Competitive Markets (Cambridge (CIE) IGCSE Economics): Revision Note

An introduction to competitive and monopoly markets

• Each firm operates in a specific market

• The conditions in different markets can vary significantly and are determined by the market structure in which the firm operates

  • Competitive markets are those with an extremely high degree of competition

  • A monopoly is a market structure in which one firm dominates the market and has significant market power

Characteristics that determine if a firm is in a competitive or monopoly market

• The answers to the questions above determine the type of market structure in which a firm is operating in

  • If a firm is selling a unique product (e.g. handmade car) it is likely operating in a monopoly market and setting high prices

Characteristics of competitive markets

• A competitive market is a market structure where a large number of buyers and sellers trade similar or identical products, and no single buyer or seller can influence the market price

1. Many buyers and sellers

• There are many sellers, as it is easy to set up businesses in a competitive market structure

  • Often, low capital or specialist knowledge is required

• There are many buyers; competitive markets often sell mass-produced goods such as t-shirts

2. No barriers to entry and exit from the industry

• Barriers to entry are conditions that make it difficult or expensive for a firm to enter a market to compete with the existing suppliers, e.g., high start-up costs

• Firms can start-up or leave the industry with relative ease, which increases the level of competition

3. Buyers and sellers possess perfect knowledge of prices

• This assumption presupposes perfect information, e.g., if one seller lowers their price then all buyers will know about it

4. The products are homogenous

• Homogeneous products mean that products sold by competing firms are identical and indistinguishable from each other

  • This means firms are unable to build brand loyalty, as perfect substitutes exist and any price changes will result in losing customers

5. Price takers

• Individual firms cannot influence market price; they must accept the market price set by demand and supply forces

Advantages and disadvantages of competitive markets

Effect of a high number of firms

• Price: More competition drives prices down towards the cost of production

• Quality: Firms must improve quality or service to stand out

• Choice: Consumers benefit from a wide range of suppliers and product variations

• Profit: Individual firm profits are likely to be lower, especially in the long run, as competition erodes abnormal profits