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Up to now, our discussions of demand and supply, their interaction, and firm’s profits have assumed a perfectly competitive market, which has the following characteristics:
- Many small buyers and sellers
- Similar products
- Easy entry and exit
Many small buyers and sellers means that each buyer’s consumption and each seller’s output is small compared to the overall volume of trade. Similar products means that one supplier’s output is essentially indistinguishable from another’s: the two are perfect substitutes. Easy exit means that if firms in the market are steadily losing money (\(p < ATC\), as discussed at the end of the Firm’s Profit chapter), they can easily leave the market. Easy entry means that if firms in the market are reliably earning a profit (\(p > ATC\)), new firms can easily enter the market to take advantage of the opportunity to earn profits, too.
The effect of all these conditions is to drive the price toward a point where all firms in the market have the same costs and are earning just enough to cover their costs (\(p = ATC\)), and everyone in the market is a price taker who has to accept the market price as a given. No seller or buyer, in other words, is big enough to manipulate the price by altering their output or consumption quantity.
In this chapter, we take a look at imperfect markets, which for one reason or another aren’t perfectly competitive.
