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A fundamental aspect of an economy is competitions. Firms compete against each other to offer goods. There is a definition of economic perfect competition. Perfect competition means economic forces at work, uninterrupted by any other force. For a market to have perfect competition, it must meet several conditions: buyers and sellers both take the market price as given, there are a large number of competing companies, there is nothing to keep more companies from entering the market, all firms produce the exact same products, firms can come and go immediately with no delay whatsoever, everyone would have instantaneous and complete information about all firms, all firms have make profit as their one and only goal.

Even though perfect markets do not exist, they are useful to analyze real markets because putting in many other factors is compounding the problem at this point. Competitive firms have supply curves, first of all. Because of the fact that they themselves must actually adjust to changing market situations. A firm with no competition can set whatever prices they want since people have to buy their products anyway. The demand curves for competitive firms, however, are almost perfectly elastic because no matter how these firms change their production, in a perfectly competitive economy, there are so many firms out there that its production will not affect anything. The market as a whole has a demand curve, but each individual firm's demand curve is perfectly horizontal: no matter how they change the production, price stays. Remember, firms are price takers, too in perfect competitions, they don't set prices. They set prices at market equilibrium.

In a perfectly competitive market, firms' only goal is to make as much of a profit as possible, profit being (revenue) - (cost). To maximize profit, they must get to a point when marginal cost, the cost of each additional unit of output, equals marginal revenue, the income of each additional unit of output. This is because, when the production is lower, you can still produce more products that will still earn you a profit, but when the production is higher than that, the extra amount of production is costing more than it is earning you.

Fig 3.2.1-Maximizing profit

This profit-maximizing concept can be seen in the graph above. The straight line represents maximum profit. It is at this point that the difference between revenue and cost is at a maximum. Remember that costs go down and then go up sharply as production increases, so you try to attain minimum cost with maximum revenue and it is at the point where marginal revenue equals marginal cost that you attain that point. Conversely, there is a shutdown point of a firm, at which a company would do better by shutting down than lose money by keep going. A company at this point saves more money by doing nothing than keep producing and turning in a loss (the cost is too high and the price is too low for each unit of output).

Another condition caused by perfect competition is zero profit condition, the condition that in the long run, total profit made is zero. This is because, in perfect competition, as companies make more profit, others will see opportunity. Given that there are nothing preventing people from entering the market, then people will enter the market, raising total production and driving prices down. This will bring profits down. However, when profits go down too much, companies will be forced out of business and the survivors will be better off. So, in the long run, there is competitive equilibrium in a perfectly competitive economy.

In reality, no such thing as a true perfectly competitive market exists. There are other types of market structures, however: monopoly, oligopoly, and monopolistic competition. A monopoly is a market structure in which there is only one single company that is in the industry. An oligopoly is a market structure in which there are a small number of interdependent companies in the industry. Monopolistic competition is a market structure in which many companies operate independent of each other (although not so many as to be the number approaching infinity specified by perfect competition) in an industry. There have been indices of market structuring developed over time. We measure how much of an industry is concentrated in the hands of a small group of companies. This tells just how competitive an industry really is.

What kind of market structure an industry is accounts for how companies operate within it. Unregulated monopolies with no government ties can generally do whatever they want. After all, there's no one else to offer a different sort of service or a different price. In oligopolies, there are few companies so if you were a copmany and you made some sort of decision, it will always be made to be a strategic tactic made to outmaneuvre your rivals. In monopolistic competition, there are too many companies and so you would just think about yourself and attract customers because what you do will not affect anyone else.

In monopolistic competition, there are many firms vying for control of one market. Each firm offers a different type of product, as opposed to perfect competition in which all offer the same product. Each firm, then, has a monopoly in the market of their own product. Thus, the firms try to advertise their products so people buy more of their product. At the same time, monopolistic competitors do not try to compete so as to undermine other competitors. There are too many other businesses in a monopolistic competition to worry about them, you simply try to get people to buy your own product as opposed to respond to others' tactics.

Monopolistic competition, because there are so many relatively weak firms, there are no barriers to entry. Companies can enter the market relatively easily (although, of course, not as perfectly easy as in perfect competition). This makes for a long-term equilibrium competition of no profit. When there is profit to be made, just as in perfect competition, new companies come in and take that profit away through expanded production and dropping prices. Unlike in perfect competition, though, monopolistic competition has a normal downward-sloping demand curve. The competing companies in monopolistic competition are not so much price takers as price setters and thus the demand curve is sloped, not set constant at the market price.

The primary property of oligopoly is a small number of competing firms. Thus, to be able to best compete, firms make decisions based on planning against their rivals. That is the key property of oligopolies: all firms in oligopolies execute strategic planning. Sometimes, a market is only an oligopoly in theory. Some oligopolies act as cartels, in which many firms act as one. There are technically several firms but they all confer together to act as a monopoly. This practice is illegal in many places, though it still does happen. Even though the cartel model is no longer prevalent, there is implicit collusion. In implicit collusion, many firms will follow each other in making decisions, though they are not really meeting. For example, when one firm drops its prices, all the other firms follow suit.

Another possible model of oglipoly is the contestable market model, in which firms make decisions based on barriers to entry and exit. In this model, oglipoly companies make decisions so that new firms can not enter the market. Oligopoly economic models really involve pre-existing business conventions that are basically unwritten laws that oligopoly companies just follow. Oligopoly companies on a small scale often use the cartel model, though a major aspect preventing that is the entry of an outside company that does not care for the cartel's rules. That outside company can drive the cartel out of business by offering much lower prices. Oligopolies also tend to get into heated competition in the form of price wars and other ways of corporate fighting. There are a small number of companies and thus, the relations between companies are very important.