Market Structure Perfect Competition

Perfect competition is a market structure in which there are large number of producers (firms) producing a homogeneous product  that no individiual firm can influence the price of the commodity.

In this type of market price is detemined by the industry, i.e. by all the firms taken together, by the forces of demand and supply, a single firm cannot affect the price of the commodity.

Features of perfect competition

A perfectly competitive market structure shows the following features.

1) Large number of buyers and sellers :

A perfectly competitive market is dominated by a large number of buyers as well as sellers.

It means that there is no such buyer or seller in the market whose purchase or sale is so large as to impact the total sale or purchase in the market.

Each buyer/seller has only a fractional share in the market demand/market supply.

Since price is determined by the forces of market demand and market supply, no individiual buyer or seller has any control on it. 

Each buyer/seller has to accept the price as it is in the market.

Therefore, it is said that a firm under perfect competition is a price taker not a price maker.

2) Homogeneous Product :

All firms under perfect competition produce homogeneous or perfectly standardised commodity.

All sellers sell identical units of the product. Homogeneity of the product refers not only to the ‘physical characteristics’ of the commodity, such as colour, size etc but also ‘enviromental factors’ such as, location etc.

Buyer have no reason to prefer the product of seller compared to that of the other.Goods are perfect substitute of each other.

Also no firms has any basis of charging higher price for its product, if he does so, he would lose all its customers to other firms selling the same product at market price.

So uniform price prevails in the market. There is absolutely no price discrimination.

3) Free entry and exit of the firms :

In perfect competition new firms are free to enter the industry and existing firms are free to leave the industry if they so desire.

In order to analyse the implications of this feature we need to focus on short period and long period situations.

Short period is too short for an existing firm to leave the industry or for a new firm to join it.

So the significance of this feature is restricted only to long period situations.

Because of free entry and exit, firms in the long run earn only normal profit (TR = TC)

If the existing firms are earning super normal profits, new firms will join the industry, market supply will increase leading to fall in the price.Super normal profit will be wiped out.

If the existing firms are earning super normal losses, existing firms will start leaving  the industry, market supply will decrease leading to rise in the price.

Super normal losses will be wiped out.

Hence, a firm under perfect competition earns only normal profits in the long run.

4) Perfect Knowledge :

Buyers and sellers are fully aware of the prevailing price in the market.

They are also aware of the fact that homogeneous product is being sold in the maket.

So producers cannot make extra profit by charging different prices from different buyers.

Firms have perfect knowledge about the available techniques of production, implying that all firms have similar cost condition leading to same per unit cost of production.

5) Independent Decesion Making :

There is no aggrement between the sellers regarding production – quantity and price. Nor is there any restriction regarding the sale and purchase of any commodity. All firms are free to take their own decesions. So competition prevails without restrictions.

6) Perfect Mobility of Resources :

Factors of production can enter or quit a firm or the industry at will, they are able to switch over from one use to another without any restriction, where they get best price.So uniform factor price prevails in the market.

Hence, factors of production are perfectly mobile.

7) Absence of Transport Cost :

For one price to prevail throughout the market, it is essential that there is no extar transport cost for the consumers while buying a commodity from different sellers.

This assumption is necessary to maintain uniform price in the market, otherwise prices for identical goods would differ.

Pure and perfect Competition

The competition is said to be pure when the first three condition is satisfied i.e. large number of buyers and sellers, homogeneous product and free entry and exit of the firms.

The competition is said to be perfect when all the seven conditions explained above are satisfied.

Perfect Competition Demand Curve

Demand curve for the firm is perfectly elastic (E_d = ∞).

It means that the firm can sell any amount of the commodity at the prevailing price. Even a slight rise in price(more than Rs. 4) would wipe out entire demand for the firm’s product. Firm’s demand curve is shown by a horizontal  straight line parallel to X- axis as shown in the graph below:

perfectly elastic demand

This shows that the firm is to accept the price as determined by the forces of supply and market demand, it can sell whatever amount it wishes to sell at this price.