Meaning and Assumptions of Perfect Competition
Meaning of Perfect Competition
Adam Smith in his ‘Wealth of Nations’ mentioned the concept of perfect competition in a casual way. Edgeworth was the first to attempt (in his book “Mathematical Psychics”, 1881) a systematic and rigorous definition of perfect competition. The concept received its complete formulation in Frank Knight’s book, ‘Risk, Uncertainty and Profit (1921)’.
Perfect competition in economic theory has a meaning, which is diametrically opposite to the everyday use of the term. As Prof. Koutsoyiannis remarks, “Perfect competition is a market structure characterized by a complete absence of rivalry among the individual firms.”
According to Prof. Bach, “Perfect competition exists in markets where there are so many sellers that no one is big enough to have any appreciable influence over market price.”
Assumptions of Perfect Competition
Perfect competition is characterized by the following assumptions:
1. Large Number of Buyers and Sellers
There is large number of buyers and sellers, each buying or selling only a trivial fraction of the total market transactions. The two forces of demand and supply determine market price. They take the market price as a given parameter beyond their control, and try to sell and buy as much as they wish at that price. In this sense, both buyers and sellers are ‘price takers’ and quantity adjusters. Price takers are people who make a decision on whether to buy or sell at a given price.
2. Homogeneous Product
Under perfect competition, rival firms sell a standardized good or service. There are no brand names, trademarks, patents in perfectly competitive market. For example, the market for eggs is likely to be competitive. This is also known as the homogeneity condition. The implication of this is that buyers will be indifferent about the choice of the seller from whom they buy the product. If one seller raises his price, all consumers immediately buy from his competitors.
3. Absence of Collusion or Artificial Restraint
Another condition is that there is no collusion among the buyers or sellers or sellers and buyers. Moreover, there are no restraints by the government in the form of tariffs, subsidies, rationing of production etc.
4. Perfect Mobility of Factors of Production
Another important characteristic of perfect competition is that the factors of production are free to move from one firm to another throughout the economy. This means that labor can move from one job to another and from one region to another. Capital raw materials and other factors are not monopolized.
5. Profit Maximization
The goal of all firms in the industry is profit maximization.
6. Perfect Knowledge
All buyers and sellers in the market possess perfect knowledge regarding the current and potential price and the availability of the commodity.
7. No Transport Costs
This assumption is essential, as the same price will prevail only then in the market. Information regarding market trends is free and costless. Future uncertainty is therefore ruled out.
Basic Characteristics of Perfect Competition
- It is the most perfect form of competition as the name suggests. And a perfectly competitive market is said to be an ideal one in which there is no exploitation of buyers.
- There are many sellers in the perfectly competitive market since entry is free and easy
- Since there are many sellers, no individual seller can influence the market supply.
- Price is determined by the market forces (supply and demand); and hence a firm is a price-taker.
- Existing price in the market determines the level of output offered for sale.
- Prices are uniformly charged to all the buyers.
- An industry is composed of all the firms producing homogeneous goods under perfect competition.
- There is no excess capacity in the production and a firm earns only normal profit in the long-run.
Perfect Vs Pure Competition
Sometimes, the concept of pure competition is distinguished from that of perfect competition. The difference is a matter of degree. While ‘perfect competition’ has all the characteristics enumerated above, ‘pure competition’ relaxes the assumptions of perfect mobility of the factors of production and perfect knowledge.
Perfect Competition – Perfect Mobility and Knowledge = Pure competition
Perfect Competition in Practice
Perfect competition is an ‘ideal market structure’ rather than an actual market reality. The model of perfect competition fits in for agricultural products like rice, wheat, cotton and eggs. It is extremely difficult to satisfy all the conditions simultaneously. Therefore, perfect competition is termed as a myth. In spite of this, we study this type of market in economic theory because of the following reasons:
- It provides a simplified model to understand the complex economic system.
- It provides crude and approximate estimates of economic variables.
- It provides a strong base for political ideology and welfare maximization.
- It helps in developing the norms for desirable performance applicable to an industry.