MS-09 Question 4

Perfect competition
is an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. According to the standard economical definition of efficiency (Pareto efficiency), perfect competition would lead to a completely efficient outcome. The analysis of perfectly competitive markets provides the foundation of the theory of supply and demand. Perfect competition is a market equilibrium in which all resources are allocated and used efficiently, and collective social welfare is maximized.
CONDITIONS FOR PERFECT COMPETITION
Often models of perfect competition assume that some subset of the following six conditions be fulfilled. In such a market, prices would normally move instantaneously to economic equilibrium. It should be noted however that these represent sufficient, not necessary conditions.
1.Atomicity
An atomic market is one in which there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are price takers, meaning that the market sets the price that they must choose.
2.Homogeneity
Goods and services are perfect substitutes; that is, there is no product differentiation. (All firms sell an identical product)
3.Perfect and complete information
All firms and consumers know the prices set by all firms .
4.Equal access
All firms have access to production technologies, and resources are perfectly mobile.
5.Free entry
Any firm may enter or exit the market as it wishes .
6.Individual buyers and sellers act independently
The market is such that there is no scope for groups of buyers and/or sellers to come together with a view to changing the market price (collusion and cartels are not possible under this market structure)
Behavioral assumptions of perfect competition are that:
Consumers aim to maximize utility
Producers aim to maximize profits.
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CHARACTERISTICS OF A PERFECT COMPETITION
1. Many suppliers each with an insignificant share of the market – this means that each firm is too small relative to the overall market to affect price via a change in its own supply – each individual firm is assumed to be a price taker
2. An identical output produced by each firm – in other words, the market supplies homogeneous or standardised products that are perfect substitutes for each other. Consumers perceive the products to be identical
3. Consumers have perfect information about the prices all sellers in the market charge – so if some firms decide to charge a price higher than the ruling market price, there will be a large substitution effect away from this firm
4. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology, other factor inputs) and improvements in production technologies achieved by one firm can spill-over to all the other suppliers in the market
5. There are assumed to be no barriers to entry & exit of firms in long run – which means that the market is open to competition from new suppliers – this affects the long run profits made by each firm in the industry. The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long term
6. No externalities in production and consumption so that there is no divergence between private and social costs and benefits
EXAMPLE OF PERFECT COMPETITION
-farm products marketing
-commodity marketing
-stock exchange securities marketing
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THERE IS A VERY FINE/ THIN LINE BETWEEN
THE PERFECT COMPETITION AND THE PURE COMPETITION.
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PURE COMPETITION
pure competition - A market model in which (1) a lower price is the only element that leads buyers to prefer one seller to another, and (2) the amount that each individual seller can offer constitutes such a small proportion that acting alone it is powerless to affect the price.
A market structure in which the following five criteria are met:
1. All firms sell an identical product.
2. All firms are price takers.
3. All firms have a relatively small market share.
4. Buyers know the nature of the product being sold and the prices
charged by each firm.
5. The industry is characterized by freedom of entry and exit.
EXAMPLE
-service businesses.
-courier service
etc etc