Competition Explained

Ashly Chole Senior Finance Researcher

Last Updated 26 March 2024

Competition

Although it seldom happens in actual markets, perfect competition is a valuable concept to consider when considering how a market operates. For instance, under this form of market system, there are several different types of flaws that might impact pricing and production. Due to the large number of producers and customers, the price will fluctuate until the market is cleared for a certain commodity or service. Because of imperfect competition, some businesses are small in comparison to other businesses and their operations. With this form of market system, there are additional flaws that may influence both pricing and output.

Definition

A market structure known as perfect competition occurs when several providers offer items that are competitively distinct. Each company in this scenario has no control over the price of its goods, and there are numerous customers who can select from a wide range of vendors. With the abundance of suppliers and consumers, it is unclear whether prices will decrease or if there will be a surplus when all businesses compete by selling at the same time. Due to the rarity of these conditions outside of academic settings—many producers manufacturing similar goods with no entry barriers for new businesses—perfect competition cannot exist in real-world marketplaces.

Benefits of perfect competition

The advantages of perfect competition are that it provides a useful framework for understanding how markets function and that ideal competition isn't always feasible in actual markets. In a market economy, supply and demand have an impact on pricing and behavior. In a market system known as perfect competition, there are numerous customers and sellers, no one can affect the price of a good or service, and all businesses sell the same thing. This indicates that there are a lot of customers and sellers, that each business is small compared to the industry's overall size, that buyers can obtain information about pricing and products, that there are no obstacles to entry or exit for companies, and that firms are powerless to affect prices. There are no impediments to entry or exit for businesses in a market with perfect competition. This indicates that any particular company can enter or exit the market without having an impact on the cost of an item or service. It also implies that customers have access to data on costs and goods, so they may make informed purchases.

Function of perfect competition

In a market arrangement called perfect competition, several providers would sell competitively diverse items to fully informed consumers. In other words, perfect competition happens when there are a lot of customers and sellers who can't control the amount or price of the good or service offered. Despite the fact that perfect competition is not necessarily the most effective method for all markets to function, it does offer a great foundation for comprehending how supply and demand impact pricing and behavior in a market economy. There are always entrance hurdles for new businesses in real-world marketplaces (such as unique resources or economies of scale). This implies that there is rarely ideal competition in the market system.

There are lots of buyers and sellers, no obstacles to new businesses and items entering the market, and similar products in a market with nearly perfect competition. In contrast, an oligopoly is a market structure where a small number of enterprises dominate sales in a particular industry. When one company has the sole right to produce a good or service or when the industry is dominated by a few large companies using similar production methods, an oligopoly may exist.

In actual marketplaces, perfect competition seldom occurs

A market system with perfect competition has a large number of providers and customers. It can be helpful in illustrating how supply and demand impact pricing and activity in actual markets. In a situation of perfect competition (PC), businesses create similar goods using the same labor, money, raw materials, and technological resources that are employed by all businesses to generate their output. No business is seen to have a considerable amount of market power, which means that it does not have enough influence over the price or quantity of its production to significantly alter the pricing system as compared to the prices or output of its competitors.

A market that is competitive is one where several vendors offer competitively unique items

When referring to a market with several competing providers, the phrase 'competitive market' is frequently used. Competition describes situations where businesses compete with one another by selling items at different price points and of varying quality in an effort to draw customers. With PC, businesses merely accept prices. The market price set by their rivals must be accepted because they have no influence over their prices. They have no control over the quantity sold and are powerless to change their own prices. Each company must accept the market price set by other companies in the sector, making each one a price taker. If all businesses are similar, then the industry supply curve will be the same as each firm's marginal cost curve. The total supply curve for a single firm is made up of its marginal cost curve plus its average fixed costs.

Since there are too many vendors and not enough buyers, prices frequently decline

Because there are too many vendors and not enough buyers in such marketplaces, prices frequently decline. As a result, the price of an item decreases when supply outpaces demand. So, in order to get rid of their inventory, sellers will be compelled to cut their prices. Less competition from other prospective customers means that purchasers who wish to pay less can do so for a particular good or service. Unless all sellers have turned in their stock at a price that is lower than it was before the entry of fresh competition into the market, this process continues.

This scenario leads directly back to equilibrium, the point at which supply and demand are equal, where each company is free to set its own prices without worrying that new competitors will enter the market or endanger its profitability by providing goods that are better suited to consumers' needs than those provided by established businesses.

Some businesses are small and inconsequential in comparison to other businesses and their operations due to imperfect competition

Some businesses are small and irrelevant in comparison to other businesses and their operations in an imperfect market. From one industry to another, the level of imperfection varies. A given sector could only have one or two major producers, or it might have dozens or even hundreds of producers vying for the same market share.

A new computer chip, for instance, is so crucial that it might make or break a company's operations moving forward. As a result, if only one company has access to this technology, it will be able to set prices higher than those demanded by any other business manufacturing comparable goods. Given that all sellers have equal access to data on demand trends, market circumstances, etc., we may argue that perfect competition is present in this environment. Companies are considered price-takers in these situations (as opposed to price-makers). As a result, they are forced to accept whatever price other sellers in the market are willing to provide for their goods. They are therefore not able to determine their own pricing for their goods.

Other types of imperfections

With a market system of this sort, there are still additional flaws that might influence output and pricing. Production and transportation charges are the two most frequent. Included in this are the expenses incurred in the procurement of raw materials, labor, and energy. Transporting products from one location to another is also included in the price. These expenses include taxes on the raw materials or intermediate products used in production, wages paid to the workers who produce these products, rent paid for the land where manufacturing takes place, interest rates paid on loans taken out by businesses to finance their operations, and advertising costs incurred when marketing products on behalf of the owners of businesses.

Production costs are frequently referred to as 'variable costs' since they change depending on the volume of output. Depending on the nature of the cost, input acquisition costs can be classified as either constant or variable. Fixed costs are those that don't change no matter how much is produced; variable costs are those that do.