Perfect Competition Market:
Question: What is Perfect competition ? Is a firm under perfect competition a price maker or a price taker ?
Perfect Competition : Meaning
Perfect competition is a market structure in which there are a large number of producers producing a homogeneous product so that no individual firm can influence the price of the commodity.
- In perfect competition market, price is determined in the industry i.e., by all the firms taken together, through the forces of market demand and supply.
- In perfect competition a firm is price taker because a single firm has no influence over price determination.
- Since there are a large number of firms producing good, the contribution of each firm in total market supply is very less.
- Thus the price is determined by all the firms, through the forces of market demand and supply.
- Thus a single firm has no influence in price determination and it takes the prices as given and takes the decision about the quantity produced and sold at that price.
- Thus, a single firm is said to be price taker in Perfect Competition.
Features of Perfect Competition:
1. Large number of buyers and sellers
2. Homogeneous Product
3. Freedom of entry and Exit
4. Perfect Knowledge about Market
5. Mobility of Resources
6. Mobility of Transport Costs.
1. Large Number of Buyers and Sellers :
- Under Perfect competition the number of sellers are large, which means each firm contributes a very small amount in total market supply.
- Hence a firm can not influence the price of commodity by increasing or decreasing the quantity of output produced.
- Therefore each firm in perfect competition is price taker.
- Similarly, under perfect competition, the number of buyers is so large that no single buyer can influence the market price by changing his demand for the commodity.
- An individual buyer buys such a small quantity of the total output of the product that any change in the quantity demanded by him has a negligible impact on the total market demand and has no influence on the market price of the commodity.
2. Homogeneous Product:
- All the firms under perfect competition produce homogeneous or identical commodity.
- A product is said to be homogeneous when it is same or identical with the product of other firms. The product is homogeneous when its physical characteristics like – colour, size, components etc are same as well as its environmental factors like location of the seller, credit facilities etc are also same.
- The products of various firms under perfect competition are perfect substitute for one another.
- If any firm tries to sell its product at a price higher than market price it would lose all its customers to the firms selling the same product at market price.
- Similarly, due to homogeneous product the buyers would not give preference to any particular firm and remain indifferent to all the firms from which he buys.
- This way, a uniform price prevails in the market.
3.Freedom of Entry and Exit:
- In perfect competition market, there is a freedom of entry and exit of the firms, means the existing firms are free to cease production and leave the industry if they desire so and new firms are free to enter into the industry and start producing the good if they wish so.
- This character is important for controlling profit. The condition of free entry and free exit ensures that all the firm under perfect competition end up earning only normal profits in the long run.
- If the existing firms are earning abnormal profit, new firms would enter into the industry and increase the market supply. This will reduce the market price and wipe out the abnormal profits.
- On the other hand, if the existing firms are incurring losses some of them would leave the industry, resulting in decrease in supply and rise in price till the losses are wiped out.
4. Perfect Knowledge:
- In perfect competition, the consumer, producers and resources owners have perfect knowledge about market conditions.
- Each firm knowing the price prevailing in the market would not sell the commodity at price below the market price.
- Each buyer who has the knowledge about the price prevailing in the market, would not pay the price higher than market price.
- Hence, a uniform price would prevail throughout the market.
- Similarly, each firm with perfect knowledge of technology would use best technique of production and earns more profit at the prevailing price.
5. Perfect Mobility of Resources :
- In Perfect competition market, the resources are perfectly mobile. This characteristic ensures that resources or factors of production can enter or quit a firm or the industry at will.
- Perfect mobility of resources means the resources mare able to switch over from one use to another without any restriction.
- This condition is essential to make the entry of the firm into and exit of the firm from the industry possible.
6. Absence of Transport Costs:
- In Perfect competition market, there is no cost of transportation in purchasing and selling goods.
- This condition is necessary to maintain a uniform price of the good throughout the market.
- Otherwise, the prices of identical good would differ in different area, due to the addition of transportation costs.