Describe main features of perfect competition.

Features of Perfect Competition (or Perfect Market)

Although there are several features as stated below but the first three are key features of perfect competition.

(i)    Very large number of buyers and sellers. The number of buyers and sellers is so large that none of them can influence the prevailing price in the market. Each buyer and seller buys or sells a very insignificant proportion of total supply of the commodity in the market. It indicates ineffectiveness of a seller or a buyer in influencing the price. In fact price of a commodity is determined by interaction of market demand and market supply (supply of all the firms) in the whole industry for which all sellers and buyers together are responsible. But once the price is determined by the industry, each firm and buyer has to accept it.

Implication of 'large number of sellers in the market' is that share of each seller in total market supply is so small that no single seller can influence the price. Hence a firm has to sell the product at the price given (determined) by the industry. It is because of this position that each firm is said to be price-taker in perfect competition. Similarly large number of buyers has the same implication, i.e., buyer's share in the total market demand is so small that no buyer on his own can influence the price. So buyer also becomes simply a price-taker.

(ii)    Homogeneous product. Products sold in the perfect market are homogeneous, i.e., they are identical in all respects like quality, colour, size, weight, design etc. They are perfect substitutes of one another. The products sold by different firms in the market are equal in the eyes of the buyers. The buyers treat products of all the firms in the industry as identical and therefore, they are willing to pay only the same price. The product being homogeneous, no individual seller can charge higher price otherwise he is liable to lose his customers. This ensures uniform price in the market. As such cross elasticity of demand and such products is infinite.

Implication of product being homogeneous is that all firms have to charge the same price for the product. Otherwise no one will buy from the firm which charges a higher price for the same item.

(iii)    Free entry and exit of firms. There is free entry of new firms and exit of existing firms. There are no artificial or government barriers in way of new firm to enter the industry. Similarly there is no barrier in the way of firm which wants to leave the industry. New firms induced by large profits can enter the industry whereas losses make the inefficient firms to leave the industry. What are the effects of free entry and exit? In case of abnormal profits (also called positive profit) at the profit maximising level of output, new firms will be attracted to the industry. This will lead to an increase in supply (i.e., supply curve will shift rightward) leading to fall in price and profit. Thus, entry process of firms will continue till there are no abnormal profits. On the contrary if there are losses due to low price, some firms will quit the industry leading to fall in supply (i.e., supply curve will shift leftward) which in turn leads to rise in market prices. Losses fall and continue to fall till they are wiped out and each firm in the industry is earning zero economic profit/normal profit. Hence free entry and exit imply zero abnormal profit.

Implication of free entry and exit is that no firm can earn above normal profit in the long run (i.e., firms earn zero abnormal profit). In short, each firm earns just normal profit (i.e. minimum profit necessary to remain in business).

(iv)    Perfect knowledge about market and technology. Perfect knowledge means that both the buyers and sellers have full knowledge about the prices and costs prevailing in the different parts of the market. All firms have equal access to technology and inputs resulting in the same per unit cost of production.

Implication of perfect knowledge. No firm is in a position to charge a different price and no buyer will pay a higher price. As a result uniform price prevails. Since there is uniform price and uniform cost, all firms earn uniform profits because profit equals price-cost.

(v)    Perfect mobility. There is perfect mobility of goods and factors of production without any hindrance or obstruction. The factors are free to enter an industry if considered profitable and leave the industry when remuneration is inadequate.

(vi)    Absence of transport cost. In perfect competition, it is assumed that there is no transport cost for consumers who may buy from any firm. This ensures existence of a single uniform price of the product.

(vii)    Demand (AR) curve is perfectly elastic and parallel to X-axis. (For detail see Q. 4.4.)

(viii)    Firm is the price-taker and industry is the price maker under perfect competition market. In such a situation all the firms earn uniform profit as there is uniform price and uniform cost of all the firms.
The firm is called price taker when it has to adopt the price determined by market demand and market supply. 
Note. In real world, perfect competition is a myth because we hardly find such a market.