Market Structure
9.3. PERFECT COMPETITION
Perfect competition is a market situation which is characterized by group of sellers who sell a similar product at a homogeneous price. In this type of market a single market price prevails for the commodity which is determined by the forces of total demand and total supply in the market. Every seller sells his/her commodity at the prevailing price. Thus in a perfect market, the producer is known as the price taker. Mrs Joan Robinson defines perfect competition in terms of elasticity of demand. According to her,
“In perfect competition there will be perfect elasticity of demand for the product of every individual producer. There should be large number of sellers, and the buyers should be aware of the various price offers and their perfect conditions, so that they have no reason to prefer one seller to another”.
Characteristic feature of a perfect market
There are certain distinct feature which characterize the perfect market:
1. Large number of sellers: A perfect market is characterized by a large group of sellers who sell similar products at a uniform price. Since the market comprises a large number of sellers, each firm's size is only a percentage of the market supply. Consequently any variation in individual supply has a very little effect on the total supply. Thus, an individual firm cannot exert any influence on the ruling market price. This is the main reason behind referring to the sellers in this market as a 'price taker'.
2. Large number of buyers: There are a large number of potential buyers in a perfectly competitive market. Since the number is large, each buyers demand constitutes just a fraction of the total market demand. Hence no individual buyer is in a position to exert his influence on the prevailing price of the product.
3. Product Homogeneity: Sellers sell homogeneous product. In other words, the product of each seller is virtually standardized.
Since, each firm produces an identical product. Their products, can be readily, substituted for each other. The buyer has no specific preference to buy from a particular seller only. Thus his purchase is only a matter of chance and not of choice, on account of the homogeneity of goods.
4. Free entry and exit of firms: There is free entry of new firms into the market. There is no legal, technological, economic, financial or any other barrier to their entry and exit. Thus the mobility of firms ensures that whenever there is scope in the business new entry will take place ad competition will remain always stiff. Due to the stiff competitive situation inefficient firms naturally quit from the market.
5. Perfect knowledge of the market conditions: the buyers and sellers must have a perfect knowledge of the prevailing market conditions, especially the prevailing price, quantities and source of supply and quality of the product. In order to prevent discrepancies in the prices of commodities, the consumers should also be aware of the prevailing price.
6. Non-intervention of the government: Perfect competition also implies that there is no government intervention in the working of the market economy. There are no tariffs, subsidies, rationing of the goods, control of supply of the raw material, licensing, or
other government interference. The non-intervention is necessary in order to enable the forces of demand and supply to work freely.
7. Absence of transport cost: Since all the firms are located in a particular geographical area, the transport cost is equally borne out by all the firms in the market. Hence the percentage of cost incurred is equally shared by all the firms.
Price determination under Perfect Competition
Price under perfect competition is determined by the interaction of demand and supply. Though individual buyers and sellers cannot influence the price of the commodity, the aggregate demand and supply play a great role in influencing the price of the commodity.
The demand curve normally is a convex curve sloping from the left to the right downwards indicating that the consumers would buy more commodities at less prices and less commodities at high prices. The supply curve on the other hand, slopes from left to right upwards, indicating the suppliers would supply more at high prices and supplying less at low prices. The level at which the demand curve intersects the supply curve determines the equilibirium price. Equilibirium price is that price at which quantity demanded is equal to the quantity of the product supplied. At this price the two forces, demand and supply, balance each other and balanced quantity is called the equilibirium quantity.
Market demand and supply schedule for wheat Price Total Demand Total supply pressure on
Per kg per week per week price
6.0 2000 10000 downward
5.0 3000 8000 downward
4.5 4000 6000 downward
3.0 5000 5000 neutral
2.0 6000 4000 upward
1.5 7000 2000 upward
The equilibirium price can be explained through the above schedule. In the table when the price of wheat is Rs. 6, the total demand of wheat for a week is 2000 kg, but the supply is 10000 kg, 8000 kg remain unsold, hence there is downward pressure on price. Similarly when the price is Rs. 5 the demand is 3000 kg
and total supply is 8000 kg. There is again a down ward pressure on price due to the surplus supply. This continues to occur till the price reaches Rs. 3. When the price of wheat is Rs. 3 per kg, the total demand is 5000 kg and total supply is 5000 kg. It is seen here that the total supply is equal to the total demand for the commodity, the equilibirium price is thus determined at Rs. 3 when the supply is equal to the demand. If there is further increase in demand for wheat due to a fall in price the supply falls short of demand. For instance, if the price is Rs. 2, the total demand is 6000 kg and supply is only 4000 kg. Hence the surplus demand forces the price increase, thus there is upward pressure of price. This continues till the equilibirium price is reached.
The derivation of equilibirium price under perfect competition can also be explained through a figure.
In the figure DD is the demand curve which slopes downward from the left to the right downwards. SS is the supply curve which slopes upwards from left to the right. The price is measured on the y axis and quantity supplied and demanded is measured on the x axis. The demand and supply curve intersect at E, the equilibirium point. The corresponding price OP at which the quantity supplied and demanded is OM. Suppose the price
Price
increases above the equilibirium price. At OP1 the demanded is only P1R while the supply is P1S. The excess supply is RS, which the buyers will not demand. In order to sell excess supply, the buyers will bring down the price to OP2 at which the demand is P2T and the supply is P2V. The excess demand is to the extent of VT. This excess demand will gradually push the price to the equilibirium point. As long as the supply and demand remain more or less equal, the current equilibirium price prevails in the market.
Time element in perfect competition
Marshall was the first economist to introduce the concept of time in price determination. Apart from price which influences the demand and supply of a commodity, there are certain other factors which influences the demand and supply of a commodity. One of these elements is time. Marshall divided time period into the three categories: market period, short period, and the long period.
1. Market Period: According to Marshall, it refers to a