Competitive Markets.html

Competitive Markets

Competitive markets are assumed to efficiently allocate resources to the production of goods and services. However, competitive markets are not perfect. They often do not allocate resources to the production of socially desired goods, such as police protection, because people who receive such goods or services cannot be forced to pay for them. Alternatively, sometimes, the market allocates too many resources to harmful activities, such as production activities that pollute the environment at no cost to the producer. When either of these events occurs, it results in market failure. Market failure is often called an externality, which can be positive or negative.

Positive externalities are situations in which a third party benefits from a transaction between some other parties. For example as society in general benefits from a higher level of education in the workforce, the government intervenes and provides funding to encourage allocation of more resources to education—more than what the markets would allocate if left alone.

Negative externalities are situations in which part of the cost of providing a good or a service is borne by a third party to the transaction. Assume the production process of a product involves disposing of contaminants into the air. Those exposed to the contaminants may fall ill. In this case, while the company pays for electricity, raw materials, and other inputs, the individuals exposed to the contaminants bear the negative effects—medical expenses and poor quality of life—of air pollution.

Most companies are characterized as competitive companies to some degree and have some control over price and output. Perfect competition is a theoretical model and does not exist in reality. Given the following conditions, competitive companies make decisions regarding prices and output levels:

• There are a large number of buyers and sellers.
• The products are somewhat homogeneous.
• Entry into and exit from the market are relatively simple.
• There is non-price competition, that is, a company tries to distinguish its product from competing products on the basis of a factor other than price.