Lecture 9 - Theory of Perfect Competition | Microeconomics- Interaction between individual buyer-seller PDF Download

 Page 1


Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
Lesson: Perfect Competition 
Lesson Developer: Harpreet kaur 
College/Department: SGGSCC, University of Delhi 
 
  
Page 2


Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
Lesson: Perfect Competition 
Lesson Developer: Harpreet kaur 
College/Department: SGGSCC, University of Delhi 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
Table of Contents 
Chapter: Perfect Competition 
Learning Outcomes: The benchmark ideal market structure of “Perfect Competition” and its assumptions; the 
industry and firm demand curve under perfect competition; the short run and long run equilibrium cases under 
perfect competition; the derivation of the short and long run industry supply curve under perfect competition; the 
maximisation of productive and allocative efficiency under perfect competition via consumer and producer surplus. 
4.1.1 Assumptions of Perfect Competition 
4.1.2 Distinction between ‘Pure’, ‘Perfect’ and ‘Market’ Competition 
4.1.3  Demand Curve facing the Competitive Firm 
4.1.4 Profits in Short Run 
4.1.5: Perfectly Competitive Firm’s Shortrun Supply Curve 
4.1.6 Perfectly Competitive Firm’s Longrun Supply Curve 
4.1.7 The Shortrun Industry Supply Curve 
4.1.8 The Longrun Equilibrium 
4.1.9 Impact of Increase or Decrease in Demand 
4.1.10 The Longrun Industry Supply 
4.1.11 Allocative Efficiency under Perfect Competition 
Summary 
Exercises 
Glossary 
References 
 
  
Page 3


Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
Lesson: Perfect Competition 
Lesson Developer: Harpreet kaur 
College/Department: SGGSCC, University of Delhi 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
Table of Contents 
Chapter: Perfect Competition 
Learning Outcomes: The benchmark ideal market structure of “Perfect Competition” and its assumptions; the 
industry and firm demand curve under perfect competition; the short run and long run equilibrium cases under 
perfect competition; the derivation of the short and long run industry supply curve under perfect competition; the 
maximisation of productive and allocative efficiency under perfect competition via consumer and producer surplus. 
4.1.1 Assumptions of Perfect Competition 
4.1.2 Distinction between ‘Pure’, ‘Perfect’ and ‘Market’ Competition 
4.1.3  Demand Curve facing the Competitive Firm 
4.1.4 Profits in Short Run 
4.1.5: Perfectly Competitive Firm’s Shortrun Supply Curve 
4.1.6 Perfectly Competitive Firm’s Longrun Supply Curve 
4.1.7 The Shortrun Industry Supply Curve 
4.1.8 The Longrun Equilibrium 
4.1.9 Impact of Increase or Decrease in Demand 
4.1.10 The Longrun Industry Supply 
4.1.11 Allocative Efficiency under Perfect Competition 
Summary 
Exercises 
Glossary 
References 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
Perfect Competition 
Introduction:  
“A perfect market is a district, small or large, in which there are many buyers and many 
sellers all so keenly on the alert and so well acquainted with one another’s affairs that the 
price of a commodity is always practically the same for the whole of the district.” 
       Marshall A. (1916), Principles of Economics -     
                                                                         An introductory volume, London, Macmillan, 
seventh edition. 
In order to analyse the pricing and output decisions of a firm it is essential that we examine the market structure or 
the environment in which the firm functions. A market structure comprises of the inherent features of a market that 
affect firm behavior. The market structure comprises of features such as the number and sizes of the firms involved 
in the market, the type of commodity being sold in the market and freedom of firms to enter and exit the market 
freely. 
Perfect Competition is a theoretical market form which is a benchmark used for understanding and explaining 
equilibrium determination in other market situations. In Perfect Competition there is a perfect degree of competition 
and a single price prevails.  
 
