Introduction
Perfect competition refers to the type of market where competition is experienced at its highest possible level (Djolov 200). Perfect competition can be described based on a number of features evident at the market setting. Consider a vegetable vendor in a busy street selling kales and onions in the open-air market. In the same market there are other vendors offering kales and onions. None of the vendors has the capacity to sell their products at either high or low price considering that everybody has full knowledge of the price of kales and onions at market (Cohen 157). As a result, any other person who is willing to sell kales, potatoes and onions in the same market is free to do so. In addition, quitting the business is at will since nobody dictates the condition to enter or leave the market. This example depicts a perfect competition.
Some of the common features of perfect competition market structure include absence of government intervention, existence of numerous firms that are all equal in power and technical characteristics; they have no capacity to set price of products in the market, and they sell identical products at normal prices. In addition, perfect competition features a scenario where both firms and buyers have perfect knowledge of the market conditions. Factors of production show high mobility. The buyers and sellers do not identify themselves with particular individuals (Hirsch 506).
No government Intervention
The action of the government is significant for any business to thrive as expected. As such, government intervention refers to the actions that a government takes, which have a significant influence on the market economy. Economists assert that government intervenes in the operations of business with the aim of controlling the outcome of the economy past normal regulations such as in the case of providing public goods or in the case of contracts (Besanko, Braeutigam and Gibbs 243).
The government thus, can intervene in any market through provision of government incentives to encourage the production of given products, provision of licenses to operate in a given area or to offer certain goods and services to the public (Mastrianna 79). Such legal requirements by the government at times adversely affect the operations of businesses. For example, in the case of perfect competition, there is no government intervention since in this type of market structure any firm can enter or leave at will. Consider a scenario whereby an individual grows farm products and takes them to the market. In such an instance, the farmer does not face any government intervention whether in licensing, incentives, or taxes.
All firms are price takers
In perfect competition, all the sellers sell their products, which are identical. The characteristic identical products make the entry and exist of sellers into the perfect competition market structure to be easy (Mastrianna 88). In this case, there are no price-setting powers among the firms. The lack of price-setting power in the perfect competition market structure which can be attributed to rather diverse agents who are active on the market (Besanko, Braeutigam and Gibbs 243). Such a scenario gives all the firms the ability to take prices since they operate with the prices set by the market. As such, in the perfect competition, all firms sell at the same price considering that the products in the market are identical. For this reason, all firms are considered equal in size such that there is no single firm that has the advantage of influencing the prevailing market price via the firm’s scale of production. The result thus, is a horizontal demand curve.
The fact that all firms are price-takers in perfect competition ensures that the sellers have the ability of selling as much products as the firm wishes at the prevailing market price. This sets a scenario whereby any firm that increases price above the market price is likely to sell nothing because the numbers of firms in this case are many, with each one of them selling similar products (Besanko, Braeutigam and Gibbs 243). As a result, buyers would tend to buy from other sellers offering the same products at the market price. An example of perfect competition is whereby firms A, B, and C sell same computers at the prevailing market price of $1000. However, whenever firm A, increases the price to $1001, the firm makes no sales since buyers have perfect knowledge of the market and thus can buy from firms B and C at the prevailing market price of $1000. In the same context, a decrease in price would tend to scare away buyers and thus the firm is likely to sell nothing.
Zero Advertising Cost
It is obvious for firms to advertise to increase the market share of their products. In perfect competition however, firms do not have to use any amount of money to advertise since consumers aware of the products as well as their characteristics. Advertisement cost will lead to an increase in the price of products since it is an increased cost in sales. As such, the sellers assume that buyers are aware that the product exists and are able and willing to buy at the prevailing market prices.
For instance, company A cannot advertise since all the products in the market have similar characteristics.
