Characteristics: Perfectly Competitive Market | Economy

The following points highlight the top seven characteristics of a perfectly competitive market. The characteristics are: 1. Large Number of Buyers and Sellers 2. Homogeneous Product 3. Perfect Knowledge about the Market 4. Free Entry and Free Exit 5. Mobility of the Factors 6. Production Cost is the Only Cost 7. Horizontal Shape of the Firm’s Average and Marginal Revenue Curves.

Characteristic # 1. Large Number of Buyers and Sellers:

In a perfectly competitive market, the number of buyers and sellers should be large. However, there is no hard and fast rule about how ‘large’ the number should be. But the number should be so large that each buyer buys, on average, a negligibly small fraction of the total quantity bought and sold in the market and each seller also, on an average, sells a negligibly small fraction.

The significance of this assumption is this. If each buyer buys a small fraction of the total quantity bought and sold, then he would not be able to exercise an individual influence on the process of determination of the market price of the product.

For, if he wants to buy at a smaller price than what the market determines and if he refuses to buy unless the price is lowered, the market demand for the good would not be affected because, in any case, he buys a small fraction, and so the market price also would not be affected by his individual efforts.

However, if the number of buyers had been so small that each buyer was in a position to buy a sizeable amount of the total quantity and if, in that case, a buyer refused to buy the good unless the price was lowered, demand for the good would have fallen considerably, resulting in a fall in the price. That is, in this case, the buyer could have influenced price determination and could achieve a lower price by his individual efforts.

It follows from above that if the number of buyers is large, then no buyer would be able to influence the determination of market price in his favour. He would have to accept the price of the product as given, i.e., he would have to behave as a price-taker. This is the implication of the assumption that there should be a large number of buyers in a perfectly competitive market.

Similarly, if each seller sells a small fraction of the total quantity sold, then no seller would be able to influence the determination of market price of the product. For, if any seller charges a higher price and refuses to sell if he cannot have this, then the total supply of the product would not be reduced appreciably, because in any case he sells a very small quantity. Consequently, the price of the product would not rise.

However, if there were a few sellers of the product, then each seller would have sold a sizable proportion of the total product. In that case, if any seller wanted to charge a higher price and withdrew his supply unless allowed to do so, the total supply would reduce appreciably and the price of the product would rise.

It is clear, therefore, that if the number of sellers is large, none of them can have any individual influence on the process of price determination. That is, like the buyers, the sellers also take the price of the product as given. They are price-takers.

Characteristic # 2. Homogeneous Product:

It is assumed that in a perfectly competitive market, the firms produce and sell a homogeneous product. In other words, in a competitive market, the buyers do not discriminate between the sellers. They accept the products of all the sellers as homogenous or identical.

Because of this assumption, the buyers do not show preference for any particular seller(s). To them all the sellers appear to be equally preferred. That is why it is said that in a perfectly competitive market, the sellers sell not only a homogeneous product, they also sell an identical behaviour.

Characteristic # 3. Perfect Knowledge about the Market:

It is assumed that in a perfectly competitive market, the buyers and sellers possess perfect knowledge about the conditions prevailing in the market. This assumption has been made because, if the buyers do not have the knowledge about the price of the product or about the sellers of the product, then some sellers may take this opportunity to charge a higher price for their products.

Consequently, the market would experience the circumstances where some sellers are taking relatively larger prices, and some are taking relatively smaller prices. In that case, there would be nothing like a ‘particular’ market price of the product. This is not compatible with the concept of perfect competition.

The sellers should also have perfect knowledge about market conditions. Otherwise some of them would sell the product at a lower or higher price than others. In that case also, a unique market price would not prevail in the market.

Characteristic # 4. Free Entry and Free Exit:

Another characteristic feature which is assumed to be present in a perfectly competitive market is that of free entry and free exit. This means that any new firm may enter the market for the product, i.e., it may participate in the production and sale of the good. Also, any existing firm may leave the industry or the market. However, free entry and free exit would be possible only in the long run.

For, a firm that intends to enter the market would have to acquire the fixed inputs, which is not possible in the short run. On the other hand, the firm that has decided to leave the industry would have to wait till it is able to dispose of its fixed inputs, and this would require a long run.

