Why are some markets more competitive than others?

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Why are some markets more competitive than others?

 

The structure of an industry affects the behaviour of its constituent firms and as a result dictates the competition that occurs within a market.  The level of competition can either be aggressive or minimal, based on the crux of the industry, and how it is shaped and operated in.  Some markets turn towards liberalisation while others have remained fixated on planned economy (socialism).  The resulting competition thus determines the demand and supply of a market – either by inducing prices (demand/supply) or by submitting and attending to the market.

 

Perfect competition describes a market where there are many buyers, many sellers, homogeneous products, no barriers to entry and perfect knowledge within the market i.e. firms and buyers are informed about the product price of each firm in the industry. Such characteristics result from the fact that the firm is effectively a ‘price taker'. That is, the firm has no control whatsoever over the price of a product. This means that changes in output by one firm do not shift the industry supply curve sufficiently to alter the price. If the whole industry increases or decreases output together, the supply will shift and the price will change, but not if only one firm increases or decreases output. This means each firm can sell all it wants at the given market price. Because firms are profit maximizers, it would be irrational to sell at a lower price as they would not sell more. As a result, perfectly competitive markets face a perfectly elastic demand curve. Therefore the degree of competition between firms within a market is absolute, total or perfect. (See Figure.1.)

 

Under the assumption of perfect knowledge, it is no secret that there are high profits to be earned in the industry. There are no barriers to entry. The existence of supernormal profits would trigger new entry in such a market. As other firms move in, the supply of the product expands and the price falls. (See Figure. 2) The supply curve slides out to the right. As it does so, price falls. As price is the firm’s MR curve it will contract production down its MC curve as MR falls, always producing where MR=MC. Price P2 and output Q2 is just one intermediate point. It is still a short run equilibrium because at P2 the total revenue of the firm is greater than the total cost. Thus, supernormal profits are still being made. Other firms continue to be attracted, and the process continues until supernormal profits are competed away, and normal profits are being earned.

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The extreme conditions required for perfectly competitive markets to exist are rarely found in the real world. In actuality, minimal competition does exist, however, in a unique form. Firms within perfectly competitive markets have to compete to sustain market share. The threat posed by the possibility of new firms entering the market is taken to be a key determinant of the behaviour of existing firms in a market. Moreover, perfectly competitive markets are highly contestable which allows for “hit and run entry” as exemplified above in Figure 2. Thus, firms have to compete to obtain the abnormal profits that ...

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