Market Structure and Perfect Competition

• Module 24: Introduction to Market Structure
• Module 25: Perfect Competition
• Module 26: Graphing Perfect Competition
• Module 27: Long-Run Outcomes in Perfect Competition

DOING WHAT COMES NATURALLY

Food consumers in the United States are concerned about health issues. Demand for natural foods and beverages, such as bottled water and organically grown fruits and vegetables, increased rapidly over the past 25 years at an average growth rate of about 20% per year. The small group of farmers who had pioneered organic farming techniques prospered thanks to higher prices.

But everyone knew that the high prices of organic produce were unlikely to persist even if the new, higher demand for naturally grown food continued: the supply of organic food, although relatively price-inelastic in the short run, was surely price-elastic in the long run. Over time, farms already producing organically would increase their capacity, and conventional farmers would enter the organic food business. So the increase in the quantity supplied in response to the increase in price would be much larger in the long run than in the short run.

Where does the market supply curve come from? Why is there a difference between the short-run and the long-run supply curve? In this section we will use our understanding of costs, developed in Section 8, as the basis for an analysis of the market supply curve. As we’ll see, this will require that we understand the behavior both of individual firms and of an entire industry, composed of these many individual firms.

Our analysis in this section assumes that the industry in question is characterized by perfect competition. We begin with an introduction to market structures, a system economists use to classify markets and industries according to two main dimensions. Perfect competition is actually one particular type of market structure, along with monopoly, oligopoly, and monopolistic competition (we will look at these three other types of market structures in upcoming sections). We continue by explaining the concept of perfect competition, providing a brief introduction to the conditions that give rise to a perfectly competitive industry. Then we show how a producer under perfect competition decides how much to produce. Finally, we use the cost curves of the individual producers to derive the industry supply curve under perfect competition.

By analyzing the way a competitive industry evolves over time, we will come to understand the distinction between the short-run and long-run effects of changes in demand on a competitive industry—for example, the effect of America’s new taste for organic food on the organic farming industry. We conclude with a more in-depth discussion of the conditions necessary for an industry to be perfectly competitive.