COMPETITIVE MARKETS
Product market: a market where goods are sold, eg cars and apples
Market structures: a way of describing the characteristics of a market in terms of its make up.
The structure of a market will influence how firms behave in that market, which has an effect upon resource allocation.
Competitive markets: a market whose operation should lead to an improvement in resource allocation
Characteristics
Many small firms: they are unable to influence the market price, ie they
are price takers having a very small share of the overall market
Very low barriers to entry and exit: it is very easy for potential
competition to enter and leave the industry in response to profit signals
Perfect knowledge: firms inside and outside the industry are aware of
current market conditions and will allocate resources in response to profit
signals in different markets
Type of product: products produced by firms are identical, or
homogeneous, meaning that firms have to compete with each other price
Motive of firms: firms aim to maximise profits so will always be looking
to produce the goods which will allow them to do so.
Implications of competitive markets
Firms will be seeking to maximise profits. They will move their resources
into industries which allow them to do this. However, competitive pressures will
be such that, firms will not be able to make abnormal profits in the long
run. If excessive profits are made in the short run, it will attract new firms
into the industry who compete prices and profits down. In the long run, only normal
profits can be earned.
Consumer sovereignty is important. Firms will only produce those goods which consumers want to purchase. This information will be conveyed through the workings of the price mechanism:
Demand rises = prices increase = incentive for firms to make more = supply rises = more resources moved into the industry
Demand falls = prices fall = profits fall = firms switch resources into other activities which generate bigger profits
Assessing competitive markets
Theoretically competitive markets should lead to an efficient allocation of resources:
Consumer sovereignty ensures that firms only produce the
goods which consumers want
Competitive pressures result in productive efficiency as firms are forced
to minimise production costs
Competitive pressures force prices down leading to allocative efficiency
Competition forces firms to underatke R&D to bring new products to the market
to give them a competitive advantage over rivals. Dynamic efficiency
should result
Competitive pressures, along with the workings of the price mechanism ensures that these industries generate an efficient allocation of resources.
However, the nature of competitive markets might mean that efficient resource allocation is not maximised:
Firms might not earn enough profits to undertake R&D to
bring new products to the market. Individuals might not have access to a wide
range of products
Firms, given their size, might not be able to achieve economies of scale which
might limit their productive efficiency gains
Firms are only concerned with their own costs and benefits. Any externalities
will be ignored when prices are set, which could lead to a misallocation of
resources
Whilst there might be productive and allocative efficiency, the pattern of
income distribution might mean that best combination of goods is produced