Market structures range from perfect competition (many small firms in an industry) to monopoly (one firm).
A perfectly competitive firm has no power to alter the market price of the goods it sells: it is a price taker. The firm confronts a horizontal demand curve for its own output even though the relevant market demand curve is negatively sloped.
The competitive firm maximizes profit at that rate of output where marginal cost equals price. This represents the short-term equilibrium of the firm.
A competitive firm's supply curve is identical to its marginal cost curve. In the short run, the quantity supplied will rise or fall with price.
The determinants of supply include the price of inputs, technology, and expectations. If any of these determinants change, the firm's supply curve will shift. Market supply will shift if costs or the number of firms in the industry change.
If short-term profits exist in a competitive industry, new firms will enter the market. The resulting shift of supply will drive market prices down the market demand curve. As prices fall, the profit of the industry and its constituent firms will be squeezed.
The limit to the competitive price and profit squeeze is reached when price is driven down to the level of minimum average total cost. Additional output and profit will be attained only if technology is improved (lowering costs) or if demand increases.
If the market price falls below ATC, firms will exit an industry. Price will stabilize only when entry and exit cease (and zero profit prevails).
The most distinctive thing about competitive markets is the persistent pressure they exert on prices and profits. The threat of competition is a tremendous incentive for producers to respond quickly to consumer demands and to seek more efficient means of production. In this sense, competitive markets do best what markets are supposed to do— efficiently allocate resources.
