The markets for major grains, like wheat and corn, are perfectly competitive: individual wheat and corn farmers, as well as individual buyers of wheat and corn, take market prices as given. In contrast, the markets for some of the food items made from these grains—in particular, breakfast cereals—are by no means perfectly competitive. There is intense competition among cereal brands, but not perfect competition. To understand the difference between the market for wheat and the market for shredded wheat cereal is to understand the importance of the two necessary conditions for perfect competition.

First, for an industry to be perfectly competitive, it must contain many producers, none of whom have a large market share. A producer’s market share is the fraction of the total industry output accounted for by that producer’s output. The distribution of market share constitutes a major difference between the grain industry and the breakfast cereal industry. There are thousands of wheat farmers, none of whom account for more than a tiny fraction of total wheat sales.

The breakfast cereal industry, however, is dominated by four producers: Kellogg’s, General Mills, Post Foods, and the Quaker Oats Company. Kellogg’s alone accounts for about one-third of all cereal sales. Kellogg’s executives know that if they try to sell more cornflakes, they are likely to drive down the market price of cornflakes. That is, they know that their actions influence market prices, simply because they are such a large part of the market that changes in their production will significantly affect the overall quantity supplied. It makes sense to assume that producers are price-takers only when an industry does not contain any large producers like Kellogg’s.

Second, an industry can be perfectly competitive only if consumers regard the products of all producers as equivalent. This clearly isn’t true in the breakfast cereal market: consumers don’t consider Cap’n Crunch to be a good substitute for Wheaties. As a result, the maker of Wheaties has some ability to increase its price without fear that it will lose all its customers to the maker of Cap’n Crunch.

Contrast this with the case of a standardized product, which is a product that consumers regard as the same good even when it comes from different producers, sometimes known as a commodity. Because wheat is a standardized product, consumers regard the output of one wheat producer as a perfect substitute for that of another producer. Consequently, one farmer cannot increase the price for his or her wheat without losing all sales to other wheat farmers. So the second necessary condition for a competitive industry is that the industry output is a standardized product (see the upcoming For Inquiring Minds).