What Is a Competitive Market? (Definition and How It Works)

Updated March 10, 2023

A competitive market forms in response to consumer demands for goods and services. This market structure creates competition to gain customers, requiring businesses to evaluate production costs, pricing structure and product quantity.

Competitive markets, and the concept of perfect competition, work to factor the buyer and seller equally and form strategies based on the market's current supply and demand. In this article, we define competitive markets, outline their characteristics and explain their purposes and differences.

Key takeaways:

In a competitive market, no single consumer or producer has the power to dictate the market.
A perfectly competitive market is an ideal market where there are many well-informed buyers and sellers, no barriers to market entry and no possibility of a monopoly.
Profit, diminishing supply, rivalry and exclusion are among the 10 characteristics of a competitive market.

What is a competitive market?

A competitive market is a structure in which no single consumer or producer has the power to influence the market. Its response to supply and demand fluctuates with the supply curve, a representation of a product's quantity. Since a competitive market means the producer must be willing to sell a product according to what the market pays, supply curves adjust to keep the producer's costs relative to its sales.

In a perfectly competitive market, multiple influences decide market prices and, therefore, market supply. In this structure, competitive market producers are price-takers who accept the market price since independent price changes can cause a sales loss.

Example: Agriculture is a price-taker industry whose price-taker farmers sell their harvest for the price the market is willing to pay. One year, wheat may sell for $6 a bushel and the following year, bumper crops increase supply and reduce demand so the price lowers to $5 per bushel. The farmer then determines how much to grow based on projected sales.

Characteristics of a competitive market

Competitive markets have several characteristics that make them what they are. Competition ensures a continuous supply and demand for the entire market—not just a single business or consumer. When a business considers changing the price of a product, it often analyzes the competition to gain insight into their strategies. The 10 characteristics of a competitive market include:

1. Focus on profit

Companies go into business for the opportunity to sell a product or service and make money. If a start-up company determines the market is willing to pay for its product and there are many potential customers, they enter the competitive market. This action may lead to similar start-ups offering similar products to compete with the original seller and make a profit of their own.

2. Diminishing supply

As companies produce products and consumers purchase the product, supply diminishes over time. This allows a company to increase prices due to less stock, or as an incentive to increase production.

Example: A business produces 200 large screen televisions and sets a competitive price of $800 each. Each television sold means there's one less available for the next consumer. In this case, the company may raise the price of the popular TVs once the stock reaches a predetermined number.

3. Consumer rivalry

A competitive market creates competition among consumers. This means that one consumer competes with another for a good or service, especially for diminished stock. For example, when it comes to purchasing tickets to a sporting event or music concert, consumers often compete to buy the best seats.

4. Exclusion or inclusion

In a competitive market, both the customer and the business can set parameters for buying behavior. If a consumer is unable or unwilling to pay for a product, the business excludes them from purchasing their product. While this poses the risk of limiting access to a product or service, the limitation may increase the product's perceived value. Alternatively, consumers may reject products or services because of their cost or method of purchase.

Example: A business says that one of its products is only available online, thus excluding store shoppers. Consumers wary of online shopping may maintain the option to reject the product.

5. Healthy margins and the ability to charge

Businesses make profits when the cost to make a good is less than the price it sells for. Competitive markets allow a business to strive for ideal margins by employing strategies such as outsourcing production or consolidating shipping and handling costs.

The ability to charge refers to the business's ability to set its prices at the point of consumption, thus giving a consumer the option to buy or reject the product.

Example: A family enjoying a day at the amusement park encounters many different price points for items like souvenirs or food. Though the prices are much higher inside the park, the consumer ultimately decides whether or not they're willing to pay more for these items.

6. Informative for the customer

A competitive market ensures consumers have the information they need to decide on a purchase. The consumer knows the benefit of the product, understands the costs and agrees to enter a purchase agreement with the seller.

Since consumers make purchasing decisions based on product satisfaction, function or cost, businesses aim to provide those determining factors. For example, a consumer may visit the same coffee shop every day and pay $3 for a cup because according to their experience, the coffee is good and worth the cost.

7. Fewer time delays

Companies benefit when a consumer purchases a product and enjoys the advantage right away. Gratification may prompt the buyer to refer friends to the business or to share their experiences.