Numerous small firms
A market or industry that is perfectly competitive has numerous small firms. These firms are however small in size in comparison with the overall size of the market or industry. The large number of firms prevents them from controlling the prices or quantities in the market. For instance, if any firm plans to double its production or not to produce, the market is not affected. Such changes do not change the price hence there is no noticeable change in the quantity of the product exchanged. Questions arise on the specific number of firms needed in a perfectly competitive market so that all of them are small in size with zero control over the market. Such a scenario can be attributed to the notion that this type of market is imaginary. Again, it is because the firms’ number in the market is not more important than the end result of their actions.
Examples can be used to explain this characteristic. The first example is company A which produces its own goods and is among the large number of companies producing the same. The products are corns that are grown in the family gardens. Company A has got no control over the market of corns since it has several producers, all producing in small scale. If company A decides to produce fewer products, more products or none at all, the overall market and the prices of corns remain unaffected. Corn consumers will still buy the products from other producers as if they did not notice any change. According to them, and in consideration for the market, nothing changes with the change in one producer’s behavior.
Again, another example is company B that produces electronics and computer memory storages. In this industry, company B is among the three main producers of the same. Since it is in the possession of a third of the market, it can have a significant degree of control in both the price and the quantity of its services and goods. As such, any change in its behavior, either to produce more products, fewer, or none at all, the market for the electronics and the computer memory storage takes notice. In this case, both the quantity demanded and the price of such products will go up.
Similar Goods
All firms in the perfectly competitive market structure produce or sell identical products which are said to be homogeneous. The most critical part of this factor is that the goods are not exactly the perfectly or exactly identical, but that the buyers are always unable to differentiate them. This means that the consumers of the products are not in a position to tell which firm produces certain goods. Brand names are not common to distinguish between various firms. For similar goods, each firm produces goods that can perfectly fit as substitutes to the goods of other firms in that industry. This makes it impossible for any firm to change the prevailing market prices. The price tends to remain constant because a slight increase will cause consumers to switch to other substitutes and any decrease will make almost all consumers to switch to that firm. Such a situation however does not exist in a perfectly competitive market structure.
Again, using the example of company A, which grows corns and bearing in mind that its corns are not different from those of other producers. They have similar looks, tastes and have same market share. The importance in this case is that they satisfy the same need among the consumers. As such, the actions of company A cannot affect the prices or the quality demanded of corns. On the other hand, company B, which produces electronics and computer storage systems has a great impact on the prices and the quantity demanded of the product. Due to its branding, the product is uniquely identified. It is thus not similar to other products for the same use as it operates under categories that are diverse and have distinct value. For such a product, any alteration in its quality or price will have a great impact on the prevailing prices and quality demanded in the market.
Resources are perfectly mobile
In perfect competition, entry to and exit from the market is free (Cohen 157). There are no borders by any market forces. This is in contrast to other firms that need extremely high star up costs and strict government permits to enter a market. Again, the government rules and regulations do not hinder a perfectly competitive firm from exiting a market like it is the case for other government regulated entities. Due to such freedom, such participants have the opportunity to access factors of production and make maximum utilization of all the needed and available resources without hesitation and restrictions. Discrimination on the basis of sexual orientation, ethnic groups, race, color and religion among others is eliminated.
For instance, if company A wants to quit the corn industry and enter into the movie industry, it can freely move without any limitations. Again, if company C wants to leave the movie industry and get into the corn industry, it can move without constraints. Such a situation indicates that the two firms are not faced with any recognition for its brand nor investment costs that may be hindrances to both entry and exit into the market. Any entry into the market means that the incoming participants can strongly influence the balance in the market.
On the contrary, when company B got into the market, it had to invest a lot in infrastructure, spend lots of money on advertisements for recognition of its brand name, and get permits from the government authorities. Again, if the electronics and the computer storage systems used are unique and mostly used by a specific group of individuals, it might not be easy for the company to quit the market. If the company quits, then a unique product will lack in the market and the firms left will shoot their prices with an aim of profit maximization.
Perfect Knowledge
In a perfectly competitive market, buyers have a complete knowledge about the prices of the sellers. It is therefore difficult or impossible for any firm to charge higher prices for the goods than the other firms. Sellers also have completely informed on the values of products at other outlets within the market. This knowledge is very crucial as it prevents aimless price fluctuations. Technology is also involved in this factor. All players in this type of market make use of similar technologies while producing goods and services. Due to the equality in knowledge of information, they all produce at the same speed, same quality and for the same price using similar machines.
