PERFECT COMPETITION

Meaning of Market

Market refers to any place or location where a product, be it a tangible commodity or intangible service, is exchanged for money between sellers and buyers. Or market is a place where  goods  and  services  are  exchanged  for  money.  It  is  a  place  of  exchange,  be  it  a household, a roadside, a pavement or even a street corner that may fit in to the descriptions of  a  market.  The  essential  feature  is  the  presence  of  buyers  and  sellers  with  intent  of exchange. Markets known for sale and purchase of particular commodities  or services are generally  named  or known  after  them.  Capital  market,  money  market,  stock  market,  car market, spare parts market, fruit market, vegetable market etc…..are few examples. There are markets  in which  prices  are fixed and uniform  throughout  and  there  are markets  in which such certainties do not exist. The former is called a perfect market, while the latter, an imperfect market. In other words, a market with least or no price distortions is a perfect or a competitive  market while one, in which the price distortions are common, is an imperfect market.

Perfect Competition

Perfect competition is a phrase used often in every day discussions, and many people have  an  intuitive  and  vague  understanding   of  what  it  means.  The  concept  of  Perfect competition is very old and was discussed in a casual way by Adam smith in his wealth of nations. Edge worth was the first to attempt a systematic and rigorous definition of perfect competition.  The concept  received  its complete  formulation  in Frank Knight’s  book, Risk, Uncertainty and profit (1921). Perfect competition is a market structure characterized by a complete  absence  of  rivalry  among  the  individual  firms.  Thus  Perfect  Competition  in economic theory has a meaning diametrically opposite to the everyday use of this term. In practice businessmen use the word competition as synonymous to rivalry. In theory, Perfect competition implies no rivalry among firms.

Features of Perfect Competition

1          Large number of buyers and sellers.

The industry or market includes a large number of firms (and buyers), so that each individual firm, however large, supplies only a small part of the total quantity offered in the market. So each firm alone can’t affect the price in the market by changing its output.

2          Product Homogeneity

The industry is defined as a group of firms producing a homogeneous product. There is no way in which a buyer could differentiate among the products of different firms. So that price may not be distorted on the grounds of visible differences among the units of the same product.

3           Free entry and exit of firms

There is no barrier to entry or exit from the industry. Entry or exit may take time, but firms have freedom of movement in and out of the Industry.

4           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 a job, which implies that skills can be learned easily.

5           Perfect Knowledge

It is assumed that all sellers and buyers have complete knowledge of the conditions of the market. This knowledge  refers not only to the prevailing  conditions  in the  current period  but  in  all  future  periods  as  well.  Information  is  free  and  costless.  Under  these conditions uncertainty about future development in the market is ruled out.

6           No government regulation

There  is no government  intervention  in the market  (tariffs,  subsidies,  rationing  of production or demand and so on are ruled out). Most of the regulations are highly distortionary.

7           Absence of Transportation costs

So that price may not get distorted by them in distant markets

8           Profit maximization

The goal of all firms is profit maximization. No other goals are pursued.

9           Absence of Collusion and independent decision-making by firms

Perfect competition  assumes that there is no collusion between the firms; they are not in league between themselves in the form of guide or cartel. Nor are the buyers in any kind of collusion  between themselves.  There is no consumer’s  association.  This condition implies   that   buyers   and   sellers   take   their   decisions   independently    and   they   act independently.

The assumption of large numbers of sellers and of product homogeneity implies that the individual  firm in a pure competition  is price taker. The price taker is a firm which adopts price fixed by market forces of demand and supply. Its demand curve is infinitely elastic, indicating that the firm can sell any amount of output at the prevailing market price. The demand curve of the individual firm is also its Average cost and Marginal cost.

                              It is not very difficult to see that a perfect competition is a myth. In real world, it is difficult to realize it.

Pure competition

A  form  of  perfect  market  which  has  only  first  three  features  of  it,  namely  large number of buyers and sellers, homogeneous product and free entry and exit.  It is a realistic form of perfect competition.

Meaning of Firm and Industry

It is essential to know the meaning of firm and industry before analyzing the two. According to R.L.Miller, “firm is an organization that buys and hires resources and sells goods

and services.”

According to Lipsey, “firm is a unit that employs factors of production to produce commodities that it sells to other firms, to households, or to the government.”

According to Lipsey, “Industry is a group of firms that sells a well-defined product or closely related set of products.”

Industry is a group of firms producing homogeneous products in a market.