On Perfect Competion - Research Paper Example

They all sell identical products, and the seller is a price taker, not price maker” (Jain & Trehan, pp. 243). The characteristic of ‘price taker’ signifies that the price is set by the interaction of demand and supply in the industry, and no individual firm can increase or decrease the price (Jain & Trehan, pp. 243). As mentioned above, perfect competition is mainly based on certain assumptions and as such, it does not exist widely in the real world (Dwivedi, pp.294). Perfect competition is based on the assumption of ‘perfect mobility’.

The model assumes that there is perfect mobility of factors of production between firms. There are, therefore, no restrictions on the movement of labor from one firm to another and there is no trade union either. In addition, no firm can control industrial input; hence, there is perfect mobility of capital as well. Another concept common to perfect competition is the free entry and exit of firms in the industry. This sheds light to the fact that there are no legal, financial or market barrier for any firm to enter or exit the industry.

Firms can choose to enter or exit at their free will. When the industry is enjoying abnormal profits, that is when the short run average cost is less than the price, and then firms enter the industry. However, when the abnormal profits are transferred into normal profits or losses, then firms leave the industry (Dwivedi, pp. 297, 298). This model makes a further assumption that there is ‘perfect knowledge’. This suggests that there is no uncertainty in the market, and information regarding the market is readily available and is free of cost.

In addition, firms act independently and they do not collude with each other in any way. Furthermore, there is no government intervention in perfect competition. There are no discriminatory taxes or subsidies, government does not put up a maximum or minimum price and does not have any sort of direct or indirect control. Such characteristics make this model unique (Dwivedi, pp. 297). “The demand curve of a perfectly competitive firm is horizontal; this signifies that the firm can sell as much as it wants at the prevailing market price” (Dwivedi, pp. 298-300). Any firm in perfect competition is so insignificant that it absolutely has no influence over price.

The diagram is shown below. (McEachern, pp. 23-25) This characteristic of perfect competition also makes it unique in all types of market structures. In addition to that, perfect competition is used as a ‘useful benchmark’ to judge the efficiency of markets. There are two broad concepts of efficiency, allocative efficiency and productive efficiency. Productive efficiency occurs when the firm is producing at the minimum of its long run average cost curve (LRAC). This signifies that the cost is less than the market price of a certain product.

In perfect competition, output is produced at the minimum of average cost in the long run. Allocative efficiency, on the other hand, ensures that producers are making the right things that consumers actually want. The market in perfect competition is left to the forces of demand and supply. These forces ensure that what the consumers want, they would get. This avoids wastage of resources. In economic technicality, allocative effi