Unit 6: Market Structures
Lesson 6.1: Perfect Competition
Perfect Competition
What You Will Learn!
 What a market structure is. SS.912.E.1.6.
 What is perfect competition, and its characteristics. SS.912.E.1.6.
In the last few units, we examined how consumers make choices about the
products they buy, how producers make choices about the products they make, and
how the interaction between consumers and producers in the market determine prices.
In this unit, we’re going to take a closer look at the producer side of things, specifically
how producers compete (if they compete at all), and what the effect of that competition
is on consumers.
Key Point #1. A market structure is how competition in a particular market,
or industry, is organized.
Quick, thinking about the market for
smartphones, how many companies can you think of
off the top of your head that make them? Apple and
Samsung
Samsung may very well come to mind, and maybe a
Apple
few companies like LG and Huawei. For the most
Huawei
part though, Apple and Samsung rule the industry.
LG
Apple’s iPhone is seemingly everywhere, but
Lenovo
Samsung seems to make up the rest of smartphones
Others
out on the market. In fact, according to research firm
International Data Corporation, Apple and Samsung control a large part of the market,
with Samsung having a market share of 31.3% and Apple having a market share of
15.3%. A market share is how much of the market is controlled by a company or
dominated by a product. In the smartphone market, Samsung and Apple combined
make for a market share of 46.6% of the entire market. Their closest competitor is
Huawei at 4.9%. Given how much of the market goes to Apple and Samsung, we can
say that there’s not a lot of competition going on in this market.
That’s where market structure comes in. A market structure is how competition
in a particular market, or industry, is organized. Some market structures are very
competitive; some are not. In this unit, we will look at four market structures: perfect
competition, monopoly, oligopoly, and monopolistic competition. With each market
structure, there are four characteristics that help us identify what type of market the
industry is in:
 Number of producers
 Product similarity
 Entry into market
 Control over price
Company
2013 Market
Share
31.3%
15.3%
4.9%
4.8%
4.5%
39.3%
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Unit 6: Market Structures
Lesson 6.1: Perfect Competition
Key Point #2. Perfect competition is a market structure where a large
number of producers supply the same product.
The first market structure we’ll discuss is perfect competition. In perfect
competition, a large number of producers supply the same product. In terms of
efficiency, perfect competition is considered the most efficient, and the most
competitive. The price of the products are determined by the market, and sold at
equilibrium, or market price.
Many producers. Perfect competition has lots and lots of producers. The large
number of producers promotes competition in the market. When we talked about the
smartphone market earlier, we saw that Samsung and Apple controlled almost half the
market, with the rest of the competitors having less than 5% market share each. There
just aren’t that many producers of cellphones, and a quick scan of the wall of phones at
an AT&T or Sprint store can confirm that. Because of that dominance, Samsung and
Apple have a large amount of influence on the smartphone market. If Samsung or
Apple (or both) make any kind of changes in production it will have a significant effect
on the market because they control so much of it. Case in point, Apple’s introduction of
the color iPhone at $99, compared to their more expensive phones, could attract more
consumers to the Apple brand.
In a perfectly competitive market, however, the amount of influence is limited
because of the large amount of producers. In perfect competition, even significant
changes by a producer in what they produce would have no influence in the market. No
one single producer has a large market share because there are so many producers
competing with each other over the same identical product.
Identical products. And that
brings us to the second characteristic:
identical products. Products in perfect
competition are identical, or, at the very
least, very similar. Consumers do not
see a difference between the product
sold by one producer or another.
These products are considered
commodities. A commodity is a
product that is the same regardless
who sells it.
How would a product be the same no matter who sells it? Look at the tasty
beverage of milk. Milk comes from cows. A cow in Florida is the same as a cow in
California. Cows produce milk. If we were to make a comparison between the milk
produced by a Florida cow and a California cow, we ultimately would not see a
difference. It’s milk. We drink it, put it in coffee, pour it on cereal. No matter how happy
the California cows might be in providing milk, you can rest assured that the milk
produced by our local dairy T.G. Lee is just as tasty and creamy.
Free entry and exit into the market. In perfect competition, there are no real
barriers to entry on entering the market. A barrier to entry is anything that makes it
difficult to enter into a market. High start-up costs, government regulations, and limited
resources to make the product are examples of barriers to entry. At the same time,
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Unit 6: Market Structures
Lesson 6.1: Perfect Competition
there’s nothing stopping a particular company from shutting down their business and
leaving the market altogether. In other words, businesses can come and go as they
please.