Company A for instance is in possession of all it takes to grow corns. This same knowledge is possessed by all other corn producers in the market. If company A knows the prevailing corn market price to be $2, all the buyers know it as the price for one corn. As such, a slight change in the price will make a shift by the buyers to other products. On the other hand, company B has several rights on the production and sale of both the electronics and the computer storage systems. It also has a safe and sound secrecy for the production of its products.
Normal Profits
All firms in the industry have an aim of making profits (Hussain 159). The firms only make normal profits both in the short-run and the long-run. However, whenever a firm makes supernormal profits or losses, the forces of demand and supply interact to force the price and quantity back to equilibrium for the firm to continue making its normal profits. When the firm is making supernormal profits, other firms become interested in joining the market and sharing profits among them.
The reason for this is that there are no entry and exit barriers and both the buyers and sellers have full knowledge about the product (Hussain 200). A representation of the short run situation of the perfect competition shows a shift of the supply curve to the right if new firms appear on the market. Increase in supply has the effect of reducing the market prices until the supernormal profits are eliminated and all the firms make normal profits. On the other hand, in case of losses, firms will be forced to exit the market since there are no restrictions (Mastrianna 80). Such exit reduces the amount of products supplied to the market, raising the price of goods which make all the firms to go back to normal profits. In the long run situation, consequences of supernormal profits are the reasons for new firms to venture the market reducing the prices until the firms only make normal profits.
No transport cost
In a perfectly competitive market, there is no existence of transport cost (Djolov 119). The fact that all the goods and services in the market have similar prices makes it reasonable that there is no transport cost. If the cost was there, then all the firms would charge different prices, leading to differences in the industry for similar products. Transport cost is however present if perfect knowledge is non-existent for the buyers and sellers. The assumption is that the enterprise is always located near its raw materials and its market for finished goods. For instance, company A is located near its firm as well as its buyers. On the other hand, company B has to hire external suppliers for its raw materials hence the difference in the prices for its finished goods in the market.
No Attachment
In perfect competition, buyers and sellers do not identify their preferences with one particular client. All sellers offer identical products at equal or similar prices. The buyers do not have special preferences for goods or services provided by one seller, which is evident in other market structures. For instance in the case of company A, all farmers grow similar corns. The buyers will thus buy from any seller without attaching to any specific one. Company B on the other hand produces goods that are unique. As such, customers will have special interests for such goods. Some buyers will thus attach themselves to its products. This means that any activity by company B will have vast impacts in the market.
Conclusion
From the foregoing, it is sufficient to point out that perfect competition is a form of market structure that is hypothetical in nature. The market involves many sellers and buyers, and there are no entry and exit barriers. As such, all production factors in perfect competition can be adjusted freely to match with the changing conditions in the market. As a result, all firms are in a position to make normal profits in the long run because any chance of super-normal profits attracts new firms into the market; a move that tends to balance maximization of profits among the involved firms. As such, the perfect competition can be seen as market structure whereby all participants are equal in size, they sell similar products, and have no power to influence the market conditions such as setting the price of products. In addition, economic theories have showed that there is no government intervention in perfect competition.
Works Cited
Besanko, David, Ronald R Braeutigam, and Michael Gibbs. Microeconomics. Hoboken, NJ: John Wiley, 2011. Print.
Cohen, Andrew. Market Structure and Market Definition. Washington, D.C.: Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, 2004. Print.
Djolov, George. The Economics of Competition. New York: Best Business Books, 2006. Print.
Hirsch, Mark. Study Guide for Fundamentals of Managerial Economics. Hillsdale, Ill.: Dryden Press, 2001. Print.
Hussain, Tahir. Engineering Economics. Oxon: CABI Pub., 2003. Print.
Mastrianna, Frank. Basic Economics. Australia: South-Western/Cengage Learning, 2013. Print.