CHAPTER 10 : PERFECT COMPETITION

10.1 Features of Competition

(A) Introduction: A firm is the smallest unit of production. The objective of a firm is to maximize profits. This it can achieve by minimizing cost of production, or maximizing total revenue (i.e. Price ´ Output). The prospects of profit for a firm are further guided by market conditions. In a market where a firm has to sell its output there may be competitive, monopolistic or oligopolistic conditions. Each market type has a different impact on the price and quantity sold by the firm. All these market types will be analyzed in the present and following chapters. Besides the difference in the number of firms under competition and monopoly there are also qualitative distinctions. In modern markets the popular practice of Product Differentiation exists. All this will be studied under different forms of the market. Let us begin with a discussion on the nature of a competitive market.

(B) Features: Traditionally perfect competition is considered as an ideal form of market. For classical writers, perfect and pure competition is a golden rule. Only under exceptional conditions, this rule may not be satisfied. In that case monopolistic elements may be present in the market. As it is understood today, the Classical Competitive Model is hypothetical in nature; it is not based on actual market conditions. Such a competitive market is supposed to provide maximum justice to a maximum number of buyers and sellers.

Competition is said to be Pure and Perfect when six basic characteristics are satisfied (three characteristics each associated with Pure and Perfect competition).

i) Pure Competition: The market is said to be pure when

i) There is a large number of buyers and sellers;

ii) Goods produced and sold are homogeneous, and

iii) There is Free Entry or Exit for any producer or seller.

The three conditions together ensure that an individual firm can have no control over market conditions of price and quantity supplied. The first condition ensures there are several competitive firms in the market. Each firm has a small and insignificant share in the market supply. Therefore, even if a firm doubles or completely withdraws its share from the market its actions will not affect market conditions. Further, each firm produces homogeneous products. The goods produced are physically and chemically identical in their qualities. This further takes away the influencing capacity of firms. Finally, there is complete freedom to enter or exit the market. So long as a firm finds existing market conditions beneficial, it will continue to produce and sell.

ii) Perfect Competition: Competitive market is supposed to be perfect in every respect. For this three conditions must be satisfied:

i) Perfect knowledge on the part of the buyers and sellers about market conditions,

ii) Perfect mobility of the factors of production, and

iii) Proximity to the market.

This further consolidates competitive force and rules out the influencing capacity of individual firms. When market conditions are perfectly understood there is no chance of a higher price being charged or paid. When factors of production are freely mobile, entry or exit of firms is facilitated. Proximity to the market further ensures that there is no extra transport cost, which may otherwise cause a small variation in the price.