PERFECT COMPETITION

Perfect competition is a market where there is a large number of buye~s and sell~rs, buying
and selling identical products, without any restriction on entry an~ exit, and haVIng pe~ect
knowledge of the market at the same time. Examples of products 1n a perfect competition
market are agricultural goods, such as vegetables, fruits and others.

&hA@c.!~~i§!ics
I Large number of buyers and sellers
An important feature of perfect competition is the existence of a large number of buyers
and sellers. The quantity a single seller sells in a market is so small compared to the
overall industry. Therefore, no one can influence the market price of goods. Thus,
in perfect competition, firms are price takers because the individual sales volume is
relatively small compared to market volume.
2 Homogenous or identical product
All the firms in a perfect competition market will sell identical or homogenous products.
In this market structure, buyers cannot differentiate products in terms of quality,
packaging, colour and design. Hence, the firm cannot charge different prices for the
same products in the market. Products which are similar in nature but different in
terms of quality and packaging are not homogenous products.
3 Free entry and exit
In perfect competition, there are no restrictions on the entry of new firms to the industry
or the exit of firms. A new firm can easily enter into the perfect competition market
and exit it at any time it chooses.
4 Non-price competition
Sell~rs practise non-price competition, such as advertising, free gifts, discounts, after sales
services and promotions wh th . •
. , en ey cannot compete among themselves using pricing
~tr_ate~ie~. However, in perfect competition market, the role of non-price competition
18
insignificant as many sellers sell the products at a fixed price and furthermore, the
products are identical.
5 Perfect knowledge of the market
All the sellers and buyers will have perfect knowledge of the market. Sellers cannot
influence buyers and similarly buyers cannot influence sellers. Sellers must know the
prices charged by other sellers in the market and the buyers must know the price being
charged by other sellers. If any seller charges a higher price, the buyer will buy from
different sellers because the products are identical with many sellers in the market.
6 Perfect mobility of factors of production
Factors of production can freely move from one occupation to another and from one
place to another. There is no barrier on their movement. The existence of perfect
mobility of factors of production in a perfect competition will lead to the existence of
a large number of sellers in the market.
7 Absence of transport cost
There should not be any transport costs between sellers. In a perfect competition, it is
asswned that various firms will work closely with each other so that transport costs are not
incurred If two identical products are at two different places, their prices will be different
because of transport cost. Therefore, in perfect competition there will be no transport costs.
 A firm in the short run will possibly enjoy three types of profits:
revenue is Supernormal Profit
1 Supernormal profit or econom ic profit, i.e. the profits earned when total or Profit
average
greater than total cost. Economic profit is also realized when price is greater than TR is greater than TC.
total cost.
is lower Subnormal Profit
2 Subnormal profit or economic losses, i.e. the losses incurred because price or Losses
than the average total cost or when total revenue is less than total cost. TR is less than TC.
s. Normal
3 Normal profit or breakeven, i.e. the profit_necessary for a firm to stay i.ri busines Norma l Profit or
e equals total cost and where no profit or loss is incurre d.
profit is when total revenu Breakeven
TR is equal to TC.
ization
The three types of profits are illustrated in Figure 7.6(a)-(c). The profit maxim
MC at the
rule, MR= MC, applies to all three possibilities. Figure 7.6 shows that MR=
ormal,
equilibrium output and the average total cost differentiates the profit levels as supern
subnormal or norma l profits.
D, where
In Figure 7.6(a), a firm under perfect competition is in equilibrium at point
charges is
MR= AR = MC. The equilibrium output of the firm is M. The price the firm
shaded area
A. In this situation, the firm is earnin g supern ormal profits, as shown by the
ABCD since AR exceeds AC.
charges
In Figure 7.6(b), the equilibrium output of the firm is M. The price the firm
(Price is
is A. In this situation, the firm is earning norma l profits, since AR equals AC.
A and AC is also A.)
shaded
In Figure 7.6(c), the firm is earning subn~rmal profits or losses, as shown by the
tion, if
area ABCD since AC exceeds AR. At the pnce of A, the firm will continue produc
the AVC, the
the price is higher than the average variable cost (AVC). If the price is less than
7.5).
firm will cease its operation, since the losses exceed the fixed costs (see Figure
 l.l _ H - - -

,; f(• ~:.. iil•)t•ll t,

Cost/Revenue Cost/Revenue
Figure 7 .6 Cost/Revenue
Short -run MC
equ ilibrium
for· perfec t ATC
competi tion
ATC
(25) B
(20) A AR = MR AR = MR
(20) A AR == MR (20)A
(15) B

'------ -~ - - - -- Quantity .___ _ _ ___.___ __ __ Quantity

(a) Supernormal profits (bl Norm al profits (c) Subnorm al pro fits

Market price grea ter than ATC & firms make Price eq uals minimum ATC . firm at breakeven Price be low mi nim um ATC, firm makes a loss.
profit. profi t . Known as Economic Loss
Known as Econom ic Pro fi t. Brea keven re qui red for a firm to stay in t he
market. Calculatlon:
Calculation : TR = OA x OM. TR "' 20 X 9
TR = OA X OM. TR = 20 X 9 Calculation: TC = OA x OM. TC = 25 x 9
TC = OB x OM. TC= 15 x 9 TR = OA x OM. TR "' 20 X 9
Therefore . P = TR - TC TC= OA x OM. TC= 20 X 9 The refore , P = TR - TC
= ABCD Th erefo re. P = TR - TC = ABCD
= 180 - 135 = 0 = 180 - 225
= 45 (PROFITI = 180 - 180 = - 45 (LOSS)
= Q (BREAKEVEN)
 Shut-down Point
$byg-ggwp Point Point where the AVC is
two possibilities equal to AR .
If the price of a produ ct is below the average total cost (AVC), there are
As discu ssed in
for a firm- to contin ue opera tion or shut down the opera tion.
Chapter 6, the two types of produ ction costs are fixed and variab
le costs. Fixed cost
ction. So, if the
is the expenditure that the firm has to incur, even if there is no produ
can contin ue with
firm can earn a price equal to minim um average variable cost, it
produ ction.
A firm will shut down when the price is less than the AVC. If the
price is below the
shut-d own point ,
AVC, the firm will stop production and exit the market. This is called the
the shut-d own
where the average variable cost equals the average revenue. Figure 7.7 shows
point for a chicken seller when the price equals the average variable cost.
Price Figure 7 .7
MC Shut-d own point

AVC

Fixed
cost MR = AR
5

1 - - - - - - : -:::-:: - - - - - - . Quantity
0 150
 Example 9.3 In a perfectly competitive mark et, the total reven ue and
total cost of a firm are given by
. R = 20q and C = q2 + 4q + 20.
Find profi t maxi mizin g outp ut and maxi mum profit.
Solution: By defin ition profi t (1t} is the difference between total ·r even ue
(R) and total cost (C)
... 1t= R-C
or 1t = 20q - q2 - 4q - 20. (9.10)
Since 7t =/(q), the maximization of profit requi res
d1t d21t
=0 and -2< 0.
dq dq
d1t
! Now = 20-2 q-4 =0
dq
or 2q = 16.
... q = 8.

d21t
Again =- 2 < 0.
dq2
Since the secon d orde r derivative is negative, q = 8 will maximize profit
of the firm. The maximum
profit is obtai ned by subst itutin g q = 8 in the profi t function (9.10).
:. Maxi mum prof it= 20 x ·s - (8)2 - 4 x 8 - 20 = 44.