Perfect competition

In the prefect market condition no individual firm or seller is able to influence the prices of commodity. The price is determined by the forces of demand and supply of the industry as a whole and the individual firms has to accept the prices set by the industry and try to adjust its output to the ruling market prices so that the average revenue is equal to the marginal revenue. In the perfect competitive market a firm’s marginal revenue is equal to the prices. Since the prices does not change irrespective of the output solved by the firm. When the prices of a commodity equal to the marginal revenue the demand curve and the marginal revenue are the same. From the characteristics’ of the firm in a perfect competitive market we see that the demand curves will be perfectly elastic.

Characteristics of a Perfect Competition:

  • There is free entry and exit for different firms operating in this market. The only hindrances to entry are firm’s related constraints like costs and lack of raw materials.
  • The goods sold in this market are homogenous. Homogenous means that the products are almost identical and the consumer does not prefer one product to the other.
  • The perfect competition market has also a very large number of buyers and sellers. This way there is no individual firm in the market that can influence the prices of goods and services.
  • The individual firms are price takers and have to accept the prices set by the laws of demand and supply.
  • In a perfectly competition market there is no information asymmetry and Perfect information is available to the buyers and sellers.

The advantages of Perfect Competition market are:

  • The high degree of competition in this market helps resources to be allocated to the most efficient user.
  • No firm in the market can make abnormal profit in the long run.
  • Degree of competition and restriction in price settings will make the firms in this market to operate at maximum efficiency.
  • A perfectly competitive market will benefit the consumers in term of pricing, quality and after sales services.

It should be noted that in price determination under perfect competition the industry is the price setter and the firm is the price taker. The firms will therefore have no power to set prices. Any firm operating in the perfect market environment will try to maximize its profit by adjusting its output. A firm in a perfectly competitive market will be said to be at equilibrium when it has no trend to increase or decrease the levels of output at thus point the firm is earning maximum possible profits. In the short run the firms operating in this market will be at equilibrium when, it has normal profits, when it is incurring losses and when the firm is earning abnormal profits. This condition will not last long due to the free entry and exit of firms in the market that ensure that the long run equilibrium output is such that survivors earn abnormal profits.

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