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What Is Perfectly Competitive Market?
A perfectly competitive market is an ideal market distinguished by many independent buyers and sellers of identical products and services with static prices due to minimal entry barriers and higher competition. As this type of market exists in theory, it acts as a model to examine the supply and demand in an ideal market.
In this market, every firm and supplier acts as a price taker, and the industry acts as a price maker. Every producer can supply a small part of the industry's total output, and even a small product change is known to all. Unfortunately, this type of market rarely exists in reality.
Table of contents
- A perfectly competitive market consists of numerous buyers and sellers of identical products at constant prices with low entry-exit for firms.
- It is rare in the real world; however, the securities market comes closer to it.
- It has certain characteristics like - homogeneity of products, a small barrier to entry & exit from the market, producers are price takers, and they cannot influence the market price of the goods.
- It is represented by two graphs, i.e., a firm and the market. The intersection of demand and supply is the equilibrium price, also called the market price.
Perfectly Competitive Market ExplainedÂ
Perfectly competitive means a theoretical market concept with infinite buyers and sellers with homogenous products whose information is known to all without any entry-exit barrier for the firms. A perfectly competitive market structure is favorable to consumers. Consumers have control over the price of the products and services as they are identical.
In other words, the firm or the producer and the seller is mere price taker who does not have any influence over the market price. Therefore, any change in the price of the goods and services will lead to its inability to sell its product or service. It happens because the producer and seller become liable to accept the equilibrium price set by the demand and supply. Moreover, producers can eventually enter and exit the market because the barriers are very low.
Furthermore, all the information about the price of products and the firm is known to everyone. Every goods-producing firm is a small player in the market. It means any change in the output of a small firm does not affect the price or the quantity supplied of the products in the market. A firm never sells its products below the equilibrium price. However, in the long run, firms in a perfectly competitive environment will reap profits by increasing their production. And any long-run losses will be dealt with by exiting the firm's industry.
Examples
Let's look at some perfectly competitive market examples to understand the topic.
Example # 1
Our first example would be the bottled water industry. The bottled water industry is such that there is no difference between the quality and taste of bottled water. Hence the product becomes identical in every respect, so the producers have no choice but to accept the consumers' determined rate.
As a result, consumers also do not have much choice of packaged drinking water from various companies. Also, the entry barriers to packaged drinking water are minimal, so any new firm can easily enter and exit. Hence the bottled water industry has all the traits of a perfectly competitive market, like identical products, absence of market influence, and lack of barriers; consumers know the complete information about the content of the product, and the firms are forced to accept the price set by consumers.
Example # 2
Another example is related to securities markets. Every company can list its security in the securities market. The companies have no entry or exit barrier to list in the securities market. The listed companies do not have any control over the price of their securities. All securities listed in the securities market have the same property of being market, profitability, and consumer-driven.
The investors or the consumers have complete information about the company's profit, loss, and price change of the securities. Moreover, none of the companies can influence the price of the securities of any company. Thus, one can see that the securities market is an ideal example of a perfectly competitive market.
CharacteristicsÂ
The perfectly competitive market features like- identical products, barrierless entry and exit, sellers & suppliers acting as price takers, transparency in product information, and sellers & suppliers can't influence the market price of products and services.
- Identical products - All the companies' products are homogenous and indistinguishable from each other.
- Barrierless entry and exit - Any company can enter the said market and exit from it easily.
- Transparency in the product information - The consumers know all the information about a product and its qualities from the producers.
- Sellers & suppliers act as price takers - The products are identical, and consumers have all the information on the products. Hence the consumers of the product become the price-determining factor or price maker. As a result, producers and sellers become price takers here.
- Sellers & suppliers can't influence the market price of products and services - As numerous sellers and buyers have the same product type, consumers can only influence the product price, not the sellers and suppliers.
Graph
The concept of the topic can also be understood by a perfectly competitive market graph, as shown below:
One can observe from the figure of the perfectly competitive market demand curve that the demand and supply together determine the prices of the products under perfect competition. The intersection of the demand and supply curve denotes the equilibrium price P1. As producers are price takers, they can not affect the price, and the demand curve is a straight horizontal line or elastic at market price. Moreover, the demand-supply curve of the industry sets the market price of the product and services.
The demand curve represents the firm's revenue, i.e., marginal revenue (MR), average revenue, and price. The output produced by the firm is denoted by MR= MC, where MC is the marginal cost. The firm can maximize its profit when marginal cost equals marginal revenue.
Frequently Asked Questions (FAQs)
The price is decided by the consolidated effect of demand and supply in a perfectly competitive market. It is because, at this point, the price becomes equilibrium that decides the demand from the consumers and supply from the producers.
Producers can maximize the profit by increasing the number of units sold at the said price after comparing the net sales and net cost and accepting the existing market rate.
In a perfectly competitive market, when the prices reach the equilibrium point, all the firms and the producer start behaving as price takers. It happens because all the products are identical, and any price change by the producer or the seller would make the customers switch to other sellers leading to loss.
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