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Lecture

BSEN 401 Lecture Notes - Ceteris Paribus, Imperfect Competition, Monopsony


Department
Business and Environment
Course Code
BSEN 401
Professor
William Huddleston

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Competitive Markets
Definition: Competition is Price Taking
Analysis of competition dates from at least Aristotle. Adam Smith described competition as
‘many buyers and sellers’ in his revolutionary discussion of the benefits of competitive markets
in his 1876 The Wealth of Nations, but it was only at the end of the nineteenth century that
economists formulated the modern analytic definition. The modern definition captures Smith’s
meaning that buyers or sellers cannot influence price in a competitive market. It also simplifies
the analysis of competitive behaviour since households and firms respond to a given price with
no ability to change that price.
Imperfect competition occurs when a buyer or seller can influence price. The most extreme
examples are monopoly (single seller), which we shall discuss later in the course, and
monopsony (single buyer).
We shall see that Demand and Supply determine price in a competitive market.
DEMAND (function, curve, schedule)
Definition: Demand is the quantities of goods and services demanded by consumers
(households)1 at each market price ceteris paribus.
Demand is the relationship between 2 variables, price (P) and quantity demanded (q for the
household and Q for the market), holding all other variables constant. The most important of the
other variables are prices of other goods (Pi where ‘i’ represents one of n commodities), income
(Y), and preferences (tastes). We can express the Demand for the X commodity as
D(qX or QX): qX or QX = f(PX Y, Pi, Preferences) (everything after is fixed)
NOTE: We analyze Demand as a quantity response to price [Q = f(P)] not as a price
response to quantity [P = f(Q].
(Alfred Marshall, the first economist to depict the Demand/Supply diagram, derived
demand as a quantity response to price. Since price was the dependent variable and quantity was
the independent variable, Marshall put quantity on the horizontal axis and price on the vertical
axis following the mathematical convention of Y = f(X)).
This concept of Demand satisfies our competitive definition that buyers are price takers.
1 Economists analyse households as the smallest unit of consumption rather than ‘consumers’ because there are
consumers such as babies that do not make economic decisions.
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