Competitive Markets

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Chapter Nine: Competitive Markets
9.1 Market Structure and Firm Behaviour
Market structure: all features of a market that affect the behaviour and performance of firms in that market, such as the number and size of sellers, the extent of knowledge about one another’s actions, the degree of freedom of entry, and the degree of product differentiation. Competitive Market Structure

Market power: the ability of a firm to influence the price of a product or the terms under which it is sold. The competitiveness of the market is the degree to which individual firms lack such market power. A market has a competitive structure when its firms have little or no market power. The more power the firm has, the less competitive the market structure is. Perfectly competitive market (structure): when each firm has zero market power. * So many firms in the market that each must accept prices set by forces of market demand and market supply * Firms perceive themselves as being able to sell as much as they choose at the prevailing market price and having no power to influence the price. * If firm charges higher price: no sales (there are so many other firms selling at market price that buyers would go elsewhere) * There is no need for individual firms to compete actively with one another because none has any power over the market * One firm’s ability to sell its product does not depend on the behaviour of any other firm Competitive Behaviour

Competitive behaviour: the degree to which individual firms actively vie with one another for business. * American Express and Visa
* Engage in competitive behaviour
* Both have real power over the market
* Each decides the fees that people pay for the use of their credit cards (within limits set by buyers’ tastes and fees of competing cards) * Either can raise its fees and still attract customers * Actively compete in a market that does not have a perfectly competitive structure * Saskatchewan and Manitoba wheat farmers

* Do not engage in competitive behaviour
* Only way to affect their profits is to change their own outputs of wheat or production costs * Firms in perfectly competitive markets do not actively compete with each other. * Firms competing with each other don’t operate in perfectly competitive markets. The Significance of Market Structure

When a firm decides how much to produce to maximise profit, it needs to know the demand and the cost of production. Market structure:
* Allows us to determine how to get from the industry demand curve to the demand curve facing any individual firm in that industry * Plays a central role in determining the behaviour of individual firms * Plays a central role in the overall efficiency of the market outcomes 9.2 The Theory of Perfect Competition

Perfect Competition: a market structure in which all firms in an industry are price takers and in which there is no freedom of entry into and exit from the industry. * Applies to agricultural and raw material markets

* Allows comparison to me made to other markets
The Assumptions of Perfect Competition
1. All firms in the industry sell identical products
Homogenous product: in the eyes of the purchasers, every unit of the product is identical to every other unit. 2. Consumers know the nature of the product being sold and the prices charged by each firm. 3. The level of each firm’s output at which its long-run average cost reaches a minimum is small relative to the industry’s total output – each firm is small relative to the size of the industry 4. Freedom of entry and exit: existing firms cannot block the entry of new firms and there are no legal prohibitions or other barriers to entering or exiting the industry. Assumptions 1 -3: imply that each firm in a perfectly competitive industry is a price taker (a firm that can alter its rate of production and sales without affecting the market...
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