Cambridge IGCSE Economics 0455 – Microeconomic Decision‑Makers: Types of Markets
Microeconomic Decision‑Makers – Types of Markets
Objective
To understand the characteristics, advantages and disadvantages of competitive markets.
1. What is a Competitive Market?
A competitive market (also called a perfectly competitive market) is a market structure in which many buyers and many sellers interact, each of whom is too small to influence the market price. The key features are:
Large number of buyers and sellers.
Homogeneous (identical) products.
Free entry and exit of firms.
Perfect information – all participants know prices and product characteristics.
Price takers – individual firms accept the market price.
2. Diagrammatic Representation
Suggested diagram: Supply and demand curves intersecting to show market equilibrium price (P*) and quantity (Q*) in a competitive market.
3. How Firms Decide in a Competitive Market
Firms aim to maximise profit. In the short run they produce where marginal cost (MC) equals marginal revenue (MR), which is also the market price (P) because they are price takers:
\$\text{Profit maximisation condition: } P = MR = MC\$
In the long run, entry and exit drive economic profit to zero, so firms produce at the minimum point of their average total cost (ATC) curve:
\$P = MC = \min(ATC)\$
4. Advantages of Competitive Markets
Allocative efficiency: Resources are allocated where they are most valued because P = MC.
Productive efficiency: Firms produce at the lowest possible cost (minimum ATC).
Consumer sovereignty: Consumers dictate what is produced through their purchasing choices.
Innovation incentives: While short‑run profit is limited, firms seek cost‑reducing innovations to stay competitive.
Dynamic price mechanism: Prices adjust quickly to changes in supply or demand, signalling scarcity or surplus.
5. Disadvantages of Competitive Markets
Limited product differentiation: Homogeneous goods may not satisfy diverse consumer preferences.
Under‑provision of public goods: Competitive markets may not supply goods that are non‑excludable and non‑rivalrous.
Externalities not internalised: Firms ignore positive or negative spill‑effects unless regulated.
Short‑run instability: Prices can be volatile due to shifts in demand or supply.
Barriers to entry in practice: Although theory assumes free entry, real‑world factors (capital, technology, regulation) can impede new firms.