The most important feature of perfect competition is the uniformity of price, fixed by the market forces of demand and supply. Firms adopt this price for selling their product. They are, therefore, called ‘price takers’.
A price-taker competitive firm, thus, has a perfectly elastic demand curve characterised by AR = MR = P [right panel, Figure 6.1]. To ensure this, perfect competition is assumed to possess the following features.
(i) Large number of buyers and sellers, so that no single seller or buyer may dictate the price.
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(ii) Homogeneity of product, so that price may not be distorted on the grounds of visible differences among the units of the same product.
(iii) Free entry and free exit, so that sellers or firms may move in and out of the market or the industry in the event of deficient and excess supply. This is essential for price stability.
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Free movement of firms or sellers, in and out of the market or industry, refers to their joining in or quitting the market, at will, without a firm incurring any loss. For instance, the movement would not be termed as free if a firm while quitting the market suffers heavy loss in disposing off its plant, equipment or machinery.
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(iv) Perfect mobility of factors of production, so that production costs may remain uniform. This is essential for uniformity of market price. Differences in factor prices lead to differences in production costs and hence in output-prices.
If factors of production are perfectly mobile, factors can move from factor-surplus regions to those factor deficient, obviously for better terms. This would reduce their supply in the surplus regions and would raise it in the deficient regions, thereby stabilising factor prices everywhere. Uniform costs lead to uniformity in product- price.
(v) Perfect knowledge, implying perfect flow of information so that buyers and sellers know where to go to buy or to sell. Free flow of information helps buyers and sellers to choose their markets of purchase and sale.
(vi) Absence of government regulations, so that free play of price mechanism may not be obstructed by government regulations of tariff, subsidy, rationing, price ceilings and price floors. Most of these regulations are highly distortionary.
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(vii) Absence of transportation costs, so that price may not get distorted by them.
(viii) Profit-maximisation, so that no firm chases objectives such as one of ‘beggar-thy-neighbour’. At times, as the sole objective, a large firm reduces price despite anticipated loss. This it does mainly to oust its rivals so that it may later have entire market to itself.
A perfect firm is assumed to have no other objective than that of profit maximisation. It is not very difficult to see that perfect competition is a myth. In the real world, it is difficult to realise it.
The presence of government regulations, heavy transportation costs, absence of perfect knowledge and of perfect mobility of factors and prevalence of ‘beggar-thy-neighbour’ policies—all make the existence of perfect competition impossible.
It is, however, possible to realise the first three requisites, namely, large number of buyers and sellers, homogeneity of product, and existence of free entry and free exit in the real world. A market form possessing these three attributes is known as pure competition.
A firm under perfect competition is, thus, a price taker. It has to adopt price fixed by the market forces of demand and supply. Its AR and MR are both horizontal and overlapping, each equal to the market price P; that is, AR = MR = P.
In the long run, a competitive firm maximises its profits at the output at which its average cost is minimum. Output produced at the minimum average cost is called its optimal output or its optimal capacity. A competitive firm always operates at its optimal capacity in the long run.
Consumers’ welfare is highest under a competitive firm. Consumers avail largest quantity at lowest price from a competitive firm.