Definition: Perfect competition describes a market structure where competition is at its greatest possible level. To make it more clear, a market which exhibits the following characteristics in its structure is said to show perfect competition: Show
1. Large number of buyers and sellers 2. Homogenous product is produced by every firm 3. Free entry and exit of firms 4. Zero advertising cost 5. Consumers have perfect knowledge about the market and are well aware of any changes in the market. Consumers indulge in rational decision making. 6. All the factors of production, viz. labour, capital, etc, have perfect mobility in the market and are not hindered by any market factors or market forces. 7. No government intervention 8. No transportation costs 9. Each firm earns normal profits and no firms can earn super-normal profits. 10. Every firm is a price taker. It takes the price as decided by the forces of demand and supply. No firm can influence the price of the product. Description: Ideally, perfect competition is a hypothetical situation which cannot possibly exist in a market. However, perfect competition is used as a base to compare with other forms of market structure. No industry exhibits perfect competition in India. A market wherein both producers and consumers are price-takers What is Perfect Competition?In a market with perfect competition, both producers and consumers are price-takers. Such a characteristic implies production and consumption decisions that individual producers and consumers face do not affect the market price of the good or service. A perfectly competitive market can be characterized as a market where there is an abundance of well-informed buyers and sellers, there is an absence of monopolies, and each firm is a price-taker. Summary
What are Price-Takers?Price-takers are market participants that are unable to affect the market price of goods through their production and consumption decisions. The two types of price-takers are: 1. Price-taking producersA price-taking producer is a producer that cannot affect the market price of the product or service they are selling. 2. Price-taking consumerA price-taking consumer is a consumer that cannot affect the market price of a good or service. Prerequisites of Perfect Competition1. No individual firm possesses a substantial market shareFor an industry to be perfectly competitive, no individual producers must have a large market share. Market share is the proportion of the total industry’s output that belongs to a single firm. For example, consider the wheat market. Many farmers grow wheat, and market share is dispersed among them. There are no farmers that could potentially affect the price of wheat on the market. 2. The industry output is a standardized productPerfect competition can only occur when consumers perceive the products of all producers to be equivalent. Therefore, it can only occur when the industry output is a commodity, otherwise known as a standardized product. Since standardized products are homogenous, a single producer cannot increase the price of their good or service without losing all sales to the competition. It implies that price-taking firms face perfect price-elasticity of demand. 3. Freedom of entry and exitThe majority of perfectly competitive industries allow firms to easily enter and exit the industry. The arrival of new firms into an industry is referred to as market entry. Market entry is enabled by the absence of obstacles posed by government regulation or low start-up costs. The departure of firms out of an industry is referred to as a market exit. Firms can easily exit the market if there are no additional costs attributable to shutting down the business. For example, consider the mining industry. In the mining industry, firms must recognize an Asset Retirement Obligation (ARO) to restore the property to its previous state after the desired metals are extracted. An ARO refers to a liability that is amortized throughout the investment horizon and exemplifies an exit cost for mining firms. Optimal Production Output in a Perfect CompetitionIn order for firms to generate maximum profits, they must determine their optimal output to produce. In a perfect competition, firms produce an output quantity where the marginal cost of the last unit produced is equal to the marginal revenue of the product. For a price-taking firm, the marginal revenue is equal to the market price. It is because no firm can affect the market price; therefore, the additional revenue generated by producing one more unit is the market price. Consequently, an individual firm faces a perfectly elastic demand curve. The price-taking firm’s demand curve is equal to its marginal revenue. The demand and marginal revenue curve can be illustrated by a horizontal line drawn at the market price. Example of Market Equilibrium in a Perfect CompetitionConsider a wheat farmer who intends to sell his wheat to customers. The current market price of wheat is $100 a bushel. The farmer’s marginal cost function is: MC = 25 + 2.5Q Given the market price and the farmer’s marginal cost function, what is the profit-maximizing quantity to produce? 100 = 25 + 2.5Q Q = 30 Therefore, the farmer should produce 30 bushels of wheat. Related ReadingsCFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
Which of the following is a characteristic of a perfectly competitive market?Answer and Explanation: The correct answer is option c. Firms can exit and enter the market freely. A perfectly competitive market is a theoretical market where firms can enter and exit the market freely or without cost.
Which of the following is characteristic of a perfectly competitive market quizlet?(The characteristics of a perfectly competitive firms are: price takers, experience no barriers to entry, sell identical products, and face a perfectly elastic (horizontal) demand curve.)
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