Perfect Competition
Candlefocus EditorIn a perfectly competitive market, there are a large number of potential buyers and sellers. Each market participant is small relative to the size of the market and has no influence over the market price. This means that each participant takes the price as given and cannot influence the market. The demand curve facing each firm is perfectly elastic, meaning that any attempt to increase price beyond the going rate will result in zero sales.
The main characteristics of perfect competition are: (1) Large number of buyers and sellers; (2) Homogenous and freely available product; (3) Perfect Knowledge of the market, meaning that all parties to the market have full knowledge of pricing, supply and demand conditions; (4) Perfect mobility of the factors of production means that the factors of production can move freely into and out of all the different industries; (5) Perfect, costless and instantaneous communication; (6) No government intervention (in the form of subsidies, taxes, etc.); (7) No entry or exit barriers.
In perfect competition, all firms are price takers. This means that price is unaffected by the activities of any single firm as other firms would enter the market if one firm were to charge a price above the market level. Even though they are role players, they are still price takers since they can not influence the price of their output. Thus, each firm faces a perfectly elastic demand curve and consequently, the profit maximization process becomes the same as the process of cost minimization. Firms in a perfect competition set their prices and production levels by finding the profit maximizing output and price with cost curves.
Overall, perfect competition is a theoretical model, which is rarely seen in the real world. However, pure competition provides insight into how pricing should work when resources are allocated efficiently and fairly. Thus, because of the theoretical advantages of this market structure, it serves as the benchmark by which other market structures can be judged.