Discusses the market structure and their relative advantages and disadvantages

1. Competitive Markets

2. Content
• Perfect competition
• Competition and resource allocation
• Dynamics of competition and competitive market
processes

3. Perfect Competition
• Perfectly competitive markets have a large number of firms
producing identical products
• As the products are the same consumers do not display a preference
for one firm over another
• There are no barriers to entry or exit so it is easy for firms to come in
to or leave the market
• All consumers have access to information on the firms and products
in the market place and they have good knowledge of the products
• Each producer is responsible for a very small % of the total quantity
supplied in the market
• Potential profits for firms in this type of market are low

4. Perfect Competition – Long run
• This is the long run
equilibrium position PQ
• The firm is making a
normal profit at this point

5. Perfect Competition – Short Run
• In the short run equilibrium price is determined by
the interaction of the market demand and market
supply curves
• The equilibrium price is the market clearing price
and this is used by all firms as they are price takers
• As market price is the same regardless of quantity
AR = MR
• In the short run if the price is above costs a
business is able to make supernormal profits

6. Perfect Competition
• The yellow area shows
profits earned by the firm
• The firm will be receiving
the supernormal profits
due to their cost curve
• Due to perfect knowledge
in the market any
differences in costs will be
eradicated in the long term
as firms know about each
others behaviour

7. Competition and the Efficient Allocation Of
Resources
• Given the following assumptions:
– Many small firms
– Complete freedom of entry / exit
– Many individual buyers
– Products are perfect substitutes
– Perfect knowledge
– Absence of externalities (private costs and benefits are equal to
social costs and benefits)
• Perfect competition results in the efficient allocation of
resources

8. Perfect Competition and Efficiency
• The model of perfect competition achieves
efficiency in three ways:
– Allocative efficiency: Price = MC and therefore
consumer and producer surpluses are maximised
– Productive efficiency: In the long run in perfect
competition equilibrium output is produced where
average costs are at their lowest point
– Dynamic efficiency: As products are all virtually the
same one business is unable to differentiate their
product and gain monopoly power

9. Perfect competition and assumptions
• In the real world the conditions of perfect competition rarely
exist
• Most markets have some barriers to entry / exit especially
barriers to contestability
• In the majority of markets some consumers purchase a
greater % of output than others giving themselves
increased power
• Most consumers face imperfect information and therefore
may not make informed choices about products

10. Perfect competition and assumptions
• Consumers are susceptible to other influences
when making their purchasing decisions such as
advertising and promotional tools
• Most products produce some externalities in
production and consumption
• Most products are not exactly the same – products
tend to be differentiated and therefore consumers
tend to prefer certain products to others

11. Perfect Competition – A Reality?
• One of the few markets that nears perfect competition is
the currency market because:
– All goods in the market are perfect substitutes
– There are a large amount of firms selling currency
– There are a large amount of consumers
– There is good quality information and most buyers / sellers have
a high degree of expertise
• However this is still not perfect as there are :
– Barriers to entry
– Government influences on the market

12. Dynamics of competition and competitive
market processes
• In addition to efficiency there are a number of
benefits that in the short and long run can lead to a
number of benefits
• In perfectly competitive markets firms need to keep
their costs to a minimum this results in reduced
wastage of resources
• Competition in the domestic market increases
international competitiveness resulting in gains from
trade

13. Benefits of Competition
• Short term:
• Firms are encouraged to make cost savings by:
– Increasing productivity
– Innovating
• This allows firms to cut the price of products
• Consumers benefit from lower prices, more choice
and higher quality products

14. Benefits of competition
• Firms in perfectly competitive markets also compete
on non price factors such as quality of service which
provide benefits for the consumers
• The main benefits of competition in the long term
relate to the efficient allocation of resources

15. Summary
• Perfect competition is a market structure with lots of small firms all
producing similar products
• This model is based on a number of assumptions including that firms
are price takers, there are no barriers to entry / exit and that products
are perfect substitutes
• In reality the majority of markets do not resemble the model of
perfect competition
• Perfectly competitive markets allocate resources efficiently within the
economy
• Perfectly competitive markets create advantages for the consumer
and the producer as they encourage costs to be reduced and
increase consumer choice