Perfect Competition (B)
What is the definition of perfect competition? Find out the difference between pure competition and perfect competition.
Posted: Feb 2012
Definition of Perfect Competition
Perfect competition is the situation in the market where the large number of manufacturers and customers of the same product exists.
The price of the product is changing only under the influence of fluctuation of the whole market. No manufacturer is significantly large enough to change the prices in the market.
The pure competition is the situation where producers and customers have no choice of price or sales or purchase. The price is given by the facts that:
There are large number of manufacturers and seller; therefore nobody can influence the price
The product is homogeneous, therefore it can be substituted.
Geographical distribution of manufacturers and customers does not cause distance preference.
The perfect competition is the situation of pure competition, with the additional elements:
Full production mobility and freedom of entrance and exit from the sector.
Perfect elasticity of production factors supply.
Free flow of information enables that every manufacturer and customer is aware about alternative solutions.
The same expectations of future trends for all participants in the market.
Profitability of the Company in the Perfect Competition Market
The equilibrium point for the company in the perfect competition market is the point with production level that enables the maximum profit. This is the level of production where marginal revenue equals to marginal cost ( MR = MC ). Since the price is the predefined by the market, the only way of reaching equilibrium point is adjustment of scale of production, in order to meet the point where the profit is largest ( P = TR – TC ).
There are three typical situations for the company
a) p = MC > AC
( company makes the profit )
b) p = MC = AC
( breakeven point – cost coverage )
c) p = MC = AVC
( closing point )
The precondition for profitability is that the price is higher than average cost ( p = MC > AC ). If the company is in the business with the loss for longer period, it leaves the sector. Reduction of competition ( supply ) is causing the increase of the price. Therefore, the new investment to the sector is attracted.