The assumption of free entry and free exit implies that, if in the short run, the firms are in a position to earn more than the normal profit, then in the long run, the number of firms in the industry would increase, and, consequently, the supply of the product would be increasing, price would be falling, and, in the long run (ultimately), the firms would be able to earn only the normal profit.

On the other hand, if, in the short run, existing firms are not able to earn even the normal profit, i.e., if they happen to suffer losses, then, in the long run, the firms would be leaving the industry.

Consequently, the supply of the product would be falling, and price would be rising till the still existing firms may again rise to a position of earning the normal profit. Therefore, owing to this characteristic feature of free entry and free exit, the firms under perfect competition would be able to earn only the normal profit in the long run.

Characteristic # 5. Mobility of the Factors:

Next, it is assumed that the factors of production that the firms use are homogeneous and perfectly mobile, The implication Of this assumption is that if the factors are homogeneous and perfectly mobile, then their prices would be the same to all firms. For if they are given lower prices by an employer, they would leave that place and join some other firm where they would get higher prices.

As a result, supply of factors to the first firm would decrease and that to the second firm would increase. Consequently, the prices of the factors would go up in the former and those would come down in the latter. If the process goes on, ultimately all the firms would have to buy all the factors at the same prices. In that case, competition between the firms would be perfect.

Characteristic # 6. Production Cost is the Only Cost:

Lastly, it is assumed that the competitive firms bear only the production cost and they do not have to bear costs like those of transport and advertisement. That the firms here are not required to bear the advertisement cost is obvious from characteristics (ii) and (iii).

According to these two characteristic features, the buyers are perfectly aware of homogeneity and uniqueness of the price of the product that the firms produce. And the firms also are aware that they would not be able to influence the buyers in favour of their respective products by means of advertisement.

What this assumption seeks to imply is that the firms are not required to bear any cost like advertisement or transport that may vary between the firms even if they are equally efficient.

In other words, this assumption implies that if the firms are equally efficient, then their total cost should be the same at any particular quantity of output, and if, by total cost we mean only production cost, then this property is easily obtained. It may be noted that this property is consistent with the concept of competition among the equals.

Characteristic # 7. Horizontal Shape of the Firm’s Average and Marginal Revenue Curves:

This property states that at a time there would be obtained only one price of the product in the perfectly competitive market and the average and marginal revenue (AR and MR) curves of each firm here would be identical and both of them would be the same horizontal straight line at the level of the price of the product.

The price of the product would be determined in the process of interaction between demand and supply for the product.

The reason for the AR and MR curves of the competitive firm to be an identical horizontal straight line may be given like this. As we know from characteristic feature (i) of large number of sellers that each seller under perfect competition is a price-taker.

Also we know from characteristic feature (iii) of perfect knowledge of the buyers that, if any seller refuses to be a price-taker and charges more than the ruling market price, then he would find no customers. For they are perfectly aware of the fact that a homogeneous product [characteristic feature (ii)] was being sold in the market by a large number of sellers.

Again, since the number of sellers is large in the market, each seller thinks that he is supplying a very small fraction of the total quantity demanded and supplied in the market and so the total quantity demanded of the product is much more than what he supplies.

Therefore, if he wants to sell more he would not have to worry about demand, i.e., he would not have to reduce the price to sell more. In other words, he thinks that he might sell more at the same price.

It is clear from the above discussion that the firm under perfect competition would not charge more than the ruling market price, for then he would not find any customer, nor would he charge a lower price because he can sell more, if he liked, at the same price. It follows then that a single price would rule the market at a time, and the firm thinks that he would be able to sell any quantity, more or less, at the ruling price.

Therefore, in this market we would obtain p = AR = constant at any q (quantity sold), and so we would also obtain MR = AR at any q. That is, the AR and MR curves of a firm under perfect competition would be identical, and it would be the horizontal straight line at the level of p.

It may be noted here that since the firm’s AR curve or the demand curve (for the firm’s product) is a horizontal straight line, the firm’s quantity demanded can change even without any change in price. Therefore, at any point on this demand curve, the numerical coefficient (e) of price-elasticity of demand will be infinitely large (e = ∞).