Effect of having a high number of firms on price, quality, choice, profit

Published by Patrick Mutisya · 14 days ago

Microeconomic Decision‑Makers: Types of Markets

Microeconomic Decision‑Makers – Types of Markets

Learning Objective

Understand how the number of firms operating in a market influences price, quality, consumer choice and the profitability of firms.

Key Market Structures

  • Perfect competition

  • Monopolistic competition

  • Oligopoly

  • Monopoly

Effect of a High Number of Firms

When many firms operate in a market, several outcomes are typically observed:

  1. Price: Tends to be lower because firms are price‑takers.

  2. Quality: Competition encourages improvements in product quality and innovation.

  3. Choice: Consumers enjoy a wider variety of products and brands.

  4. Profit: In the long run, economic profit is driven toward zero (normal profit).

Why Does This Happen?

MechanismExplanation
Price competitionFirms cannot set price above market equilibrium; otherwise, buyers switch to cheaper alternatives.
Product differentiationTo stand out, firms improve features, branding, or service, raising quality.
Entry and exitHigh profits attract new entrants, increasing supply and pushing price down until only normal profit remains.
Consumer sovereigntyWith many options, consumers dictate which firms survive based on preferences.

Illustrative Example

Consider a market for bottled water where the cost function for each firm is \$C(q)=50+2q\$, where \$q\$ is output in litres.

\$\$

\text{Average Cost (AC)} = \frac{C(q)}{q} = \frac{50}{q}+2

\$\$

If the market price falls to \$P=3\$ (due to many firms), the profit per firm is:

\$\$

\pi = (P - AC) \times q = \left(3 - \left(\frac{50}{q}+2\right)\right) q = q - 50

\$\$

Profit is zero when \$q=50\$ litres, illustrating the long‑run normal‑profit condition.

Implications for Decision‑Makers

  • Consumers: Benefit from lower prices, higher quality, and greater choice.

  • Firms: Must focus on efficiency, cost control, and product differentiation to survive.

  • Policy‑makers: May need to monitor for anti‑competitive behaviour, but generally encourage competition.

Suggested diagram: Supply‑demand interaction in a perfectly competitive market showing price equal to marginal cost and zero economic profit in the long run.

Summary Checklist

  1. Identify the market structure.

  2. Assess the number of firms and the likely impact on price.

  3. Consider how competition influences product quality and variety.

  4. Determine whether firms can earn economic profit in the long run.