Perfectly competitive market
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The market for goods and services consists of all the buyers and sellers of the goods. Currently, most economists are representing a basic market in the form of demand and supply. The theory of supply and demand assumes that businesses should analyze a perfectly competitive market. However, the economic theory describes industries as either experiencing perfect or imperfect competition (Cohen, & Cyert, 2003). For instance, the production of agriculture free software and street food vendors are some of the examples of perfect competition industries. Agricultural markets are marketplaces that have a large number of vendors selling fruit, poultry, and vegetables. Here, the prices of goods are competitive, and no single seller can yield influence over the pricing, however, the consumers may be free to pick any seller, depending upon their choice. Therefore, this paper will discuss the meaning of the perfectly competitive market, its characteristics along with how the producers or suppliers’ supply curve is determined in this kind of market.
Perfectly competitive markets are market structures which are characterized using a large number of small firms, a homogeneous product, freedom of entry and exit, and equal access to information. Firms can be regarded as competitive depending on several important factors such as the number of firms in the industry, the degree of rivalry, the degree of homogeneity of the product as well as, the ease of entry and exit. Perfect competition describes the market structure whose assumptions are very strong and as a result, they are unlikely to exist in the real world markets. Today, the economists are becoming more and more interested in pure competition because of the growth of electronic commerce (e-commerce) as being the means where businesses can buy and sell their goods and services (Cohen, & Cyert, 2003). The assumptions for a perfectly competitive market include many sellers, many individual buyers, perfectly freedom of entry and exit from the industry, perfect knowledge and homogenous products.
Characteristics of a perfectly competitive market
The characteristics of perfectly competitive markets include;
- Large number of small firms
Perfectly competitive markets tend to have a large number of small firms. Each of these small markets seems to be relatively small especially when compared to the overall size of other different markets. This is significant because it ensures that no single firm or businesses can exert quantity or the market control over price. Therefore, if one firm happens to stop producing or double its output, the market will definitely remain unaffected. In this case, the price of goods does not change; hence there is no noticeable change that can be experienced in the quantity exchanged within the markets(Cohen, & Cyert, 2003).
- Identical Products
Identical products are also termed as homogenous goods. Therefore, firms in perfectly competitive markets tend to sell identical products. The important aspect of this characteristic is that most buyers will not be able to discern differences even if the goods are exactly the same. In short, buyers are not able to tell exactly which firm produces which product. Hence there will be no brand names that will distinguish or differentiate the features of the product.
- Perfect resource mobility
A perfectly competitive firm should be free to enter as well as, exit in the industry at their own will. These firms are not restricted rules and regulations that are set up by the government or any other barriers to entry such as the start-up cost. However, there are some firms that have to incur high start-up cost and need the government permits to enter an industry, but this should never be the case for the perfectly competitive firms. Similarly, perfectly competitive firms are not prevented from entering as well as, leaving industries as is the case for the government-regulated public utilities (Cohen, & Cyert, 2003).
- Perfect knowledge
Perfect knowledge is much required in perfectly competitive firms. For example, in most cases when buyers and sellers are marketing their products, buyers are always completely aware of the sellers’ prices such that when a firm will not be in a position of selling their goods at higher prices than those other firms who have the same product to be sold in the markets. In addition, the sellers tend to have complete information regarding the prices changed by other sellers so that they do not charge less or more than the market price. Perfect knowledge in firms also extends to new technologies. It is evident that all firms that are competitive tends to have access to production techniques which are the same hence no firm can produce their products or goods much faster, better or cheaper than the other just because of the special knowledge of information (Cohen, & Cyert, 2003).
How producers’/suppliers’ supply curve is determined in perfectly competitively markets
Supply is a schedule of quantities of goods that will be offered to the market at various prices. In a perfectly competitive market, economists assume that there are many suppliers who tend not to have influence over the market supply conditions. However, the validity of the supply curve in a competitive market rests on several assumptions (Cohen, & Cyert, 2003). Perfect competition is said to be the only market structure for which the supply function can be derived in spite of it assuming that there are many sellers and buyers, each of whom are price takers. The decisions in short-run production for perfectly competitive firms have direct implications for the supply curve. In the short-run supply curve for a perfectly competitive firm, the segment of marginal cost curve lies higher than the average of variable cost curve. As a result, the firms should produce a quantity of output which equates the marginal revenue, also equals to the price as well as, the marginal cost in the fact that the prices exceed the average variable cost. Generally, the profit maximization choices of the output at alternative prices tend to generate a short-run supply curve of perfectly competitive firms (Cohen, & Cyert, 2003).
The other assumption in regards to the suppliers’ supply curve in perfectly competitive firms is that, here, the firm’s supply curve happens to rise above the shutdown point in both the long and short run, however, the supply curve may tend to be flat in the long run. This may be true if only the entry of new firms in the market or industries do not change the input and production costs. However, economists do not hold this assumption because the long run market supply curve are always upward sloping especially when the average cost curve shifts up, whereas the input prices rise as a result of an increase in the industrial output. This type of industry is known as an increasing cost industry, and it is more likely to happen when firms use specific inputs from the industry (Cohen, & Cyert, 2003).
In short-run supply curve of perfectly competitive firms, the marginal cost curve becomes the supply curve this is because perfectly competitive firms mainly equate the price with the marginal cost. This normally happens because the price is seen to be equal to the marginal revenue for the perfectly competitive firms. However, should both the price as well as, marginal revenue happen not to be equal, as a result, a profit-maximizing firm will not equate the price to a marginal cost, and in the case, a marginal cost curve is renowned not to be the supply curve for firms(Dutt, 2005). The diagram below shows a short and a long-run supply curve in a perfectly competitive market
Given that perfect competition does not really exist in the real world, most real-world firms today do not have the equality existing between the price as well as the marginal revenue, and thus this does not equate price to the total marginal cost. In fact, the real world firms that have varying degrees of the market power in most case fails to have supply curves which are comparable to that of idealistic perfectly competitive firms(Cohen, & Cyert, 2003). The following graphs show Price and output in the short run under perfect competition
Price and output in the short run under perfect competition
In short-run, the interaction between demand and supply determines the “market-clearing” price. A price P1 is established, and output Q1 is produced. This price is taken by each firm. The average revenue curve is the individual demand curve. Since the market price is constant for each unit sold, the AR curve also becomes the marginal revenue curve (MR) for a firm in perfect competition. For the firm, the profit-maximizing output is at Q2 where MC=MR. This output generates a total revenue (P1 x Q2). Since the total revenue exceeds the total cost, the firm in our example is making abnormal (economic) profits. This is not necessarily the case for all firms in the industry since it depends on the position of their short-run cost curves. Some firms may be experiencing sub-normal profits if average costs exceed the price – and total costs will be greater than the total revenue (Dutt, 2005).
References
Cohen, K. J., & Cyert, R. M. (2003). Theory of the firm: resource allocation in a market economy (2d ed.). London: Prentice-Hall.
Dutt, A. K. (2005). A Keynesian model of an economy with a perfectly competitive goods market. New York: Dept. of Economics, Florida International University.
Herck, G. v. (2003). The market value rule and the perfectly competitive market structure under uncertainty. London: Katholieke Universiteit Leuven.
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