market price. At a given market price, if an individual firm charges a higher price, it would obtain no sales; so many other firms would be selling at the market price. That is the perfectly competitive market. One firm’s ability to sell its product does not depend on the behaviour of any other firm; neither can change the market price for its product by altering its own behaviour. Usually, the terms market and industry have the same meaning. More precisely, a market consists of an area over which buyers and sellers can negotiate the exchange of some commodity. The firms that produce a well-defined product or a closely related set of products constitute an industry. However, the definition of a product or of a set of closely related products is a difficult task because the relations among products can be very complex. The economic theory uses the perfect competition as the frame of reference in order to study different market structures. The less or non competitive markets are evaluated according to the assumptions establishing the theoretical competitive market structure. The key assumptions of the perfect competition are:

- All the firms in the industry sell an identical product. That is the homogeneity of products on a given market. There is no difference (qualitatively speaking) among the products of different firms which produce and sell on the considered market. Consumers know the nature of the product being sold;

- The firm is price taker. This means that the firm can alter its rate of production and sales without significantly affecting the market price. Individual firms’ decisions have no effect on the market price. Firms are atomistic because the individual firms’ size is small relatively to the size of the market;

- All production factors (as labour or capital) are free to be moved from one market to the other according to the profit opportunities that firms can detect. The industry is characterized by freedom of entry and exit. Any new firm is free to enter the industry and any existing firm is free to stop production and leave the industry. There are no legal or economic barriers to entering or exiting the industry. The consumers are free to enter or to exit the market when they formulate their demand for the products sold by firms;

- Consumers and producers know the prices charged on all markets (by each firm and by each factor of production). The market is perfect (perfect information) which means that the observed prices give economic agents sufficient information in order to undertake efficient economic activities. There is no asymmetry of information and nobody can fool others. These assumptions give perfect competition the competitive mechanism which consists for economic agents in entering or exiting markets in order to buy at the lower price. This mechanism force competitive firms to apply a price which must equalize the marginal cost of their production curve.