Wednesday, January 25, 2012


A market with a large number of buyers and sellers, such that no single buyer or seller is able to influence the price or control any other aspect of the market. That is, none of the participants have significant market control. A competitive market achieves efficiency in the allocation of scarce resources if no other market failures are present.
A competitive market is a market with a sufficient number of both buyers and sellers such than no one buyer or seller is able to exercise control over the market or the price. Efficiency is achieved because competition among buyers forces buyers to pay their maximum demand price and competition among sellers forces sellers to charge their minimum supply price for the given quantity exchanged.

Working the Market Model

Competitive Market
Competitive Market
The market model presented here depicts a typical competitive market that has achievedequilibrium. The market demand curve is labeled D and the marketsupply curve is labeled S. Competition among buyers forces the market price up to the maximum demand price on the demand curve. Competition among sellers forces the market price down to the minimum supply price on the supply curve. With competition among both buyers and sellers, the market price is simultaneously on both the demand curve and the supply curve.
This result is illustrated by the market equilibrium achieved at price Po and quantity Qo. The competitive forces of demand and supply automatically generate this market equilibrium. If the going market price is higher or lower than Po, creating a shortage or surplus, then competitive forces eliminate the imbalance and restores equilibrium.

The Invisible Hand of Efficiency

A competitive market is efficient because equilibrium is achieved where the demand price and supply are price equal.
  • Competition on the demand side forces buyers to buy a good at the maximum demand price that they are willing and able to pay. The demand price is the value society places on the good produced based on the satisfaction received.
  • Competition on the supply side forces sellers to sell the good at the minimum supply price that they are willing and able to accept. The supply price is the opportunity cost of production, which is the value of goods NOT produced.
Equality between the demand and supply prices means that the economy cannot generate any greater satisfaction by producing more of one good and less of another.
Competitive markets are the cornerstone of capitalism and a market-oriented economy. They efficiently address the scarcity problem and answer the three questions of allocation automatically (as if guided by aninvisible hand) with little or no government intervention.

Uncompetitive Markets

The real world contains some markets that come close to this competitive ideal and other markets that fall short. These real world markets can be grouped into three distinct market structures.
  • Monopolistic/Monopsonistic Competition: The most competitive real world markets are termed monopolistic competition or monopsonistic competition, depending on whether the focus is on the sellers (monopolistic) or the buyers (monopsonistic).
  • Oligopoly/Oligopsony: Real world markets with a modest amount of competition, but not a lot, are termed oligopoly or oligopsony, depending on whether the focus is on the sellers (oligopoly) or the buyers (oligopsony).
  • Monopoly/Monopsony: Real world markets that have no competition are termed monopoly, if there is only one seller, or monopsony, if there is only one buyer.

Other Market Failures

Competitive markets achieve an efficient allocation of resources as long as other market failures are not present. The lack of competition, also termed market control, is one key market failure. Three noted market failures are externalities, public goods, and imperfect information.
  • Externalities arise if the demand price does not fully reflect the value generated by the good or if the supply price does not fully reflect the opportunity cost production. As a result, the market equilibrium does not include all of the information about value and cost needed to achieve efficiency.
  • Public goods are goods characterized by nonrival consumption and the inability to exclude nonpayers. The use of the good by one does not impose a cost on others and no one can be prevented from consuming the good.
  • Imperfect information occurs if buyers or sellers do not know as much about the good as they should for an efficient allocation. In other words, buyers are not aware of the full value they obtain from consuming the good or sellers are not aware of all opportunity cost incurred in production.

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