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Pricing in Perfect Competition

Last updated date: 17th Apr 2024
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What is Perfect Market

In economics, we learn about the various types of markets, such as monopolistic markets, monopolies, oligopolies, duopolies, etc. However, to first understand these, we must understand the concept of what is a perfect market, which can also be called perfect competition. Perfect competition is the ideal form of market for consumers and producers and therefore acts as the bar to which all markets are characterised. In a way, all markets are imperfect or monopolistic rather than being perfect markets.

A perfect market consists of several features, which we will discuss below. In perfect competition, prices are controlled by the market forces, i.e. demand and supply, and producers and consumers cannot change the price as they want. The following are the defining factors of a perfect market:

  • Homogeneous product

  • The firm is the price-taker

  • There are no barriers or restrictions for firms entering the market

  • Buyers have complete information about the product

  • There is absolute mobility of labour, goods and services

  • Demand and supply are fully elastic

Homogeneous Product

The products sold by sellers in a perfect market are identical and thus, the consumer is given an equal choice about where they would like to buy it from. For example, let’s consider two vegetable shops, where both shops have the same items available for purchase, at the same price, this will be considered perfect competition.

Firm is the Price Taker

The firm is a ‘price taker’ means that the sellers have to ‘take’ the price that is given to them by the market forces, i.e. demand and supply. Since the products are homogeneous (as per the first factor above), if a firm changes its price, it will not necessarily work. With a small price increase, the consumers will choose to go to other sellers, and with a decrease in price, all other sellers will also have to reduce their prices to match the low price.

No Barriers

This is a factor which is on the supply side of the perfect market. Usually, suppliers may face restrictions to enter a market, such as the exclusivity of the product, patented products, governmental intervention, cost requirements, etc. In other markets, these are problems that suppliers will most likely face, but in perfect competition, none of these barriers exists.

Knowing the Complete Information

One of our consumer rights is the right to information, and this means that each consumer must be told what they would like to know about the product, including the conditions in which it was produced, what kind of materials were used to produce it, etc. In a perfect market, it is assumed that the consumer has been given all of this information, that the consumer knows the complete information about the products being sold by the sellers.

Mobility of Labour, Goods and Services

This factor of mobility points to the assumption that labour as well as the goods and services produced by the labour have complete mobility to move to the places where the maximum profits will be made.

Elasticity of the Market Forces

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Perfectly Elastic Demand

In perfect competition, prices are controlled by the market forces completely, without giving much ado about the other factors that may affect the same.

  • The elasticity of demand, in a perfect market is ∞ meaning that the demand is totally elastic and a small change in the price can make a huge change in the demand.

  • The same goes for the supply side, where the elasticity of supply in a perfect market is also ∞ and thus a small price change will bring a large change in the supply.

What is Perfect Competition in Real Life?

Perfect competition has been deduced using the theories of the neoclassical and classical economists who believed in free and fair competition, free of government intervention and what seems like, in today’s world, quite an unrealistic idea of how an economy works. It seems that the nuances of perfect competition build from this, but to explain it, there is an example or two to do so.

Economists like to use the agriculture industry to explain perfect competition, where grains and other agricultural products must be sold at the same price because it is a homogeneous product. In a way, agricultural markets are the perfect example of perfect competition, but once you add the middleman into the picture, this goes slightly haywire. Another example of perfect competition, in the Indian context, is sabzi mandis, where equal prices, homogeneous products and elastic demand and supply prevail.

FAQs on Pricing in Perfect Competition

Q1. What Do You Mean by Elastic Demand and Supply in a Perfect Market?

Ans. Elasticity of demand and supply refers to the rate at which the demand for and the supply of a commodity will change when the price of the commodity changes. A perfectly elastic demand and supply refer to when there is a large change in demand and supply with a small change in the price, and this is how perfect competition functions. For example, if a firm sells a vegetable for 20 rupees per kilo, but increases their price by 10 rupees, the consumers will refuse to buy from this seller, as they have options for lower-priced vegetables from somewhere else.

Q2. What are the Features of a Perfect Market?

Ans. In a perfect market, you will find these features:

  • There is a homogeneous product, meaning that each seller has identical products.

  • The firm is the price-taker, meaning that the firm has to take whatever price is decided by the working of the market forces.

  • Free entry and exit of firms into the market, meaning there are no barriers to entering the market.

  • Consumers know the full information about the product being sold to them.

  • The labour force and the goods and services produced by them are highly mobile.

  • There is perfect elasticity of both supply and demand, meaning that a small price change will influence the market a lot.