Economics of Competition

The MES gives a range of production values, but its relationship with the market determines how many firms can operate effectively in the market.When MES is significantly smaller compared to the market demand then the market will be concentrated with small firms, each producing a very small market share. In this case, the firms which are comparatively small will enjoy a cost advantage over the larger firms. Consequently, the economies of scale are exhausted rapidly. An example of such a case is the market for personal services.When MES is one-quarter of the market demand, then the market observes a few large competitors. Such market economies of scale are created with a huge amount of inputs until each of the firms expands enough to produce a large share of the market.Economic theory explains that perfect competition is the most socially optimal market structure. But in reality, markets always deviate from perfect competition reducing the social welfare. Departure from the perfect competition gives way to market power. Most of the markets contain large firms and the presence of even a single large firm is sufficient to influence the price through output adjustment. Large firms are always coupled with cost advantages which help them to enjoy the economies of scale. And this ability to influence the market price is termed as market power.The highly concentrated market involves the accumulation of a very small number of firms sharing larger shares of the market. Such a condition is not desirable since it leads to high prices and low outputs. Consequently, the firms existing in such market accrue high profits and sustain for a long period of time. These firms, earning high profits, tend to lower the competition level in the market. Influencing the price thorough output adjustment is not the only way of using the market power by these firms. There are other ways to use market power.