The market for wheat is often taken as an example of a competitive market, because there are many producers, and no individual producer can affect the market price by increasing or decreasing his output. For this reason, each farmer takes the market price as predetermined. A wheat farmer doesn't have to worry about what prices to set for his wheat - if he wants to sell any at all, he has to sell it at the market price. In other words he is a price taker. The price is pre-determined as far as he is concerned and all he has to do is to decide on how much to produce at that price.

A perfectly competitive industry is characterized by many small firms producing the same good under similar cost conditions.

In a perfectly competitive market each firm assumes that the market price is independent of its own level of output. Thus each firm only has to worry about how much output it wants to produce. Whatever it ends up producing can be sold at the going market price. Finally the buyers can costlessly observe prices and can buy at the lowest price.

IO theory predicts that in a competitive market, the price is at the intersection of the supply and demand, where the marginal value of the last unit purchased is equal to the marginal cost of the last unit produced.

Typically there are a few more assumptions added to the above description such as free entry and exit of participating firms, perfect divisibility of output and no externalities in either the production or the consumption of the good. Although a traditional description of a perfect competition outcomes presumes these conditions, recent experimental work has seriously challanged the necessity of some these assumptions. To read a brief discussion on some of these issues, click here.

Experiments on the competitive market model are included in MarketLink. If you haven't yet used MarketLink to run an experiment, go to the MarketLink page for information. If you are familiar with MarketLink, you can add these experiments to you profile from the competitive market experiment configurations page.

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