                                                                                  
4.1.1 Assumptions of Perfect Competition 
(i) Large Number of Buyers and Sellers: In a perfectly competitive market structure there are a large number of 
buyers and sellers in the industry. Every consumer demands a very small portion of the total market demand and 
every seller or individual firm produces a minor fraction of the total industry or market supply. The number of 
consumers and suppliers is so large and the quantities that they command so trivial that the power of these buyers 
and sellers to influence market prices through individual action is very insignificant.  
In a competitive market the firms are only concerned with the level of output they produce, taking the market price 
as independently given. Whatever level of output the firm produces is sold at the ongoing market price determined 
Page 4


Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
Lesson: Perfect Competition 
Lesson Developer: Harpreet kaur 
College/Department: SGGSCC, University of Delhi 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
Table of Contents 
Chapter: Perfect Competition 
Learning Outcomes: The benchmark ideal market structure of “Perfect Competition” and its assumptions; the 
industry and firm demand curve under perfect competition; the short run and long run equilibrium cases under 
perfect competition; the derivation of the short and long run industry supply curve under perfect competition; the 
maximisation of productive and allocative efficiency under perfect competition via consumer and producer surplus. 
4.1.1 Assumptions of Perfect Competition 
4.1.2 Distinction between ‘Pure’, ‘Perfect’ and ‘Market’ Competition 
4.1.3  Demand Curve facing the Competitive Firm 
4.1.4 Profits in Short Run 
4.1.5: Perfectly Competitive Firm’s Shortrun Supply Curve 
4.1.6 Perfectly Competitive Firm’s Longrun Supply Curve 
4.1.7 The Shortrun Industry Supply Curve 
4.1.8 The Longrun Equilibrium 
4.1.9 Impact of Increase or Decrease in Demand 
4.1.10 The Longrun Industry Supply 
4.1.11 Allocative Efficiency under Perfect Competition 
Summary 
Exercises 
Glossary 
References 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
Perfect Competition 
Introduction:  
“A perfect market is a district, small or large, in which there are many buyers and many 
sellers all so keenly on the alert and so well acquainted with one another’s affairs that the 
price of a commodity is always practically the same for the whole of the district.” 
       Marshall A. (1916), Principles of Economics -     
                                                                         An introductory volume, London, Macmillan, 
seventh edition. 
In order to analyse the pricing and output decisions of a firm it is essential that we examine the market structure or 
the environment in which the firm functions. A market structure comprises of the inherent features of a market that 
affect firm behavior. The market structure comprises of features such as the number and sizes of the firms involved 
in the market, the type of commodity being sold in the market and freedom of firms to enter and exit the market 
freely. 
Perfect Competition is a theoretical market form which is a benchmark used for understanding and explaining 
equilibrium determination in other market situations. In Perfect Competition there is a perfect degree of competition 
and a single price prevails.  
 
                                                                                  
4.1.1 Assumptions of Perfect Competition 
(i) Large Number of Buyers and Sellers: In a perfectly competitive market structure there are a large number of 
buyers and sellers in the industry. Every consumer demands a very small portion of the total market demand and 
every seller or individual firm produces a minor fraction of the total industry or market supply. The number of 
consumers and suppliers is so large and the quantities that they command so trivial that the power of these buyers 
and sellers to influence market prices through individual action is very insignificant.  
In a competitive market the firms are only concerned with the level of output they produce, taking the market price 
as independently given. Whatever level of output the firm produces is sold at the ongoing market price determined 
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
by the interaction of market demand and market supply curves. Both the buyers and the sellers do not have any 
perceptible influence on market prices. 
(ii) Homogenous Product: Each firm produces and sells a homogeneous product. The homogeneity is not only in 
terms of the physical or technical characteristics of the product or commodity but also with respect to the services 
associated with the product and the ‘background’ in which the purchase is made. A homogenous or standardized 
product ensures that the consumer is indifferent with respect to the firm from whom he makes the purchase.  Since 
the product is homogenous it implies that no firm can charge a price different from the market price thus ensuring a 
single market price consistent with demand-supply analysis. 
The assumptions of large number of buyers and sellers and a homogenous product imply that the firms as 
well as the consumers are price takers in a perfectly competitive set up.  
However, a large number of sellers is not necessary to warrant price taking. Even if there are only a few firms in the 
industry, the market price can still be taken as given if the product being sold is standardised and the supply of the 
same is fixed. For instance if in a local market there are only a few firms selling fresh vegetables each firm would 
take the prices of other firms as fixed. The customers would obviously be buying at the lowest price which then 
would have to be the market price. Thus the firms would now be forced to sell at the market price or risk not being 
able to sell at all and have their stock of perishable commodities being spoilt. 
Under perfect competition the firm’s demand curve is perfectly elastic, a horizontal line parallel to the X-axis.  
The market demand curve on the other hand is conventionally downward sloping.              
The Competitive industry and the Firm 
 