Today, online shopping presents a delayed benefit as the product is in shipment rather than readily available. Companies factor this into efforts to reduce the time between purchase and reward. For example, they may shift the customer's reason for making the purchase from the item being set at the lowest price to the fastest delivery method.

8. Reduced external influences

External influences may have positive and negative cost effects. These may relate to the practices of nearby companies, or they may be in response to consumer behavior or demand. Below are two examples of external influences:

Positive external influence example: A pizza restaurant opens near the local movie theater and faces the theater sign so patrons can see which movies are playing while they eat. Hungry moviegoers stop in the pizza restaurant for dinner. The businesses may work together to offer coupons or discounts for cross-promotion.
Negative external influence example: A recent study suggests movie theater popcorn butter isn't particularly healthy and it's best to limit consumption. The movie theater responds to this negative cost and turns it into a positive by introducing healthier snack options and changing its butter recipe.

9. Protection of property rights

Property rights protect a company's assets and shield them from theft or damage. Boundaries become less defined when property rights aren't available.

Example: A small business harvests mushrooms from the forest and sells them at a farmer's market. Since there are no property rights to the forest—and since the mushrooms are exchangeable—the harvester doesn't face restrictions on how many mushrooms they can pick. If a competitor enters the mushroom harvesting market, they may establish their own right to a section of the forest.

10. Elevated entrepreneurial opportunity

Competitive markets inspire entrepreneurs to take calculated risks and enter the market. They may launch a competitive product or service based on the market's conditions and acceptance of a new product. Entrepreneurs enter the market when it's assured the product meets certain conditions such as the following:

Consumer pays the price set
Company charges at point of consumption
Company earns a revenue
Company makes a profit

Related: How To Use Product Positioning

Purpose of a competitive market

The purpose of a competitive market is to create ideal conditions where the buyer and the seller both benefit from the purchase of goods or services. Competitive markets control the relatively small number of buyers and sellers in relation to the overall market size so neither has a direct influence over the entire market. In addition, competitive markets work to:

Provide similar products

A competitive market gives consumers many options by offering similar products with different approaches to branding and marketing. Consumers can substitute one product for another with the price typically influencing the consumer's decisions. For this reason, a business that changes a product price—even by a small amount—may experience a reduction in sales.

Remove barriers to entry

In a competitive market, anyone can enter. If you have an idea for a product or innovation and your research proves the market is ready, there are no obstacles to entry. This also means a business can exit the market if the product doesn't make a profit.

4 types of market structures

Here are the four basic types of market structures, including those that are competitive and noncompetitive:

Perfect competition

A perfect competition involves many firms that don't have the ability to influence the industry due to their size. In theory, a perfectly competitive market provides an infinite number of buyers and sellers for goods and services. This competitive structure aims to:

Provide many different producers and consumers
Ensure no single buyer or seller influences prices
Remove barriers to enter the market
Ensure producers are price-takers that serve the market supply and meet its demands

Monopoly market

A monopoly is a system that controls the supply or trade of a good. In a monopoly, a single business produces a product that has no substitutes. Called price-makers, monopolies determine the price of a good or service, create barriers to enter the market and continuously change prices to maintain profits. Monopolies fall under two categories, natural and legal:

Natural: These monopolies include public utilities. Consider water and the state and local offices that control both the flow and distribution of water, as well as the installation of pipes and sewage systems.
Legal: This monopoly involves patents for exclusive product use for a limited time. Vaccines and medications are examples of patented products.

Monopolistic competition

Monopolistic competition combines perfect competition and monopoly to create a system where many sellers offer products that serve the same purpose, but slightly differ. In this system, businesses work to make consumers aware of the product differences that may influence their buying decisions.

Monopolistic competition slightly controls pricing by attracting more consumers, allowing the company to raise the price of the more popular product. These actions invite competition into the market since there are few barriers to entry.

Oligopoly market

Oligopolies are systems where a small selection of producers offer a good or service. This means the competition is low since the difference in the products may be significant. Oligopolies maintain some control over pricing, evidenced when one producer lowers a price and the others follow. Costs to enter this market are high, making barriers to entry significant and further reducing competition.

The airline industry is an example of an oligopoly since it controls a specific service. Individual airlines must remain competitive with each other. As a result, when one airline offers discounts, others typically follow.