Perfect competition is a unique form of the marketplace that allows multiple companies to sell the same product or service. Many consumers are looking to purchase those products. None of these firms can set a price for the product or service they are selling without losing business to other competitors. There are no barriers to any firm that is looking to enter or exit the market. The final output from all sellers is so similar that consumers cannot differentiate the product or service of one company from its competitors.
Features of Perfect Competition
The main features of perfect competition are as follows:
- Many Buyers and Sellers – There will always be a huge number of buyers and sellers in this form of marketplace. The advantage of having a large number of small-sized producers is that they cannot combine to influence the market price. If the quantity offered by an individual seller is very small compared to the total market produce, they cannot influence the market price independently.
Similarly, if there are many buyers, then an individual will not have the power to dictate conditions to the market or influence the price by altering demand for a product. The individual demand will not be large enough to change the price.
- Homogeneity – The product or service produced by the buyers in a perfectly competitive market should be homogenous in all respects. There should be no differentiation between them in terms of quantity, size, taste, etc., so that the products are perfect substitutes for each other. If a seller tries to charge a higher price for products that are so similar, they will lose their customers immediately.
- Free Entry and Exit – Another condition of a perfectly competitive market is that no artificial restrictions prevent a firm’s entry, or compel an existing firm to stay put when they want to leave. Their decision to enter, stay or leave the market depends purely on economic factors.
- Perfect Knowledge – The buyers and sellers have perfect knowledge about the market conditions. The buyers are aware of the details of the product sold as well as its price. At the same time, the sellers know about the potential sales of their products at different price points. Since the buyers are already informed about the product, there is no need for advertising or sales promotion. So firms don’t have to invest a single penny in these activities. It also helps sellers save on advertising or other marketing activities, which keeps the price of their products low.
- Mobility of Factors of Production – The factors of production like labour, raw materials and capital should have total mobility under perfect competition. The labour should have the freedom to move from one place (industry, market or production unit) to another depending on their remuneration. Even the raw materials and capital should not have any restrictions in movement.
- Transport Cost – In the perfectly competitive market, the costs for transporting goods, services or factors of production from one place to another is either zero or constant for all sellers. The assumption is that all sellers are equally near or farther away from the market. Thus, the transport cost is uniform for all of them. The result is that the overall costs for production and the selling price are the same across the board.
- Absence of Artificial Restrictions – There is no interference from the government or any other regulatory body to hinder the smooth functioning of the perfect competition. There are no controls or restrictions over the supply or pricing and the price can change solely based on the demand and supply conditions.
- Uniform Price – There is a single uniform price for all products and services in a perfectly competitive market. The forces of demand and supply determine it.
Perfect competition is one of the most smoothly functioning markets, with many buyers and sellers working together in total harmony. Unfortunately, it is a hypothetical situation that does not exist in reality. But markets should aim to be as close as possible to this form of market to ensure a fair price for all goods and services.
Frequently Asked Questions on Perfect Competition
Why is a firm known as a price taker in a perfectly competitive market?
A firm is a price taker in a perfectly competitive market because it is under pressure from rival firms to accept the equilibrium price prevailing. If the firm raises the price of its products even by a small margin, it will lose all its sales to competitors.
What is the main difference between perfect competition and monopoly?
The main difference between perfect competition and monopoly is that perfect competition involves many buyers and sellers, but a monopoly has a single seller and many buyers.
Give an example of a difference between perfect and monopolistic competition?
There are several differences between perfect and monopolistic competition. One of them is that the firms under perfect competition are price-takers and those under monopolistic competition are price-makers.
Give an example of a difference between perfect competition and oligopoly?
There are several differences between perfect and oligopoly. One of them is that in perfect competition, the firms earn zero profit in the long run, but in an oligopoly, the firms earn an economic profit in the long run.
Why do firms have zero profit in the long run under perfect competition?
In a perfectly competitive market, many firms are producing high quantities of homogenous products. Firms can enter the market without restrictions and all consumers have complete information about the product. So if a firm raises the price of its product, the consumers will stop buying from them and switch to another seller. Thus, they have zero opportunity to make a profit in this market.