Competitive market

  • In the late 18th century Adam Smith wrote about the impact of competition on firms’ abilities to set prices and make profits above a “natural” level.

    However, there was no formal analysis of the situation until British economist Alfred Marshall published Economic Principles in 1890. The ideas in Marshall’s model remain a key part of mainstream economic theory, although the theory has been criticized as not representing the true nature of competition.

  • The assumptions of Marshall’s model create certain consequences for firms in perfectly competitive industries. One of the most important of these is that firms have no power over the price that they can charge. This is because there are so many firms selling an identical product that if any one firm attempts to sell at a price higher than its competitors, it will sell nothing. This is virtually guaranteed because the consumer has perfect knowledge about the prices being asked by all firms. In this way the market price is determined by the collective interaction of all the firms and consumers, and each firm has to accept that one particular price is the price at which they can sell the product. They have to “take” the price, not make it.

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