Perfect Competition

Definition of Perfect Competition

A fully competitive market (1) is characterized by many buyers and sellers that only a small fraction of the total amount is bought or sold in each market; (2) firms sell an item that is a standardized product, such as a bushel of wheat, a dozen eggs, such a product does not differ from suppliers; (3) market participants are fully informed about all prices and production processes; (4) Firms and resources are freely mobile, and over time they can easily enter or leave the industry due to barriers such as patents, licenses, and high capital costs. A fully competitive market is characterized by a situation when the market is fully competitive. Various definitions given by various economists are completely competitive:

Robinson, complete competition can be defined as “when the number of firms is large, so that a change in their production has a negligible effect on the total production of an object, in that sense, the object is completely identical. A firm and its competitors are buyers in terms of their preference (or indifference) It’s similar, when the competition is successful, and its competitors, then the competition is perfect, and the personal firm’s lagi is limited.

Spencer, “Perfect competition is the name given to an industry or a market characterized by a large number of buyers and sellers all engaged in the purchase and sale of a homogeneous commodity, with perfect knowledge, of market price and quantities, no discrimination and perfect mobility of resources.”

Prof. Liftwitch, “Perfect competition is a market in which many firms are selling identical products with no firms large enough relative to the entire market to be able to influence the market price.”

Bilas, “The perfect competition is characterized by the presence of many firms. They all sell identical products. The seller is a price taker, not a price market.”

Joan Robinson has said, “Perfect competition prevails when the demand for the output of each producer is perfectly elastic.”

Boulding, “A perfect competition market may be defined as a large number of buyers and sellers all engaged in the purchase and sale of identically similar commodities, who are in close contact with one another and who buy and sell freely among themselves.”

A perfect competition market is a type of market in which the number of buyers and sellers is very large; all are engaged in buying and selling a homogeneous product without any artificial restrictions and possessing perfect knowledge of the market at a time. In other words, it can be said, that a market is perfect when all the potential buyers and sellers are promptly aware of the prices at which the transaction takes place. Under such conditions, the price of the commodity will tend to be equal everywhere.

Characteristics of Perfect Competition Market

More specifically, four conditions (Browning and Zupsn, 2015) characterize a perfectly competitive industry. The model of perfect competition is based on the following features.

A large number of buyers and sellers

The presence of a great many independent participants on each side of the market, none of whom is large about total industry sales or purchases, normally guarantees that individual participants’ actions will not significantly affect the market price and overall industry output. In a market with many firms, each firm recognizes that its impact on the overall market is negligible and does not view other firms as personal rivals.

Free entry and exit

Industry adjustments to changing market conditions are always accompanied by resources entering or leaving the industry. As an industry expands, it uses more labor, capital, and so on; resources enter the industry. Similarly, resources leave a contracting industry. A perfectly competitive market requires that there be no differential impediments across firms in the mobility of resources into, around, and out of an industry. This condition is sometimes called free entry and exit. Examples of barriers to entry and exit include an incumbent firm with an exclusive government patent or operating license and economies of scale that impede the entry of new firms.

Product homogeneity

All the firms in the industry must be producing a standardized or homogeneous product. In consumers’ eyes, the goods produced by the industry’s firms are perfect substitutes for one another. This assumption allows us to add the outputs of the separate firms and talk meaningfully about the industry and its total output. It also contributes to the establishment of a uniform price for the product. One farmer will be unable to sell corn for a higher price than another if the products are viewed as interchangeable because consumers will always purchase from the lower-priced source.

Perfect information

Firms, consumers, and resource owners must have all the information necessary to make the correct economic decisions. For firms, for example, the relevant information is knowledge of the production technology, input prices, and the price at which the product can be sold. For consumers, the relevant information is a knowledge of their preferences and the prices of the various goods of interest to them. Moreover, the consumers, in their role as suppliers of inputs, must know the remuneration they can receive for supplying productive services.

No government regulation

There is no government intervention in the market (tariffs, subsidies, rationing to production or demand, and so on are ruled out). The above assumptions are sufficient for the firm to be a price-taker and have an infinitely elastic demand curve. The market structure in which the above assumptions are fulfilled is called pure competition.

Perfect mobility of factors of production

The factors of production are free to move from one firm to another throughout the economy. It is also assumed that workers can move between different jobs, which implies that skills can be learned easily. Finally, raw materials and other factors are not monopolized and labor is not unionized. In short, there is perfect competition in the markets of factors of production.