Why would this be important? Well, let’s revisit Orange City’s pizza market from
Lesson 5.3 for a second. Bumbino’s is the only pizzeria in town, and they’re making a
fairly hefty profit per pie. Assuming that this was a perfectly competitive market and that
all pizza is identical, that is, pizza is a commodity, we could see other pizza makers
enter the market to sell pizza and make money too: Stavro’s and Jay’s. Of course, now
that there’s more competition, the three pizzerias will also end up sharing the market,
which means that profits can and will drop, and will do so as more pizza guys enter the
market. Eventually, so many pizzerias will enter the market that profits start to become
losses. Once they start taking losses, we’ll see pizza guys exiting the market to go do
something else, like make Chinese food or tacos, or maybe even a Chinese taco.
Free entry and exit into the market helps ensure competition among producers,
which causes them to adapt to any change in the market. At the same time, it prevents
existing producers from keeping somebody new out.
No control over price. Finally, in perfect competition, producers have no control
over price. Why? First off, there are so many producers. Since there are lots of
producers, no one producer really dominates the market with a huge market share and
can’t really influence price. Additionally, producers will come and go as profits increase
or decrease. Second, the products in perfect competition are commodities, identical,
and consumers don’t see a difference between them. Because of that, they’ll buy
whatever is cheapest. If a producer were to raise his price, the consumer would just
find someone else to buy from. If Wal-Mart brand milk and Publix brand milk were
sitting side by side, and the Wal-Mart milk was $3.79 a gallon, and the Publix milk was
$4.29 a gallon, it’s a good bet that you’re going to choose the Wal-Mart milk because
you wouldn’t see a difference.
Market Structure Characteristics
Perfect
Monopoly
Oligopoly
Competition
Number of
Producers
Product
Similarity
Entry and Exit
Control over
Price
Many
identical,
commodities
free
none
3
Monopolistic
Competition
Unit 6: Market Structures
Lesson 6.1: Perfect Competition
So what’s a good example of a
perfectly competitive market? When
you’re driving past citrus groves in
DeLeon Springs or Oak Hill, you’re
looking at a relatively perfectly
competitive market. The citrus industry
in Florida has lots of producers in almost
every county and across the state from
Miami to Pensacola. When you buy an
orange off the side of the road on State
Road 44, there is no difference between
that orange and the one you buy at the
New Smyrna Farmers’ Market. An
orange is an orange. There’s no real
barriers to entry or exit in the citrus industry, other than start-up costs of buying land,
planting trees, and, of course, time. Finally, because there’s so much competition in the
market, the average price for a box of Florida oranges was $9.73 in 2012.
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Unit 6: Market Structures
Lesson 6.1: Perfect Competition
Wait, why “relatively”? Here’s where
things get interesting. When we started our
discussion on perfect competition, we said
that prices and quantity were set at
equilibrium. All that competition between
producers drives down prices to the bare
minimum. What we mean is that in perfect
competition, the profits that producers make
are just enough to cover their costs, both
fixed and variable, and no more.
So, in perfect competition, nobody
makes any real profit? It all just zeroes out?
Yes, that’s correct. Sellers are selling the
product for the exact amount that it costs to
make it and buyers are buying the product
for that exact amount.
How realistic is this? If you were to open your own business, it’s a good bet that
you’d want to make more money than just enough to cover your costs. You probably
want to make mountains of cash like every good red-blooded American, right? In the
real world, perfectly competitive markets don’t really exist.
“Wait, you just made me read this for 15 minutes, and you’re telling me, it isn’t
real?” You mad, bro? Why in the world would we even discuss this if it doesn’t really
matter? Well, actually, perfect competition does matter. Economists want to model the
economy the best they can so that they can make accurate predictions about consumer
and producer behavior—what choices they will make given a certain set of
circumstances. Perfect competition gives us a model of what happens in a market
where everything is, well, perfect. Producers are producing the exact amount
consumers want at the exact price, with absolutely nothing going to waste, the very
picture of efficiency. No one is taking advantage of another, everyone is behaving
appropriately and as they should be.
In the end, perfect competition is a baseline of how the market should be when
everybody is behaving. We need this baseline to make a comparison, so that we can
see what happens when somebody is misbehaving, that is when competition is
imperfect: monopoly, oligopoly, and monopolistic competition.
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