Meaning of Perfect Competition Market

We might think that a perfect competition market involves intense rivalry or strong competition among sellers and buyers.

However, economist Anna Koutsyiannis defines a perfect competition market as, “Perfect competition is a market structure characterised by a complete absence of rivalry among the individual firms.”

In a perfect competition market, there is a large number of sellers and buyers. The price of a good is determined by the interaction between the total demand of all buyers and the total supply of all sellers in the market. This price is the same for all sellers and buyers, so there is no price competition among them. 

Furthermore, in such a market, every producer or firm sells homogeneous or identical goods. Since there are many firms/sellers within an industry producing a particular good, the transactions of one firm cannot affect the market price of the good. Firms in the industry sell goods at the price determined by the industry, making them price takers in this market.

Characteristics of a Perfectly Competitive Market

The main characteristics of a perfectly competitive market are presented below:

(a) Large Number of Buyers and Sellers

In a perfectly competitive market, there is a large number of sellers selling a particular good and buyers purchasing it. The transaction of any single buyer or seller is so negligible compared to the total market transactions that it cannot affect the market price of the good.

(b) Homogeneous Product Production

In a perfectly competitive market, every firm produces or sells goods with identical qualities, sizes, colors, weights, etc. In other words, there is no distinguishable difference between the goods produced or sold by one firm and another. This means that every firm produces or sells homogeneous or identical goods.

(c) Freedom of Entry and Exit for Firms

In a perfectly competitive market, a group of firms producing/selling homogeneous goods is called an industry. In such a market, new firms are free to enter the industry, and existing firms are free to exit.

(d) Perfect Knowledge of the Market

In this market, buyers and sellers have complete knowledge of the price and quality of goods. Therefore, no buyer is willing to pay a higher price for goods, and no seller can sell at a higher price.

(e) Perfect Mobility of Factors of Production

In a perfectly competitive market, factors of production such as labor and capital are perfectly mobile. Labor and capital can be transferred from one place to another based on available opportunities and conveniences in the market.

(f) Government Non-Intervention

In a perfectly competitive market, the government does not directly intervene in controlling the price or quality of goods. The price of goods and services in the market is determined by the interaction of demand and supply, not by government regulation.

Price Determination in a Perfectly Competitive Market (Price Determination under Perfect Competition)

In a perfectly competitive market, the price of a good or service is determined by the interaction of market demand and market supply. In such a market, the price of a good or service is determined within the industry. Firms within the industry follow that price. There is a negative relationship between the price of a good and the quantity demanded, but there is a positive relationship between the price of a good and the quantity supplied. The price determination process, or the interaction of demand and supply, can be explained with the help of Table 2.1.

Table 2.1: Price Determination of a Good in a Perfectly Competitive Market

In Table 2.1, when the price of the good is Rs. 30 per kg, the market demand for that good is 300 kg, and the supply is 100 kg. In this situation, the market demand for the good is greater than the market supply. Therefore, this is called a state of excess demand. In a state of excess demand, there is competition among consumers to obtain the good, and as a result, the price of the good starts to increase. 

The price of the good continues to increase until the market demand and market supply of the good become equal. In the table, since there is a state of excess demand when the price of the good is Rs. 30 per kg, the price of the good increases. When the price of the good increases from Rs. 30 per kg to Rs. 35 per kg, the demand for the good decreases to 250 kg, and the supply increases to 150 kg. 

This state is also a state of excess demand, so the price of the good increases again to Rs. 40 per kg. Here, when the price increases to Rs. 40 per kg, the market demand and market supply of the good become equal.

Similarly, when the price of the good is Rs. 50 per kg, the market demand for the good is 100 kg, and the supply is 300 kg. In this situation, the supply of the good in the market is greater than the market demand. Therefore, this is called a state of excess supply. In a state of excess supply, there is competition among producers to sell the good. As a result, the price of the good starts to decrease. 

The price of the good continues to decrease until the market demand and market supply of the good become equal. In the table, when the price of the good decreases from Rs. 50 per kg to Rs. 45 per kg, the demand for the good increases from 100 kg to 150 kg, and the supply decreases from 300 kg to 250 kg. This state is also a state of excess supply, so the price of the good decreases again to Rs. 40 per kg. 

Here, when the price decreases to Rs. 40 per kg, the market demand and market supply of the good become equal, i.e., equilibrium is established between demand and supply. 

Here, the equilibrium demand and supply quantity is determined to be 200 kg, and the equilibrium price is determined to be Rs. 40 per kg. The price determination process of goods in a perfectly competitive market is also illustrated in Figure 2.1.

Figure 2.1: Price Determination under perfect competition