🏪 Many firms
There are lots of sellers, so each one has only a small share of the market. Customers have many places to buy from.
Types of Markets » Competitive Markets
What you'll learn this session
Study time: 30 minutes
Cambridge spec: 3.7.1
- What a competitive market is and its main characteristics
- How a high number of firms affects price, quality, choice and profit
- The advantages and disadvantages of competitive markets
- How to answer exam questions on competitive markets
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Unlock This CourseWhat is a competitive market?
Think of a busy street food market where 25 stalls all sell noodles. If one stall puts up its prices, hungry customers simply walk ten steps to the next stall. Each stall has to work hard to win and keep customers. That is a competitive market.
In a competitive market, many firms compete with each other to sell to buyers. No single firm is big enough to control the market.
Key terms:
- Competitive market: a market with many firms competing with each other for customers.
- Barriers to entry: anything that makes it difficult or costly for a new firm to start selling in a market.
- Competition: firms trying to win customers from each other, for example by offering lower prices or better quality.
Characteristics of competitive markets
Competitive markets usually have these four characteristics:
🚪 Low barriers to entry
It is easy and cheap for a new firm to start up, for example with a small amount of money and no special licence.
🛍 Similar products
The goods or services are very alike, so customers see little difference between one firm and another. Buyers often choose on price.
💰 Little control over price
Because customers can easily switch, a firm that charges much more than its rivals loses sales. So a firm has little control over the price it can charge.
Notice how these fit together. Low barriers to entry bring in many firms. Many firms selling similar products leaves each firm with little control over price.
The effect of a high number of firms
When there are many firms in a market, four things tend to happen.
- Price: prices tend to be lower. Firms must keep prices down or customers will switch to a rival.
- Quality: firms often try to improve quality to stand out from rivals, so quality tends to be higher for the price paid.
- Choice: consumers have more choice, with many sellers and often many different versions of a product.
- Profit: profits tend to be lower, because lower prices mean less revenue for each firm and the firms share the customers between them.
Here is a made-up example from the town of Havora. The table shows how the price of a box of noodles might change as more stalls open.
| Number of noodle stalls | Price of a box of noodles |
|---|---|
| 3 | $5.00 |
| 10 | $4.00 |
| 25 | $3.00 |
As the number of stalls rises, price falls. Customers gain, but each stall earns less profit on every box sold.
Low barriers to entry also explain why high profits do not last. If noodle stalls were making large profits, other people would see this and start their own stalls. The extra firms push the price down, and profits fall back.
Advantages and disadvantages
✅ Advantages
For consumers: lower prices, better quality and more choice.
For firms: competition gives them a reason to be efficient and to keep their costs low.
For the economy: firms that satisfy customers survive, so resources are used to produce what people want.
❌ Disadvantages
For firms: low profits, and some may be forced out of business.
For workers: jobs may be lost when firms close.
For the market: small firms with low profits may not be able to afford to invest in new machines or research.
So a competitive market is usually good news for consumers. For firms and their workers it can be hard work, with low profits and a risk of closing.
Common mistakes
1. Saying firms in competitive markets make no money at all. They make lower profit, not zero.
2. Forgetting to say why price falls. It falls because customers can switch to rival firms.
3. Only listing characteristics. In the exam, link each one to its effect, for example "many firms, so customers can switch, so firms keep prices low".
4. Giving only one side. Questions that ask you to discuss need an advantage and a disadvantage.
Exam-style question
Caldris is a made-up town with 30 small hair salons. All of them offer very similar haircuts. A new salon can open with a small loan and a rented chair, and the salons often have to lower their prices to attract customers.
(a) Identify two characteristics of a competitive market shown in the information. [2 marks]
(b) Explain how a high number of firms may affect the price and the choice available to consumers in Caldris. [4 marks]
(c) Discuss whether a competitive market is good for everyone in Caldris. [6 marks]
Model answer
(a) Many firms (30 salons) (1). Low barriers to entry, because a new salon can open with a small loan and a rented chair (1). (Other correct answers: similar products; little control over price.)
(b) Price: with many salons offering similar haircuts, customers can easily switch to a cheaper salon (1), so salons keep their prices low (1). Choice: there are 30 salons to pick from (1), so consumers have a wide choice of where to go and what service to buy (1).
(c) For consumers, it is good because prices are lower and quality may be higher as salons compete for customers (1). They also have more choice (1). For salon owners, it is less good because lower prices mean low profits (1), and some salons may be forced to close (1). Workers in those salons could then lose their jobs (1). Overall, a competitive market mainly benefits consumers, but firms and their workers may lose out (1).
Exam tip
For part (c), write one paragraph for each side and finish with a short conclusion. You must say who gains and who loses, because the question asks about "everyone".