Fig.1 
Source: Lieberman & Hall: Introduction to Economics, 2
nd
 Edition, South-Western 
 
(iii) Free Entry and Exit: In perfect competition, there are no barriers for firms to enter or leave the industry. Free 
entry implies that there are no hidden hurdles, in terms of copyrights or patents, prohibiting new firms from entering 
the industry. Free entry and exit of firms strengthens the competitive element in the industry, by ensuring, that any 
new firm is free to set up production and any existing firm can stop production and leave the industry whenever it 
desires. This also implies if existing firms make exorbitant profits newer firms would be attracted to the industry and 
are free to do so diluting the profits of the existing firms in the process.  Thus if an existing firm raises the price of 
its product, consumers are free to switch to a rival firm. Similarly if firms tend to make losses they are again free to 
leave the industry.  
Page 5


Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
Lesson: Perfect Competition 
Lesson Developer: Harpreet kaur 
College/Department: SGGSCC, University of Delhi 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
Table of Contents 
Chapter: Perfect Competition 
Learning Outcomes: The benchmark ideal market structure of “Perfect Competition” and its assumptions; the 
industry and firm demand curve under perfect competition; the short run and long run equilibrium cases under 
perfect competition; the derivation of the short and long run industry supply curve under perfect competition; the 
maximisation of productive and allocative efficiency under perfect competition via consumer and producer surplus. 
4.1.1 Assumptions of Perfect Competition 
4.1.2 Distinction between ‘Pure’, ‘Perfect’ and ‘Market’ Competition 
4.1.3  Demand Curve facing the Competitive Firm 
4.1.4 Profits in Short Run 
4.1.5: Perfectly Competitive Firm’s Shortrun Supply Curve 
4.1.6 Perfectly Competitive Firm’s Longrun Supply Curve 
4.1.7 The Shortrun Industry Supply Curve 
4.1.8 The Longrun Equilibrium 
4.1.9 Impact of Increase or Decrease in Demand 
4.1.10 The Longrun Industry Supply 
4.1.11 Allocative Efficiency under Perfect Competition 
Summary 
Exercises 
Glossary 
References 
 
  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
 
Perfect Competition 
Introduction:  
“A perfect market is a district, small or large, in which there are many buyers and many 
sellers all so keenly on the alert and so well acquainted with one another’s affairs that the 
price of a commodity is always practically the same for the whole of the district.” 
       Marshall A. (1916), Principles of Economics -     
                                                                         An introductory volume, London, Macmillan, 
seventh edition. 
In order to analyse the pricing and output decisions of a firm it is essential that we examine the market structure or 
the environment in which the firm functions. A market structure comprises of the inherent features of a market that 
affect firm behavior. The market structure comprises of features such as the number and sizes of the firms involved 
in the market, the type of commodity being sold in the market and freedom of firms to enter and exit the market 
freely. 
Perfect Competition is a theoretical market form which is a benchmark used for understanding and explaining 
equilibrium determination in other market situations. In Perfect Competition there is a perfect degree of competition 
and a single price prevails.  
 
                                                                                  
4.1.1 Assumptions of Perfect Competition 
(i) Large Number of Buyers and Sellers: In a perfectly competitive market structure there are a large number of 
buyers and sellers in the industry. Every consumer demands a very small portion of the total market demand and 
every seller or individual firm produces a minor fraction of the total industry or market supply. The number of 
consumers and suppliers is so large and the quantities that they command so trivial that the power of these buyers 
and sellers to influence market prices through individual action is very insignificant.  
In a competitive market the firms are only concerned with the level of output they produce, taking the market price 
as independently given. Whatever level of output the firm produces is sold at the ongoing market price determined 
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
by the interaction of market demand and market supply curves. Both the buyers and the sellers do not have any 
perceptible influence on market prices. 
(ii) Homogenous Product: Each firm produces and sells a homogeneous product. The homogeneity is not only in 
terms of the physical or technical characteristics of the product or commodity but also with respect to the services 
associated with the product and the ‘background’ in which the purchase is made. A homogenous or standardized 
product ensures that the consumer is indifferent with respect to the firm from whom he makes the purchase.  Since 
the product is homogenous it implies that no firm can charge a price different from the market price thus ensuring a 
single market price consistent with demand-supply analysis. 
The assumptions of large number of buyers and sellers and a homogenous product imply that the firms as 
well as the consumers are price takers in a perfectly competitive set up.  
However, a large number of sellers is not necessary to warrant price taking. Even if there are only a few firms in the 
industry, the market price can still be taken as given if the product being sold is standardised and the supply of the 
same is fixed. For instance if in a local market there are only a few firms selling fresh vegetables each firm would 
take the prices of other firms as fixed. The customers would obviously be buying at the lowest price which then 
would have to be the market price. Thus the firms would now be forced to sell at the market price or risk not being 
able to sell at all and have their stock of perishable commodities being spoilt. 
Under perfect competition the firm’s demand curve is perfectly elastic, a horizontal line parallel to the X-axis.  
The market demand curve on the other hand is conventionally downward sloping.              
The Competitive industry and the Firm 
 
