Under perfect competition a large number of firms compete against each other. Therefore, the degree of competition number perfect competition is close to one. Of the different kinds of market structures, the maximum competition happens in perfect competition. Monopoly has the least competition . The major characteristics of a perfect competition market are as follows :
a) There are a large number of buyers
b) There are a large number of sellers
c) The product is homogeneous
d) There are no entry and exit barriers
The more nearly perfect a market is, the stronger is the tendency for the same price to be paid for the same thing at the same time in all parts of the market.
A market is said to be perfect when all the potential sellers and buyers are promptly aware of the price at which transactions take place and all of the offers made by other sellers and buyers, and when any buyer can purchase from any seller, and vice versa.
Thus Perfect Competition is a market situation in which large number of buyers and sellers are gathered to deal in the similar product, having full knowledge of the market, equal price all over the market, and firms are free to enter into and to leave market.
Features/Characteristics of Perfect Competition
- A large number of sellers and buyers
Under perfect competition , the number of sellers and buyers is very large. The number of sellers and buyers is so large that the share of each seller in total supply and the share of each buyer in total demand is so small that no single seller can affect the market price by changing his supply, nor can a single buyer influence the market price by changing his demand.
- Homogeneous Product
The products sold by perfectly competitive firms are so identical, that buyers are not able to distinguish the product of one firm from that of another firm. The product of each firm is regarded as a perfect substitute for the product of other firms. Nor do the firms distinguish between the buyers. For example unbranded spices, it would be very difficult for any consumer to differentiate between spices sold across the market. This is what we refer to as product homogeneity. This makes the buyers totally indifferent towards various sellers with respect to purchase of the product, because products of all the firms are perfect substitutes of each other.
- Freedom of entry and exit
All the firms are free to join or leave industry. There is no restriction on their entry and exit. Hence if the industry is making profits, new firms will enter into the market. Contrarily, if the industry is suffering loss, many firms will leave the market.
- Perfect Knowledge of Market Conditions
There is perfect dissemination of the information about the market conditions. Both buyers and sellers are fully aware of the nature of the product, its availability or saleability and of the price prevailing in the market.
- Perfect mobility of factors of production
For a market to be perfectly competitive, there should be perfect mobility of resources. This means that the factors of production must be in a position to move freely into or out of an industry and from one firm to another.
- Independence of Decision Making
All the buyers and sellers are fully independent. None of them is committed to any one. Hence the buyers are free to purchase the commodity of their need from any seller and sellers are free to sell their commodity to any buyer or buyers. The price of a commodity at a particular time tends to be equal all over the market which all the firms have to follow.
- Perfectly Elastic Demand Curve
The demand curve of a perfectly competitive firm is perfectly elastic. If a particular firm decides to charge a price higher than the existing market price, its demand will be reduced to zero. This is because buyers have perfect knowledge about the product and the prevailing market price and they are indifferent about a particular firm, if one firm increases the price, buyers would promptly move away from this firm and shift over to its rival firms. On other hand, if a firm tries to gain advantage of increased demand by lowering the price, its demand would increase to infinity. Either of these lead to a perfectly elastic demand curve.
- No government intervention
In a perfectly competitive market, there is no government intervention with the working of the market system. There is no licencing system regulating the entry of firms to the industry, no regulation of market prices, i.e. fixation of lower or upper limits of prices, no control over the supply of inputs, no fixation of quota on production, and no rationing of consumer demand, etc.
Price Determination under Perfect Competition
By definition perfect competition is a market setting in which, there are a large number of sellers of a homogeneous product. Each seller supplies a very small fraction of the total supply. No single seller is powerful enough to influence the market price. Nor can a single buyer influence the market price. Market price in a perfectly competitive market is determined by the market forces- market demand and market supply. Market demand refers to the demand for the industry as a whole. It is the sum of the quantity demanded by each individual consumer or user at different prices. Similarly market supply is the sum of quantity supplied by the individual firms in the industry. The industry in interaction with demand forces, determines the price. The individual firm takes this price as given, and is free to sell any amount without fear of all in price.
The demand curve is based on the inverse relation between price and demand. The supply curve is based on the positive relation between price and supply. Price of a commodity is determined at the point at which these curves intersect each other i.e. at point E in the given diagram. The price is OP. This price is known as equilibrium price and the quantity of demand and supply is known as equilibrium quantity.
The firm adopts the price and is free to sell any quantity at this price. It makes the demand curve for the firm’s product (curve d – AR) perfectly elastic.
Importance of the study of Perfect Competition
- Understanding the reality
Concept of perfect competition is helpful in understanding the reality of market conditions. Its knowledge is helpful in understanding and solving the economic problems of the country.
- Knowledge of an Ideal Economy
Concept of perfect competition is helpful in knowing an ideal economy which can be helpful for the whole society.
- Knowledge of the causes of Lack of Perfect Competition
Study of perfect Competition is helpful in knowing the causes of its absence. Under Perfect Competition, the business and industrial firms get normal profit only, though in its absence, they can earn abnormal profit.
- Study of Imperfect Competition
Study of the conditions of Perfect Competition is very helpful in the study of Imperfect Competition which is the market situation which lies between Perfect Competition and Monopoly.
- Knowledge of Imperfections
Study of perfect competition is helpful in establishing the imperfections of market conditions. Actual market conditions are compared with the conditions of Perfect Competition and the nature and extent of market imperfections is established.
Thus, though Perfect Competition is not a practical concept but only an imaginary market situation, its study is very helpful in understanding and solving the problems of an economy.