Features of perfect competition

The essentials

Perfect competition is a market form in which a very large number of firms sell an identical product to a very large number of buyers. Each firm is so small relative to the market that it cannot affect the price; it is a price taker. The price is set by market demand and market supply.

Key points

• Large number of buyers and sellers: no single buyer or seller can influence price.
• Homogeneous product: output of every firm is identical, so buyers have no reason to prefer one seller.
• Free entry and exit: firms can join or leave the industry freely; in the long run this removes supernormal profits and losses, so firms earn only normal profit.
• Perfect knowledge: all buyers and sellers know the market price, so no one can charge more.
• Perfect mobility of factors and no transport cost differences are also assumed.
• Demand curve facing a firm is perfectly elastic (horizontal) at the market price. AR = MR = P.
• If a firm raises its price even slightly, it loses all its buyers; it can sell any amount at the market price, so it has no reason to lower it.
• No selling costs or advertising, since products are identical.

Exam tips

• Link each feature to its result: many firms + homogeneous product + perfect knowledge → price taking; free entry and exit → normal profit in the long run.
• Distinguish the industry (downward-sloping demand) from the firm (horizontal demand).

Common mistakes

• Thinking the market demand curve is horizontal. Only the demand curve facing an individual firm is horizontal.
• Saying firms earn zero accounting profit in the long run; they earn normal profit, which is included in cost.