Let us study about Perfect Competition. After reading this article you will learn about: 1. Meaning of Perfect Competition 2. Features of Perfect Competition.

Notes # Meaning of Perfect Competition:

The term ‘perfect competition’ in economics has a different as well as a diametrically opposite view of what a businessman holds. Competition always involves ‘rivalry’. But as far as economics is concerned, rivalry is absent in perfect competition; here competition is entirely impersonal. So, perfect competition refers to a market situation where competition among economic agents is completely absent.

Obviously, this sort of market situation is far from reality. Still this model has usefulness since it provides a very useful analytical model. Above all, usefulness of any theory “lies in the predictions it can generate”. That is why the model of perfect competition is the starting point of business decisions relating to output and price.

The concept of perfect competition is about 235 years old. Adam Smith used this phrase in a casual way in his celebrated book “Wealth of Nations” (1776). Later, Edge-worth (1881) and Frank Knight (1921) gave a complete nature of the model of perfect competition.

Notes # Features of Perfect Competition:

Perfect competition is a market structure characterized by the following conditions:

(a) Large Number of Sellers and Buyers:


A perfectly competitive firm is characterized by the existence of innumerable number of sellers or firms and buyers so that everyone in the market is so small that it cannot exert any influence on the price. Every firm in the market is so small relative to the market that it cannot affect market price by changing its output. Similarly, buyers aim at buying the product at a lower price.

Such is ruled out since their numbers are so large that an individual cannot obtain special favour from the sellers. Thus, every economic unit behaves as a ‘price-taker’ or no one possesses ‘market power’. Price is given to both buyers and sellers. Only market forces can bring about a change in the price of the product.

(b) Homogeneous Product:

A closely related provision is that the products sold by all firms are standardized or homogeneous or identical in quality. In other words, buyers could not differentiate the product as well as the services sold by one from those of another. That is to say, goods and services of each and every seller are perfect substitutes.


It is due to the homogeneity of the product that price is uniform or same to all. Products are differentiated here by advertising, packa­ging or quality. Because of this, every participant in the market has “complete information” about prices ruling in the market. If products were differentiated, firms would have been able to influence the price—at least partially.

The assumptions of innumerable number of sellers and buyers and product homo­geneity imply that the individual firm and consumer are price-takers and the demand curve (AR) faced by a competitive firm becomes perfectly elastic. Further, the demand curve or the AR curve coincides with the MR curve.

(c) Free Entry and Exit:

Any firm is free to enter or leave the industry, if situation demands. If it wishes, a new firm may join the industry; the existing firms will not put an obstacle. However, new firms become interested in joining an industry mostly when some or most of the existing firms enjoy something more than normal profit. Excess profit is, thus, an incentive on the part of a firm to join the industry.

Similarly, if some of the firms incur losses chronically, they have the liberty to close down business. No existing firm will ask them to stay on. As a result, all firms in the long run enjoy only normal profit. Remember, this particular feature is valid only in the long run since entry or exit in the short run is not so easy. In other words, there are barriers to entry and exit in the short run, but not in the long run.

(d) Perfect Knowledge:


It is assumed that all the participants (consumers, producers, input suppliers) have perfect knowledge and information regarding the conditions of the market. If consumers have perfect knowledge of the market, only then a uniform price will prevail.

If producers and buyers know costs, prices, product quality, etc., then there cannot be more than one price. Resource owners also supply their inputs at the going price. No one has any incentive to change price. Further, everyone also has complete knowledge of the future.

(e) Perfect Mobility of Resources:

Resources are completely free to move from one firm to another, not only geographically, but also among jobs. In other words, mobility of resources is costless.

(f) Absence of Externalities:

If con­sumption of one individual or production of one firm is not influenced by the actions of other individuals, then there exists absence of externalities—either in consumption or in production. Under perfect competition, consumption and production decisions are not interdependent; rather, these are indepen­dent decisions. This means that there is no third-party effect.

Collectively, all these features define perfect competition. No industry, in actual practice, satisfies all these features. In this sense, this market form does not fit with the reality.

Anyway, with these assumptions in mind, we will now examine equilibrium of a firm both in the short run and in the long run. Buyers are also at liberty to switch over from one seller to another seller if they desire.