Perfect competition is a market characterization in which
there are a large number of small sellers or producers trading in a homogeneous
and standardized product with individual sellers not able to influence price. Furthermore, sellers freely enter or exit the market and there is unnecessary
non price actions. A firm is, therefore, free to adjust its inputs in the long
run. For a decisive discussion on this topic contact scholars at HomeworkScholars.com
In perfect competition, economic profits and economic
losses are very vital. New firms are attracted in an industry if there will be
realized economic profits in the long run. This entry of new firms will shift
the supply curve to the right leading to a fall in prices and profits. Firms
will keep coming into the industry until the economic profits fall to zero.
When this happens, firms will starts experiencing economic losses and start
leaving, shifting the supply curve to the left and eventually prices will
increase reducing losses to zero again.
A large number of firms in perfect competition show that
individual firms are very small as compared to the total market. This means
that if one of them becomes big, then competition will be eliminated or
reduced. Products in perfect competition are similar or standardized in that it
does not matter to customers who are selling the products. The firms dealing in
such a competition have no control over the price of commodities, they are
price takers. The free entry and exit from a market ensures that no firm
dominates over the others keeping the number of firms in the market at a
constant number. Actions such as advertising, after-sale-service or warranties
are not necessary as customers will still buy at the prevailing prices and
extra expenses will only lead to losses to a firm. Demand in this competition
is elastic.
The marginal revenue of firms in perfect competition is
represented by the horizontal demand curve. Additional revenue or marginal
revenue from an extra unit sold is just equal to the prevailing price. For maximum
profit, firms must sell output volume that will give total revenue exceeding
the total cost by the largest amount. If the firm realizes fewer revenues that
can cover its costs, then the firm must shut down. This is called the “Close
down Decision.” Another thing that firms in perfect competition should look at
in order to maximize profits is the break-even point. Break-even point is the
level of production where volume of output in total revenue is equal to the
total cost. Profit maximization can also come about if the marginal revenue
marginal cost rule is applied. Profit maximization will occur if marginal
revenue equals marginal cost. This also works for loss minimization. But if these
two costs intersect below average variable cost, it shows that revenues are not
enough to cover fixed costs. In such a situation, the firm should close down.
Firms in perfect competition can only experience long run
equilibrium if demand is tangent to the minimum average total cost. The firm
does not gain or lose from engaging in that particular business. There will be
no pure or economic profits, but normal profits might be covered. When demand
rises above the average total cost, a firm in perfect competition will realize
pure profits. This in turn attracts other firms to the industry. Many of them
will increase market supply thereby reducing price, this in turn drives demand
for each firm down making them incur losses and eventually starting leaving the
industry. And the cycle will repeat itself again. The long run supply curve is
perfectly elastic for firms in the industry in perfect competition.
The emergency of many firms participating in global trade
and competition has seen many similar products being produced by these firms.
This, therefore, called for perfect competition as customers will always
dictate the market prices. No firm will, therefore, want to work on its own as
no one will buy from it. Perfect competition also helps to bring about efficiency and productive efficiency. Marginal social benefits and marginal
social cost are measurements used to determine the change in benefits over
change in quantity. Marginal social
benefit is equal to the marginal social cost at the point of intersection of
their curves. This is regarded as the most economically efficient production
and consumption point. This point is also important environmental wise because
it captures the fundamentals of trade-offs.
In conclusion, it is worth noting that assumptions made
in the perfect competition model make sure that every party making decision is
a price taker, because the price in the market is determined by the interaction
of demand and supply. Maximization of profits by firms in perfect competition
is done by producing an output level whereby marginal revenue is equal to
marginal cost. If the industry's firms are earning economic profits, more firms
will come in driving down price until a long run equilibrium value of zero is
achieved. This is same for firms making losses; they will exit until the long
run equilibrium of zero is achieved. Long run equilibrium can only change if
there is a change in production cost or demand that can affect supply. This can
bring about economic losses or profits in the short run, but will be done away
with in the long run by entry or exit of firms.
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