In microeconomics, competition is influenced by five factors: product features, the number of sellers, barriers to entry, information availability, and location. Each factor hinges on the availability or attractiveness of substitutes, and most markets lie somewhere between perfect competition and monopoly.
1. Product Features
Product features describe its level of differentiation. If a company’s product is similar to others already on the market, the good or service is indistinguishable from products sold by competitors. This situation would imply heavy competition. Alternatively, a product might be completely differentiated or unique with low levels of competition.
2. Number of Sellers
The number of sellers impacts competition. If there are many sellers of an undifferentiated product, competition is considered high. If there are few sellers, competition is low. If there is a single seller, the market is regarded as a monopoly.
3. Barriers to Entry
Barriers to entry can influence the number of sellers. Market characteristics such as high capital investment requirements or heavy regulation may prevent new companies from entering the market, which in turn provides a level of protection to existing firms. With lower competition through barriers to entry, firms will be able to charge higher prices.
4. Information Availability
Information availability revolves chiefly around price discovery. When customers can efficiently and accurately define prices across competitors, companies are unable to set prices, and competition is robust.
5. Location
A proactive location strategy can corner potential customers and reach them more effectively than the competition. For example, gas stations are often strategically located on busy corners.
Levels of Competition
Most markets are somewhere in between perfect competition and monopoly. In perfect competition, each firm’s marginal profit equals marginal cost. There is no economic profit. In a monopoly, the marginal profit equals marginal revenue, which is the incremental revenue generated from selling one more unit.
Companies in perfect competition are considered price takers, meaning that they have no scope to set prices, the reason why marginal profit is equal to marginal cost. Perfectly competitive markets are defined by a homogeneous product, many sellers with low market share, and no barriers to entry or exit. These firms cannot differentiate their products, and their customers have highly accurate information.
Check out my video on the topic: https://www.youtube.com/watch?v=Ko2vplHn2dY
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