Fig.1 
Source: Lieberman & Hall: Introduction to Economics, 2
nd
 Edition, South-Western 
 
(iii) Free Entry and Exit: In perfect competition, there are no barriers for firms to enter or leave the industry. Free 
entry implies that there are no hidden hurdles, in terms of copyrights or patents, prohibiting new firms from entering 
the industry. Free entry and exit of firms strengthens the competitive element in the industry, by ensuring, that any 
new firm is free to set up production and any existing firm can stop production and leave the industry whenever it 
desires. This also implies if existing firms make exorbitant profits newer firms would be attracted to the industry and 
are free to do so diluting the profits of the existing firms in the process.  Thus if an existing firm raises the price of 
its product, consumers are free to switch to a rival firm. Similarly if firms tend to make losses they are again free to 
leave the industry.  
Perfect Competition  
Institute of Lifelong Learning, University of Delhi 
(iv) Perfect Mobility of Resources: Perfect mobility of resources implies that the factors of production are free to 
move physically from one firm to another and are free to respond to monetary incentives. It is assumed that the 
supply of inputs is not dominated by owners or unions and that new skills can be acquired easily.  
(v) Perfect Knowledge: Firms and consumers are assumed to possess all relevant information essential for making 
economic decisions. Consumers and producers are aware about product and input prices, various technologies 
available, consumer preferences and so on. This knowledge is freely available. The information of all of these 
components is essential to ensure competition. For instance, consumers need to be aware about the product prices so 
that they are able to get hold of the standardized product from the cheapest possible source.  
Perfect knowledge and homogenous products together ensure that only a single uniform price prevails in the 
perfectly competitive market. Likewise, information about input costs is vital to acquire inputs from the cheapest 
source.  
Perfect mobility of resources and perfect knowledge ensure that erstwhile firms do not have competitive cost and 
other advantages over new entrants thereby guarantying free entry and exit for firms.  
The assumptions of perfect competition are very rigid and unlikely to be satisfied in the real world. Perfect 
competition is rare in the real world, but the model is important as it helps analyze industries with characteristics 
similar to perfect competition. Purely competitive markets represent allocative efficiency. Thus perfect competition 
provides a benchmark or standard to compare and evaluate the efficiency of the real world.  
Though the assumptions of the perfectly competitive model are rigid and unlikely to be fulfilled, however, moderate 
deviations from these assumptions do not undermine the usefulness of the model. 
                                                             
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
REAL WORLD EXAMPLES OF PERFECT COMPETITION 
Agricultural commodities markets are close approximations of perfectly competitive markets with 
producers accounting for small shares of the market demand and selling more or less a 
homogenous product. 
 
http://www.tradingbiz.com/products/48480/food-grains-agro-food-broken-rice-183139.htm 
For instance consumers of foodgrains or vegetables are indifferent as to whom they are buying 
the product from as long as they are getting the lowest price. Also any single tomatoes, wheat or 
corn producer cannot individually influence the price of wheat or corn. There are hardly any trade 
secrets involved in foodgrain or vegetable production. Also the barriers to entry and exit in terms 
of movement of resources are practically non-existent. 
The stock market is another close approximation of the perfectly competitive market structure. 
The price of a particular stock is determined by the demand and supply of that stock. Individual 
buyers and sellers are too small to influence the price of the stock and hence are thus ‘price 
takers’. Again all units of the stock are identical and homogenous. Resources are also mobile as 
the stocks can be traded as frequently as desired. Again the assumption of perfect knowledge is 
also met as this information is readily available regarding the prices and quantities of stocks 
traded.