Competition

An industry is the set of all firms making the same product. The output of an industry is the sum of the outputs of its firms. Yet different industries have very different numbers of firms. Letters in the UK are delivered by the Post Office, which we call a nationalized industry because it is owned and run by the state. However, some sole suppliers are private firms. Eurostar is the only supplier of train journeys from London to Paris. In contrast, the UK has 200 000 farms and 30 000 grocers.

What about the size and number of firms in industry? Why indeed do some industries have many firms but others only one? These are questions about market structure.

The market structure is a description of the behavior of buyers and sellers in that market. First it is useful to establish two benchmark cases, the opposite extremes between which all other types of market structure must lie. These limiting cases are perfect competition on the one hand and monopoly or monopsony on the other hand.

A perfectly competitive market is one in which both buyers and sellers believe that their own buying and selling decisions have no effect on the market price. A monopolist is the only seller or potential seller of the good in that industry. A monopsonist is the only buyer or potential buyer of the good in that industry.

In a perfectly competitive industry nobody believes that their own actions affect the market price. Such an industry must have many buyers and many sellers. In London the New Covent Garden fruit market confronts many buyers with many sellers. Neither buyers nor sellers believe their own actions affect the market price. The perfectly competitive firm is too small to worry about the effect of its own output decision on industry supply. It can sell as much as it wants at the market price.

A monopolist is the sole supplier and potential supplier of the industry’s product.

The firm and the industry coincide. The sole national supplier need not be a monopolist if the good or service is internationally traded. The Post Office is the sole supplier of UK stamps and is a monopolist. British Steel, although effectively the sole UK steel supplier, is not a monopolist since it must compete with imports. Some monopolists are nationalized industries. The state market price and output decisions may not aim primarily to maximize profits.

Perfect competition and pure monopoly are useful benchmarks of extreme kinds of market structure. Most markets lie somewhere between these two extremes. What determines the structure of a particular market? How does the structure of an industry affect the behavior of its constituent firms?

A perfectly competitive firm faces a horizontal demand curve at the going market price. It is a price-taker. Any other type of firm faces a downward sloping demand curve for its product and is called an imperfectly competitive firm.

An imperfectly competitive firm cannot sell as much as at the going price. It must recognize that its demand curve slopes down and that its output price will depend on the quantity of goods produced and sold.

There are two intermediate cases of an imperfectly competitive market structure – an oligopoly and a monopolistically competitive industry. An oligopoly is an industry with only a few producers, each recognizing that its own price depends not merely on its own output but also on the actions of its important competitors in the industry. An industry with monopolistic competition has many sellers producing products that are close substitutes for one another. Each firm has only a limited ability to affect its output price.

In most countries the car industry is a good example of an oligopoly. The price Rover can charge for its cars depends not only on its own production levels and sales, but also on the decision taken by major competitors such as Ford and Toyota.

What makes oligopoly so fascinating is that the supply decision of its firm depends on its guess about how its rivals will react. However, one should take into consideration the basic tension between competition and collusion in all oligopolistic situations.

Collusion is an explicit or implicit agreement between existing firms to avoid competition with one another. Collusion and co- operation between firms is easiest when formal agreements are legally permitted. Such arrangements are called cartels. The most famous cartel is OPEC, the Organization of Petroleum Exporting Countries.