Perfect competition is a market structure where no participant can influence prices. Under perfect competition there will be a free flow of information without any barriers to entry, and consists of a large number of buyers and sellers. Thus perfect competition in economic theory has a diametrically opposite meaning to the everyday usage of this term.
A perfectly competitive market model is based on the following assumptions:
- There are a large number of buyers and sellers in the industry/market, so that no individual buyer or seller, however large, can influence the price by changing the purchase of output. This means the individual buyer or seller is an insignificant player in the market.
- All firms in the industry produce a homogeneous product. The technical characteristics of the product as well as the services associated with its sale and delivery are identical. There is no way in which a buyer could differentiate among products of different firms.
- Entry and exit of firms is free for the industry. That is there is no barrier to entry or exit from the industry. Entry of exit may take time, but firms have freedom of movement in and out of industry.
Features of Perfect Competition
The following are the main characteristics of perfect competition:
- Existence of Large Number of Buyers and Sellers. The number of buyers and sellers is so large that no individual buyers or seller can influence the market price and output by his independent action. Every buyer and seller purchases or sells a very insignificant amount of the total output. The individual firm must take the price as given. It is a price taker not the price fixer.
- Free Entry and Exit of the Firms. Every firm is free to join or leave the industry. If the industry is making profits new firms can enter the market to share these profits. Similarly, if the industry suffers losses, the individual firm may decide to quite the market.
- Homogeneous Products. A firm produces a product that is accepted by customers as homogeneous or identical. The firm cannot different among buyer. It will not earn profit or suffer loss by selling its product to a particular buyer. An Individual firm cannot change any other price more that that already prevailing in the market.
- Perfect Knowledge. There is perfect and complete knowledge on the part of all buyers and sellers about the conditions in the market. For a market to be perfect it is essential that all buyers and sellers be aware of what is happening in any part of the market.
- No Transport Cost. It is necessary that the commodity of the perfect competition market should be capable of being easily transported from one part of the market to another. It is presumed that the transportation cost from one part of the market to another part is zero.
- Perfect Mobility. There is perfect mobility of factors of production geographically (i.e.,) from one place to the other) as well as occupationally (i.e., from one job to the other).