Why is perfect competition often described as the “ideal” market structure?
The concept of competition has a twofold application in economics. First, in certain settings, firms compete with each other to take the largest share of the market. Second, in other settings, the decisions made by buyers and sellers do not affect the overall operations of the market about the prices of products (Kreps, 2013). Perfect competition is often described as the “ideal” market structure because individual buyers and sellers are small components of the entire market, and their operations do not affect the prices of products and services (Kreps, 2013).
In that regard, prices are determined by market forces and not by firms and consumers. Besides, perfectly competitive markets do not have barriers to entry, sellers offer identical (homogeneous) products, and numerous small firms are competing with each other. These firms take market prices as they are, and do not try to alter them in any way. Under perfect competition, the volume of products on offer is very high, and the prices are low (Kreps, 2013).
This market structure benefits consumers as they get a variety of products and services at low prices. The stability of prices is maintained because individual firms have no market power (they are price takers). The output of a single firm is insignificant when compared to the total output of the market. Consumers have access to complete information about the market, including the commodities available as well as the prices (Kreps, 2013).
Firms are profit maximizers because they determine the number of products to supply based on market prices. Perfect competition is also beneficial to suppliers due to efficient production processes. Examples of entry barriers include social, political, and economic factors. However, these factors play insignificant roles in preventing entry because common obstacles include technology and patents.
Why does a high elasticity indicate a very competitive market?
A high elasticity indicates a very competitive market because of the changes in supply and demand. In that regard, consumers are more responsive to changes in market factors such as prices, income, and supply of products (Penner, 2013). High elasticity exists in markets with numerous firms that supply homogeneous products and services to consumers. The prices of commodities are determined by market forces, and so, firms play an insignificant role in price determination. For example, a firm cannot increase the prices of its products because such an attempt would prompt customers to buy the products of firms that offer lower prices.
In that regard, prices remain low and firms refrain from attempts to alter them in their favor. An increase in demand leads to higher prices that consequently lead to higher profits (Penner, 2013). Existing firms respond to the increased prices and demand by stepping up their output. Also, new firms enter the market and introduce their products. As a result, there is an increased supply of products and decreased product prices (Penner, 2013).
The prices fall so low that all the profit is shared among existing and new firms. The original firms try to address the situation by returning to their original output. However, the influx of new companies leads to an increase in the total market output. In a perfectly competitive market, an increase in price results in a decrease in the quantity demanded (Penner, 2013). In that regard, price is determined by market demand and supply. The demand curve of a firm in a competitive market is horizontal, meaning that if the firm decides to raise the prices of its products above the prevailing market price, then the demand for its products would lower to zero (Penner, 2013).
Kreps, D. M. (2013). Microeconomics foundations I: Choice and competitive markets. Princeton, NJ: Princeton University Press.
Penner, S. J. (2013). Economics and financial management for nurse and nurse leaders, 2nd ed. New York, NY: Springer Publishing Company.