perfect competition

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Perfect competition

An idealized market environment in which every market participant is too small to affect the market price by acting on its own.
Perfect competitionclick for a larger image
Fig. 140 Perfect competition. See entry. (a) Short-run equilibrium. (b)Long-run equilibrium.

perfect competition


atomistic competition

A type of MARKET STRUCTURE characterised by:
  1. many firms and buyers: that is, a large number of independently acting firms and buyers, each firm and buyer being sufficiently small to be unable to influence the price of the product transacted;
  2. homogeneous products: that is, the products offered by the competing firms are identical, not only in physical attributes but are also regarded as identical by buyers, who have no preference between the products of various producers;
  3. free market entry and exit: that is, there are no BARRIERS TO ENTRY (hindrances to the entry of new firms) or impediments to the exit of existing sellers
  4. perfect knowledge of the market by buyers and sellers.

In a perfectly competitive market, individual sellers have no control over the price at which they sell, the price being determined by aggregate market demand and supply conditions. Each firm produces such a small fraction of total industry output that an increase or decrease in its own output will have no perceptible influence upon total supply and, hence, price. Further, given the infinite cross ELASTICITY OF DEMAND between the homogeneous outputs of the competing sellers, no seller can increase his price above the ruling market price without losing all his custom. Thus, the demand curve facing the firm will be a horizontal straight line at the ruling market price. In consequence, marginal revenue (MR) equals average revenue (AR). The competitive firm is a price taker, accepting price as something completely outside its control, and will simply adjust its output independently to the most profitable level at that price; that is, the firm will continue to produce additional units of output so long as price (= MR = AR) exceeds marginal cost. When these are equated, the firm will maximize profits. Fig. 140 (a) shows the short-run competitive-equilibrium position for a ‘representative’ firm and the industry.

The individual supply schedules (MCs) of x’ number of identical firms are summed horizontally to obtain the industry supply curve (SS). Given industry demand (DD), the short-run equilibrium price and output are Pe and Qe. Taking the equilibrium price as given, the competitive firm establishes its profit-maximizing output at the level Qf (P = MC) and, in this case, realizes ABOVE-NORMAL PROFITS (Pfxyz).

The long-run equilibrium position can also be ascertained. It is deduced, from the assumptions of profit maximization, perfect knowledge and free entry and exit, that, unless the returns to the productive resources employed in the industry are at a level that could be derived from alternative uses elsewhere in the economy, there will be resources entering or leaving this industry. In general, outputs will be adjusted to demand until market output is extended (or reduced) and price reduced (or increased) to the point where the average cost of supplying that output is just equal to the price at which that output sells.

If, as in the example above, established sellers are earning above-normal profits, then new resources will be attracted into the industry, thereby increasing total market supply and reducing market price. This process will continue until the excess profits have been competed away. Fig. 140 shows the long-run competitive equilibrium position for the ‘representative’ firm and the industry. Given an unchanged industry demand (DD), the long-run equilibrium price and output for the industry are P1e and Q1e. Given the equilibrium price, the firm establishes its profit-maximizing output at the point Q1f, where P = MC at the point of minimum long-run average cost.

Static market theory shows perfect competition to result in a more efficient MARKET PERFORMANCE than other forms of market organization (see especially the comparison with MONOPOLY). Specifically, market output is optimized at a level equal to minimum supply costs; consumers are charged a price just equal to minimum supply costs, with suppliers receiving a NORMAL PROFIT return. The conclusion of competitive optimality, however, rests on a number of assumptions, some of which are highly questionable, in particular the assumption that cost structures are identical for small perfectly competitive firms and large oligopolistic and monopoly suppliers (see OLIGOPOLY, ECONOMIES OF SCALE), while, given its static framework, it ignores important dynamic influences, such as TECHNOLOGICAL PROGRESS. See also MONOPOLISTIC COMPETITION.

References in periodicals archive ?
As with [lambda], the meaningful range of values for [delta] is [0, 1]: [delta] = 1 identifies the pure monopsony case; [delta] = 0 corresponds to price-taking behavior by retail firms in the wholesale market.
Figure 4 shows that the two triplets of quantity/price observations can be reconciled with bilateral price-taking behavior given the retailer marginal cost curve ([MC.
where [gamma] [epsilon] [0, 1] indexes conduct ranging from price-taking ([gamma] = 0) to pure monopoly in the wholesale market ([gamma] = 1).
The fact that [delta] is identified in the MPT solution means that bilateral price-taking conduct can be empirically distinguished from retailers' exercise of monopsony power in the wholesale market.
It is easy to see that a simple parametric restriction, [delta] = 0, converts the MPT solution to the BPT solution, so one could test a null hypothesis of bilateral price-taking versus an alternative of manufacturer price-taking coupled with a nonzero degree of retailer oligopsony power by testing [delta] = 0 versus [delta] [greater than] 0 using an asymptotically valid t-test procedure based on the results of maximum likelihood estimation of the equations of the MPT equilibrium.
22] The economic interpretation of this result is that noncompetitive pricing distortions exist in this bilateral oligopoly setting and that they appear to be the result of the exploitation of oligopsony power on the part of retailers while manufacturers exhibit benign, price-taking conduct.
Because the properties of the stable cartel derived above contrast not only with those obtained for a price-taking fringe, but also with those of Cournot merger models with simultaneous play, it is important to examine the equilibrium sequence of moves between the cartel and the fringe.
However, even though cartel firms do earn lower profits than fringe firms, as in the case of a price-taking fringe, the set of stable cartels is not empty.
Uniqueness of the stable cartel for n [is not equal to] 4 is not a surprising result, given its existence, since [4] has derived unique stable cartels with a price-taking fringe.
An open question is whether the same pattern of preferences characterizes a market with a price-taking fringe.
Again, a question remains whether this result is also true given a price-taking fringe.
A price-taking fringe would produce a quantity such that price equals marginal cost.