Perfect Competition to the economist implies the absence of monopoly power that is the absence of any power on the part of any inpidual firm or consumer to influence market prices. In the perfect market there can be only one price for identical goods at the same moment in time.
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Conditions necessary for a perfect market/industry.
1. Large number of buyers and sellers must be large enough to prevent a single one of them from influencing the market price. In the other words, one single producer or purchaser will be able to influence the market price. The output of any single firm is only a small portion of the total output and the demand of any single purchaser is only a small proportion of total demand. Hence the market price has to be of total demand. Hence the market price has to be taken as given and undertaken by any purchaser and seller. If any seller attempts to change even a slightly higher price then others, the consumer will at once go to the other seller. Thus, no inpidual purchaser can influence the market by varying his own demand and no single firm is in a position to affect the market price by varying his own output.
2.Homogenous product: The commodity produced by all firms must be highly standardized that is, each unit must be identical with another. As a result, the buyers find that each seller is offering units of a product which are perfect substitutes for each other. Thus, it is immaterial for the purchaser or to who has produced it.
3.Free entry or exit: There shall be no restrictions on the firms entry or exit from that industry. This will happen when all the firms are making just normal profit. If the profit is more, new firms will enter and extra profit will be completed away; and if on the other hand, profit is less, some firms quite raising the profits for the remaining firms.
4. Perfect knowledge: Buyers and sellers have exact knowledge of what is happening in any part of market. This does not necessarily mean that the market involves a small area, but it does emphasis the importance of communication. When buyers and sellers know what prices are being offered by buyers, and buyers know what prices are being asked by the sellers. If follows that buyers can purchase a lowest price and sellers can sell at the highest price. The result of the efforts of buyers and sellers to obtain the best terms for themselves is the establishment of a single price through the market.
5. Actions solely based on price considerations: Buyers and sellers must base their actions solely on price, that is, there is no preference shown for buying from selling to any particular person. There must not be any ‘brand loyalties’ preferential treatment or discrimination. It implies that no consumer has a favorite shop to which he remains loyal when the owner raises his prices; neither do sellers have favorite customer to who to give special discounts.
6. Perfect mobility of the factors of production: this mobility is essential in order to enable the firms top adjust their supply to demand. If demand exceeds supply, additional factors will move into the industry and in the opposite case move out. Mobility of the factors of production is essential to enable the firms and the industry to achieve on equilibrium position.
7. Absence of artificial restriction: There must not be any restrictions of trade, e.g. price control. The seller should be free to sell their products to any buyer and the buyers should be free to purchase from any seller. When these conditions (outlined above) necessary for a perfect market are fulfilled price differences for the same commodity are quickly eliminated so that one price tends to be established.
Nature of market equilibrium.
We are going to look on how demand and supply interact, and thus find an explanation of the determination of he price of any commodity in the market. In the theory of price determination, the concept of average and marginal revenue is the indispensable tools of analysis average revenue are the revenue per unit of the commodity sold. But since different units are sold at the same price in the market, therefore, average revenue equals price at which the commodity is sold. Thus, average revenue means price.
As the consumer’s demand curve is the graphic relationship between price and the amount demanded, it also represents the average revenue or price at which the various amounts of a commodity are sold. Since the price offered by the buyer is the revenue from sellers point of view, therefore, average revenue (AR) curve of the firm is really the same thing as demand curve for the consumer. Average revenue can be determined by piding the total revenue by the number of units sold, i.e AR = TR No. of units sold.
Marginal revenue: marginal revenue at any level of firms output, is the net revenue earned by selling another (additional) unit of product. If the price of a product falls when more of it is offered for sale, then that would involve a loss of the previous units which were sold at a higher price before, and will now be sold at the reduced price along with the additional one. This loss from the sale of the serious units must be deducted from the revenue earned by the additional unit. Relationship between AR and MR.
The relationship between marginal and average revenues at various levels of output will be discussed as shown in the table below.
Average revenue and marginal revenue are two different things. Column 3 shows average revenue while column 4 shows the marginal revenue. When average revenue is falling , marginal revenue is less than marginal revenue. Marginal revenue curve and MR , the dotted curve, is the marginal revenue curve.
However under perfect competition, the average revenue curve of the firm is a horizontal straight line. This is so because inpidual firm under perfect competition, by its own action, cannot influence the price. The seller under the commodity at the ruling market price. In the case when average revenue curve is a horizontal line, the marginal revenue curve coincides with the average curve. This is because additional units are sold at the same price as before on loss is caused by the previous units which would have resulted if the sole of additional units would have forced the price down.
EQUILIBFRUILM OF THE FIRM.
A firm is in equilibrium when it has no incentive to change its levels of output when its total profits are the maximum. The equilibrium of a firm is usually discussed in two stages, viz, the short run and the long run. Firms equilibrium in the short run.
Under perfect competition for an inpidual firm price is given. It cannot influence the price by its own action. It operates under the assumption that it can sell as much as it likes, at the prevailing price. Therefore, the demand or average revenue curve facing a firm under perfect competition is perfectly elastic at the ruling price. Since a perfectly competitive firm can sell as much as it wants without affecting the price, addition made to total revenue by an extra unit of out put, i.e marginal revenue, is equal to the price (average revenue) of the commodity.
Therefore the average revenue or demand curve and marginal revenue would coincide with each other for a firm under perfect completion. Given the price OP, the firm will fix its output where its profits are he maximum. Profits are the largest at the level of output for which marginal cost is equal to marginal revenue and the marginal curve cuts the marginal revenue from below. Firms’ equilibrium in the long run.
The long run is a period of time long enough to permit changes in the variable as well as in the fixed factors. In the long run equilibrium refers to a situation where free and full scope of adjustment has been allowed to economic forces. Both in short run and long run, firm in perfect completion is in equilibrium at that output at which marginal cost equal cost price (or marginal revenue). But in the long run, for a perfectly competitive firm to be in equilibrium besides marginal cost being equal to price. Price must also be equal to average cost. For a perfect competition firm to be in equilibrium. in the long run the following two conditions must be satisfied. Price = marginal cost Price = average cost
Equilibrium of industry: The concept of equilibrium of industry is of great importance in the analysis of price determination, particularly in product pricing. An industry Is said to be in equilibrium where there is no tendency for its output to increase or decrease. The output of the industry can vary firstly by the expansion or contraction of output by the inpidual firms and second by the entry or exit of the firms. Thus industry would be in fequilibri9um when neither the inpidual firms have intensive to change their output nor is there any tendency for new firms to new firm to enter or existing firm to leave it.
Conditions of equilibrium. The following two conditions must be satisfied if there is to be equilibrium of the industry. (a) Each and every firm in the industry should be in equilibrium. This will happen at that output of a firm where marginal cost is equal to marginal revenue, and marginal revenue cost curve cuts marginal revenue below at the equilibrium point. (b)The second condition is that the industry as a whole should be in equilibrium that is there should be no tendency for the either to move into or out of the industry. This will happen when all the entrepreneurs are earning only normal profits. An industry will be earning normal profits if the price (AR) is to average cost. (AC) . If the price is higher, then obviously normal than normal profits are being made and new fill be attracted to the industry.
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