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
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
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,
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.
Return to the IO index.