Price and Output Determination of Firm and Industry is Short-run

A short run is a run so short that existing plants cannot be expanded and new plants cannot be erected to meet the increased demand. However, producers have enough time to adjust their output somewhat to the increase in demand by overworking their fixed capacity plants. In economic analysis, equilibrium is a state of rest; Once achieved, no external factor, previously fixed, will change unless it is changed. How can a firm find the level of output that will earn it the largest possible profit? We will look at many questions, each of which gives us more insight into the behavior of the firm and industry.

Price and Output Determination (Market Equilibrium) of the Industry in the Short-run and Long-run

An industry is in equilibrium at a price and output at which its market demand equals its market supply. Under perfect competition, the firms are assumed to achieve the same level of efficiency in the long run. Since the industry yields only normal profits, there is no incentive for new firms to enter the industry. Thus, only when the quantity demanded and quantity supplied of the product of the industry are equal, there will be no tendency for the industry either to expand its output or to contract it.

Thus an important condition for the industry to be in equilibrium is that it produces the level of output at which the quantity demanded and quantity supplied of its product are equal. Thus, the equilibrium of the industry is Quantity demand = Quantity supply

The forces of demand and supply determine the price and output of a commodity under perfect completion. A demand and supply schedule and curve will show the determination of the equilibrium price.

Market Demand and Supply Schedule

Price (Rs.)Market Demand (Units)Market Supply (Units)Equilibrium
Excess Supply (D<S)
Equilibrium (D=S)
Excess Demand (D>S)

In the table, the demand and supply of the commodity at different prices are shown. The equilibrium price is fixed at Rs. 3 where the quantity demanded and the quantity supplied are equal to 3 units. There is excess supply at Rs. 4 and excess demand at Rs. 2.

Equilibrium of the Firm in the Short-run and Long-run

A firm is a unit engaged in production for a sale at profit and to maximize the profit. In the short-run, only variable factors are to be considered, and keeping machines, and buildings are constant. As a price taker, firm has no control over the price set by the market. It takes’ (accepts) the price determined from the overall supply and demand conditions that regulate the market.

In the short run, the firm will maximize profit or minimize loss by producing the output at which marginal revenue equals marginal cost (as long as producing is preferable to shutting down). In the short run, firms can earn excess profit, normal profit, or loss. It is determined by the price (AR) and average cost (AC) as illustrated in the following table.

ConditionIn Words Outcome
P or AR > ATC or ACThe price or average revenue is greater then the average total cost of production.The Firm makes an abnormal profit.
P or AR = ATC or ACThe firm makes losses or the firm will operate to minimize losses.The firm makes losses or the firm will operate to minimize loss.
AC > P or ARThe firm makes a normal profit.The average total cost of production is greater than the price the firm changes, but the price or average revenue.
AZC > PThe price is less than the average variable cost of production.The firm will temporarily shut down.

Price and Output Determination of Firm (with Industry) in Long-run

The short run is, by definition, the period in which the firm’s cost and revenue curves are given. Firms cannot change their size – their capital is fixed; Existing firms have no opportunity to leave the industry; And new firms have no opportunity to enter the industry. In contrast, the long run is a period in which these barriers disappear. Long-runs permit changes in technology and employment of both labor and capital, meaning firms can change their size.

In the long run, firms are in equilibrium when they have adjusted their plant to produce at the minimum point of their LAC curve, which is tangent (at this point) to the demand curve (MR=AR=P) defined by the market price. Thus, the firms can earn normal profit only. Under the marginal rule, there are two conditions for the long-run equilibrium of a firm.

  • long-run marginal curve = Marginal revenue (LMC=MR)
  • LMC intersects the MR from the below

Firm’s equilibrium

In the long run, Firms enter and exit the market and neither economic profits nor economic losses are possible. In the long run, firms make zero economic profit. The zero-profit condition is enormously powerful; it analyzes competitive markets far more applicable to the real world than would otherwise be the case.

Industry equilibrium

When a market is in long-run equilibrium, the short-run supply curve (SSR) and short-run demand curve (DSR) intersect along the long-run supply curve (SSR). At this point, the price that the firm changes is equal to the minimum point along the long-run average total cost curve (LAC). The existing firms in the market earn zero economic profit, and there is no incentive for firms to enter or exit the market.

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