Perfect Competition


It is a market form in which there are large number of sellers and buyers of homogeneous product. There is freedom of entry into and exit from the industry, and all firms in the industry are price takers. Uniform price prevails in the market, and buyers and sellers possess perfect knowledge of market conditions.

(Note: A firm is an individual producing unit, while a group of firms producing a particular commodity make up an industry.)

Characteristics

Following are the main features of perfect competition:

1. Large Number of Buyers and Sellers: The number of buyers and sellers is so large under perfect competition that each buyer and seller comprises of a just small part of the market. So small that no one?neither seller nor buyer?is in a position to influence the market price and output in the industry. The demand put by a buyer is so small that he cannot influence the market price of the product by his individual action. Similarly, each seller sells a very small proportion of output supplied by the industry in the market. Therefore, individual seller cannot influence the price of product by increasing or decreasing the supply. Thus, we can say here that each buyer or seller is a price taker. Each firm, which is a price taker, sells its product at the price fixed by the industry.

2. Homogeneous Product: The product being sold under perfectly competitive market is homogeneous in nature. Every seller sells same kind of product or that there is no product differentiation in terms of brand names, packaging, etc. Consequently, single price prevails in the market and firms need not incur any advertisement costs or selling costs.

3. No Artificial Restrictions: Perfect competition is characterised by absence of artificial restrictions. Price of the product is determined by the demand and supply in the market. There is no interference by any agency, not even the government, in the price mechanism.

4. Free Entry or Exit: Firms are free to enter into or exit from the industry. Attracted by the super normal profit, new firms may enter into the industry. Similarly, those incurring losses may leave the industry. Of course, it is only in the long-run that a firm can join the industry or quit it. Short period, by definition, is too short to do it.

5. Perfect Knowledge: Buyers posses complete knowledge about the price at which a particular commodity is being traded in the market. This forces the sellers to sell their product at the prevailing market price. Exploitation of the consumer is ruled out.

6. Perfect Mobility: There is perfect mobility of goods and factors among firms and even different industries. Factors can move from one low paid industry to another high paid industry. Same is true about goods also. Accordingly, uniform factor-price prevails in the market.

7. No Transport Costs: There are no transport costs for carrying the product under perfect competition because if we add transport costs to the price of the product, the identical products of different sellers will have different prices at different places depending upon the transport costs.

Distinction Between Pure Competition and
Perfect Competition

The difference between pure competition and perfect competition is of some degree only. The concept of pure competition was given by Prof. Chamberlin who considered pure competition to be a competition which did not contain monopoly elements. Though perfect competition contains all the elements of pure competition, it also contains certain perfections in many respects. While first four characteristics of perfect competition, discussed earlier, constituted pure competition, all the seven characteristics described above are required to have a perfectly competitive market.

Important Observations

Following points are worth noting:

1. Firm?s Demand Curve under Perfect Competition

Demand curve of the firm under perfect competition is perfectly elastic as price of the product is fixed by industry and firm is just price taker. So demand curve is perfectly elastic and is parallel to X-axis implying that firm has just to take the decision regarding the level of output it wants to produce at the price which is fixed by industry. In Fig. 1, DD is the demand curve of the firm under perfect competition which is parallel to X-axis.

Fig. 1

2. Industry?s Demand Curve

It is also called market demand curve. It refers to total demand for a product in the market. Obviously, at a higher price, demand would be low, while at a lower price, demand would be high. Accordingly, industry?s demand curve (or market demand curve) slopes downward from left to right, showing an inverse relationship between price and quantity demanded. It is as in Fig. 2.

Fig. 2

Quantity demanded extends from in response to a fall in price of the commodity from .

3. Relation between AR and MR for a Firm

For a firm, AR=MR under perfect competition because price or AR (say) is constant. Therefore AR curve of a firm is a straight line and is parallel to X-axis. Since AR=MR here, AR and MR curves coincide with each other and AR or say demand curve of the firm is perfectly elastic. In Fig. 3, DD is the line reflecting AR=MR. This line is parallel to X-axis, showing perfectly elastic demand of the firm.

Fig. 3

Example:

Price

Quantity

TR

MR

10

1

10

10

10

10

2

20

10

20 ? 10 = 10

10

3

30

10

30 ? 20 = 10

10

4

40

10

40 ? 30 = 10

10

5

50

10

50 ? 40 = 10