Economics, 3rd Edition

150  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

WHAT IS A COMPETITIVE MARKET?

Having looked at a firm’s costs we now turn our attention to a firm’s revenue. To do this we need to con-

sider the nature of a competitive market.

The Meaning of Competition

Competition refers to a situation where there are rivals in production who allow the consumer to make 

a choice. A market in which there is only one supplier has no competition as consumers have no choice, 

but a market where there are many suppliers gives consumers the opportunity of making a choice based 

on quality, value for money, price and so on. We can summarize the meaning of competition in the 

 following way:

 

●

Where more than one firm offers the same or a similar product there is competition.

 

●

Competition can also manifest itself where substitutes exist: for example, gas and electricity are separ-

ate markets but there is the opportunity for consumers to substitute gas cookers for electric ones and 

so some element of competition exists.

 

●

The closer the degree of substitutability the greater will be the competition that exists.

 

●

Firms may influence the level of competition through the way they build relationships with consumers, 

encourage purchasing habits, provide levels of customer service and after sales service, and so on.

At the extreme end of the competitive scale is a perfectly competitive market. A competitive market has 

a number of characteristics:

 

●

There are many buyers and many sellers in the market.

 

●

The goods offered by the various sellers are largely the same (if identical the goods are described as 

being ‘homogenous’).

 

●

Firms have to accept the price determined by the market as a whole – no individual firm can influence 

supply and thus price. Firms are referred to as being ‘price takers’. Each seller can sell all he wants at 

the going price, he has little reason to charge less, and if he charges more buyers will go elsewhere.

 

●

There are no restrictions (called barriers to entry) on firms entering or exiting a market. Any firm is free 

to set up and conduct business and equally there are no reasons why they cannot just close down and 

leave the industry.

 

●

There is a high degree of information available to buyers and sellers in the market.

There are few examples of markets where all these assumptions hold all the time. However, this does 

not mean that the model of perfectly competitive markets is not of value. It provides a benchmark to ana-

lyse how firms would behave if these assumptions held. We can then look at how firms’ behaviour would 

differ if some of these assumptions were relaxed.

An example of a market which is close to being a perfect market is the market for milk. No single 

buyer of milk can influence the price of milk because each buyer purchases a small amount relative to 

the size of the market. Similarly, each seller of milk has limited control over the price because many other 

sellers are offering milk that is essentially identical (although even in this market firms try and make their 

product appear different by offering skimmed milk, semi-skimmed milk, full cream milk, flavoured milk 

and so on).