The level of competition in a market influences pricing and output decisions

“Competition refers to the process of active rivalry between the firms operating in a market as they seek to win and retain buyer demand for their brands”. (Pass & Lowes 1994) In any business, competition is necessary for companies to strive towards a more successful organisation. If a company had no competition they would not try to give the customer the best service or product at the lowest available price. They could and would charge any rate for the poorest quality good. There are many different models of market structure; perfect competition, monopolistic competition, oligopoly and monopoly.

A perfectly competitive market does not really exist but is essential for comparison purposes against the other market structures. There are several conditions that must exist for a market to be perfectly competitive. Firstly there is complete free entry and exist to the market place; “Perfect competition is characterised by; free market entry and exit, that is, there are no barriers to entry (hindrances to the entry of new firms) or impediments to the exit of existing sellers”. (Pass & Lowes 1994) Moreover it is assumed that both buyer and seller have perfect knowledge about the products and services available in the market place.

Consumers are presumed to know how good quality the product is or how competitive the price is compared to other firms. In a perfect market place there are to be no dominating industries that could determine prices, or control output. “There are a large number of buyers and a large number of sellers, none of whom are large enough individually to influence the market price”. (Perman & Scouller 1999) Thus a perfect market place is made up of small organisations, if they raised any of their prices the only impact would be on them selves by losing their own customers.

Customer loyalty in a perfect market does not exist as the consumer is only out to get the product at the cheapest possible cost. As there is no product differentiation or brand names the price is the only contributing factor. A perfectly competitive market is said to be a price taker as apposed to a price maker. A price taker; “Is forced to through a high degree of competition to price at a level which induces only normal profit as the consumer has perfect knowledge and will otherwise shop elsewhere”. (Anderson, Putallaz & Shepherd 1983) However a monopoly market is a price maker.

That is they can determine what price to charge the consumer as one industry can have a huge place in the market and dictate the price level. A perfectly competitive market has a horizontal demand curve (perfectly elastic demand curve) as all smaller firms can sell what they want but only for the same price as the other small firms. If they go above the equilibrium price the demand curve will not change as the consumers will not buy anything from that firm any longer. They are able to get the same product elsewhere at the lower price from one of the company’s competitors.

Therefore in a perfect market a company can never establish the price of a good, they will never get any business if they go above the equilibrium price. If a company cuts its prices it will not make any profit and will therefore go bankrupt and exit the market place. A question asked by a firm in a perfectly competitive market is how much should they produce? Choosing their output level that maximises their profit is a major decision. As stated in Anderson, Putallaz and Shepherd, that if a firm has reached its profit-maximising point of operation, then a one unit increase or decrease in output should reduce its profits.

These changes are referred to as marginal cost and revenue cost. In a perfectly competitive market if they produce anything less than the equilibrium price and output then each additional unit produced adds more to revenue than to cost, so profits will rise. Nonetheless, anything produced beyond the equilibrium price, adds more to cost than to revenue, so profits will fall or losses will rise. Thus producing more will do nothing to increase a firms profit so the output decision has to be to remain at the same constant level and just break even.

Therefore a perfectly competitive market place is one which has lots of small firms that only have a small part of the market share and cannot determine the price of any of their goods. If they did put their prices up nobody would buy from them and thus would only have to put the price back down to the equilibrium so as to sell any of their products. In a free market there is free entry and exit into the market place and both buyer and seller have perfect product knowledge. That is the consumer knows where to get the cheapest available product so would never buy from any company that raises their prices.

In addition there are no brand names in the market place or differentiation between goods so as no consumer can favour any particular good. Thus, because of the perfect competition in this market place if any firms choose to raise the price of their product no consumer will buy from them so they have to keep their price the same as the other companies. Also if any of the firms choose to make more of a certain product then it will cost them more to make the product, and because of the type of market place no consumer will buy any more from them so they will make a loss.

The perfectly competitive market is central to economics because it creates the yardstick for judging the economic efficiency of differing market structures”. (Perman & Scouller 1999) The only way that a firm in a perfectly competitive market can make money is to produce and charge at the equilibrium price and output level, which is the same as all their other competitors. This is the balance of the perfectly competitive market.