Pure perfect competition is a market structure characterized by a large number of buyers and sellers of a homogenous products
Each buyer and seller have no influence over the market price and output
Information is available freely to all market participants and there is no collusion among firms in the industry
Characteristics of perfect competition
- Perfect competition has a large number of buyers and sellers: Each seller supplies only a small part of the total quantity offered in the market. Neither the buyers nor sellers can affect the price in the market. Prices are determined by market forces of demand and supply. Marginal revenue of a firm under perfect competition will normally be equal to the price which is equal to the average revenue
- Free entry and exit of firms – there is no barrier exit or entry from the market. Buyers and sellers are free to join or leave the market whenever they desire to
- No government regulation -government does not interfere with the market through imposing tariffs, subsidies meaning that the forces of demand and supply bring the market to equilibrium
- Information is freely available to all buyers and sellers. All buyers and sellers have complete knowledge of the conditions of the market. Information is free and costless
- Free mobility of factors of production: – factors of production are free to move from one firm to another throughout the economy. Labor is not unionized.
- All firms in the industry aim to maximize profit. No other goal is pursued
- Product homogeneity: the product of any one seller (i.e. firm) is identical to the product of every other firm in the market. There is no way in which a buyer could differentiate among the products of different firms
Perfect competition in the short run
In the short run a firm experience either super normal profits and losses.
If a firm is earning above normal /super normal profits in the short run, other firms will be attracted to the industry which will wipe out the profit
If a firm is incurring losses in the short run, in the long run the firm will leave the industry
In the long run the firm only earns normal profit
Case of abnormal profit
In the short run depending on the position of the average cost curve, the firm can make excess profit or loss. In this case the firm is making excess profit represent by the shaded area .Where the average cost curve is below the equilibrium where marginal revenue is equal to marginal cost hence the firm makes abnormal profits
The sufficient condition for profit maximization is for the marginal cost MC to cut the marginal revenue MR curve from below where the slope of marginal cost is greater than slope of marginal revenue.
Firms will maximize profit where marginal revenue is equal to the marginal cost
Profit= TR-TC
If TR>TC economic profit
If TR<TC economic loss
Marginal revenue MR=P=AR
Firms will expand production as long as each additional unit add more to total revenue than total cost
When the average cost curve is above the equilibrium i.e where marginal revenue is equal to marginal cost then the firm is making losses
Perfect competition in the long run
In the long run the firm only earns normal profit hence the Marginal revenue=Average cost=Marginal cost .The firm is earning enough to keep it in the industry