Resources | Subject Notes | Economics
This section explores the impact of a large number of firms within a market. We will analyze how this market structure affects price, product quality, consumer choice, and the profitability of individual firms.
A market characterized by a high number of firms is typically referred to as perfect competition. Key features of this market structure include:
In a perfectly competitive market, individual firms are price takers. This means that no single firm can influence the market price. The market price is determined by the forces of supply and demand. If a single firm tries to charge a price above the prevailing market price, consumers will simply buy from other firms offering the same product at the lower price.
| Characteristic | Effect on Price |
|---|---|
| Number of Firms | Many |
| Product Type | Homogeneous |
| Market Power | None (Price Taker) |
| Price Determination | Determined by Market Supply and Demand |
Due to the intense competition, firms in a perfectly competitive market are incentivized to offer high-quality products. If a firm's product is of poor quality, consumers will readily switch to competitors offering better alternatives. This constant pressure ensures that firms continuously strive to improve their products and services to attract and retain customers.
The presence of many firms offering homogeneous products leads to a wide range of choices for consumers. Consumers can easily compare prices and qualities across different firms and select the option that best suits their needs and budget. The ease of switching between firms enhances consumer welfare.
In the long run, firms in a perfectly competitive market earn only normal profit. Normal profit is the minimum level of profit required to keep a firm in business. If firms are making economic profit (profit above normal profit), new firms will enter the market, increasing supply and driving down the market price. This process continues until economic profit is eliminated and firms earn only normal profit. Conversely, if firms are making economic losses, some firms will exit the market, decreasing supply and increasing the market price, eventually leading to normal profit.
The following table summarizes the long-run profitability of firms in perfect competition:
| Long-Run Profit | Status |
|---|---|
| Economic Profit | Attracts new firms to the market |
| Normal Profit | No incentive for new firms to enter or existing firms to leave |
| Economic Loss | Causes firms to exit the market |
A market with a high number of firms, such as perfect competition, results in lower prices, higher quality products, greater consumer choice, and normal profits for firms in the long run. The absence of market power ensures that firms operate in a competitive environment, constantly striving to meet consumer needs and maintain profitability.