Price Determination under Perfect Competition

A perfectly competitive market is a hypothetical market where competition is at its greatest possible level. It is theoretical free-market situation in which the following conditions are met.

Features:

  1. Very large numbers of firms in the market: No single firm can influence the market price, or market conditions. Every firm in the market is so small that it cannot exert any perceptible reference on price. Thus the firm is a price taker and not price maker.
  2. Homogenous product: In the eyes of the consumer, the product of one seller is identical to that of another seller. Firms produce homogeneous, identical, units of output that are not branded.  This ensures that buyers are indifferent as concerned to the firm from which they purchase.
  3. Freedom of entry and exit: The industry is characterized by freedom of entry and exit. Any new firm is free to setup production if it so wishes and any existing firm can stop production and leave the industry according to its will.
  4. Free mobility of factors of production: All resources are perfectly mobile. For instance, labour is mobile geographically and among jobs.
  5. Perfect knowledge: All buyers and sellers haveaccess to information regarding availability, prices, and quality of goods being  There is perfect knowledge, with no information failure or time lags. Knowledge is freely available to all participants, which means that risk-taking is minimal and the role of the entrepreneur is limited. Consumers know prices; producers know costs; workers know wage rate; and so on.
  6. No government interference: There is no government interference in the market. Tariffs, subsidies and so on are ruled out.

Pure and Perfect Competition

A distinction is often made between pure competition and perfect competition. But this distinction is more a matter of degree than of kind. For a market to be purely competitive, three fundamental conditions must prevail.

(i) A large number of buyers and sellers.

(ii) A homogeneity of product and

(iii) The free entry or exit of firms.

 For the market to be perfectly competitive, following additional conditions must be fulfilled,

i) Perfect knowledge of market.

ii) Perfect mobility of factors of production.

iii) Absolutely no government interference and

iv) No transport cost difference incidentally;

The term perfect competition is traditionally used by British economists while discussing the price theory. American economists, however, prefer to construct a pure competition market model realistically assuming that additional conditions for perfect competition, such as perfect mobility of labour, perfect knowledge etc. may not be attainable.

The firm as price taker

The single firm takes its price from the industry, and is, consequently, referred to as a price taker. The industry is composed of all firms in the industry and the market price is where market demand is equal to market supply. Each single firm must charge this price and cannot diverge from it.

Under perfect competition, an individual firm has to accept, price determined by industry. The firm under perfect competition is a price taker and not price maker. Demand curve or average revenue curve of the firm is a horizontal straight line (i.e. parallel to X-axis). Since perfectly competitive firms sell additional units of output at the same price, marginal revenue curve coincides with average revenue curve.

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By Hassham

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