What Factors Influence Competition in Microeconomics?

From a microeconomics perspective, competition can be influenced by five basic factors: product features, the number of sellers, barriers to entry, information availability, and location. Each factor hinges on the availability or attractiveness of substitutes and, when no alternatives exist and the company is a single seller of a unique product, a monopoly exists and there is zero competition.

Influential Factors

Product features essentially describe the level of differentiation. For example, if a company’s product is homogeneous (similar to others already on the market), the good or service is completely indistinguishable from products sold by competitors. This situation would imply heavy competition.

Alternatively, a product might be completely differentiated, meaning that it is unique. If so, there might be few alternatives and thus low levels of competition. The level of differentiation is largely a subjective matter and subject to consumer opinion.

The number of sellers also impacts competition. If there are many sellers of an undifferentiated product, competition is considered to be high. If there are few sellers, competition is low. If there is a single seller, the market is considered a monopoly.

Barriers to entry can influence the number of sellers. Market characteristics such as high capital investment requirements or heavy regulation may prevent new companies from entering the market, which in turn provides a level of protection to existing firms. With lower competition through barriers to entry, firms might be able to charge higher prices.

Information availability is also important, and it revolves chiefly around price discovery. When customers can efficiently and accurately find out prices across competitors, companies are less able to set prices and competition is more heated.

An effective location strategy can corner a group of potential customers or otherwise reach them more effectively than the competition. For example, gas stations are often strategically located on busy corners.

Characteristics of Competition

It’s easiest to understand these characteristics of competition through the lens of the two most extreme versions: perfect competition and monopoly. In perfect competition, each firm’s marginal profit is equal to the marginal cost; there is no economic profit. In a monopoly, the marginal profit is equal to the marginal revenue, which is the incremental revenue generated from selling one more unit of the product.

Companies in perfect competition are considered to be price takers, meaning that they have no scope to set prices—this is the reason why marginal profit is equal to marginal cost. Perfectly competitive markets are defined by a homogeneous product, many sellers with low market share, and absolutely no barriers to entry or exit. These firms are unable to differentiate their products, and their customers have highly accurate information.

Most markets are somewhere in between perfect competition and monopoly. For example, the market for soft drinks, dominated by Coca-Cola and Pepsi, could be considered an oligopolywhere a few large firms dominate most of the market. The market for tomatoes could be considered a step or two above perfect competition; after all, some people are willing to pay more for organic or heirloom tomatoes, while others look only at the price.