- A pure or perfect competition is when there are a large number of sellers and buyers of a

homogeneous product or an identical product. A perfect competition or a perfectly competitive market

is that scenario which is close to impossible to exist. This kind of a market exists on the basis of
assumptions which may or may not occur, for example – In this kind of a market or scenario, it is
believed that the buyers and seller possess all the knowledge about the market, in other words perfect
knowledge. It means that the buyers(consumers) know everything about the businesses and the sellers
know everything about their business and others business as well.
According to Boulding— ”A Perfect Competition market may be defined as a large number of
buyers and sellers all engaged in the purchase and sale of identically similar commodities, who
are in close contact with one another and who buy and sell freely among themselves.”

As distinguished above the different types of markets or the market structures, we know they all
function differently. In case of perfect competition, there are large number of buyers selling the same
product so that way these products are highly substitutable. There exists intense competition amongst
the sellers and the seller would anything to make the maximum profits.

This concept of Perfect Competition, is also known as “Pure competition” , is more abstract than to
be applied in real life. It is used as a standard to differentiate with other market structures that are
functioning in reality.

Lets list below assumptions or criteria’s that make a perfectly competitive market :-

 All the sellers sell the same product.

 No seller has influence on the market price
 Since there are many sellers, each seller has a very little market share or penetration.
 Buyers have all the knowledge about the sellers and their prices
 Any seller can come into the market without any restriction.
 No government intervention
 Motive to maximize profits from sellers perspective and, lesser price from the buyers
perspective.
 Transportation cost is nil. It means the transportation of the product from the place of
production to the market is done without any cost. If the cost were to be added, even if the
products sold are similar, there would be a different price for different seller.

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Pricing factor in the perfect competition

When the above assumptions are fulfilled, we know it is a perfect competition. Lets assume, a seller
decides to sell his product at a price higher than the said market price, every buyer will know about
this price change and they may or may not purchase from the seller anymore.

In the existence of perfect competition, no seller will challenge the market price and sell at higher rate
neither will the buyer have enough purchasing power to buy at a higher price. So the seller here is
only a price taker whereas the buyer can only adjust their quantity to purchase.

To understand the pricing in the perfect competition lets divide the situations into 3:-
A) Very Short Period in the Perfect Competition;
B) Short Period in Perfect Competition;
C) Long Period in Perfect Competition.

A) Very Short Period in the Perfect Competition :-

In this situation, the supply is fixed and so are its inputs. It is the difference in demand that
defines the price. It is different in cases of the type of goods sold in the market. If the product
is something like oranges that lose its durability, the products are priced such that the supply
or the stock is sold out at the earliest. On the flip side, if it’s a durable good, like say a
notebook, they don’t perish but their utility reduces and eventually their demand falls. In both
cases, the supply curve is a straight
line, where as a movement in the
demand determines the price.

Before we move further into the Short run or Short period in Perfect competition, lets
understand the 3 possibilities of Short run Equilibrium :-

Three possibilities of Short run equilibrium

Normal Profit

In below figure revenue and cost are plotted on the X axis and quantity on the Y axis.
Here Marginal cost (MC) curve cuts Marginal Revenue curve from below at point A, where P
is the equilibrium price and Q is the equilibrium quantity

Here, Average cost is equal to Average revenue corresponding to equilibrium quantity. This
also means that firm is earning normal profit

Loss

In below figure revenue and cost are plotted on the X axis and quantity on the Y axis. Here
Marginal cost (MC) curve cuts Marginal Revenue curve from below at point ‘A’, the
equilibrium point, where ‘P’ and Q are the equilibrium price and equilibrium quantity
respectively

Here, corresponding to equilibrium quantity(Q), Average cost is more than Average revenue,
which is why there is a loss. For the total quantity OQ the loss can be identified as P*P’BA
Super-normal Profit

In the figure above, the per unit revenue or average revenue is represented as OP* and the per
unit cost or average cost is represented as OP’. And we can observe that, the per unit receipts
are high as campared to per unit cost because of which the revenue curve lies above the
average cost curve resulting into the firm earning super-normal profits,which can be identified
as P’P*BA for OQ* quantity

B) Short period in Perfect Competition :-

In the short period and, in the very short period like above, the entry and exit of sellers is not
possible given the time window. In short run, sellers can change their factors of production
except for land or in otherwords, their production plant which remains fixed and is not
feasible to make any amendments considering the period of time. The supply can be increased
or decresed only by a certain percentage depending on the unchanged Factor of Production.
Given below is a curve graphical representation of the demand and supply curve in the short
run :-
In the short period, prices are determined by the demand and supply.
DD and SS are the demand and supply curve. OP AND OQ is an equilibrium price and
quantity.
An increase in the Demand, the shift of the demand curve to D” or D’ shows the change in the
price to OP” or OP’ and similarly, OQ” or OQ’ .
Therefore, an increase in the demand leads to an increase in the price and quantity, and
decrease in the demand leads to decrease in price and quantity.

To understand further, lets assume a seller wants to make maximum profits keeping his cost
of the factors constant and, the costs involved depends on its own production. Suppose, the
seller makes an increasing returns with an increasing output or production but right after
makes decreasing returns.

As shown in the graph above, the total revenue(TR) earned as the production
increases(assuming they have made sales of that quantity) is equal to the current market price
of the quantity multiplied by the production or output, and hence is shown as a straight line in
the graph. The slope of this straight line is equal to the market price, that is unaffected by any
other firm.
Profit = TR – TC (varies with the change in production or output)
The firms profit is indicated by a on the curve and reaches the maximum at . At that
given output, the slope of TR curve = the slope of total cost(STC) curve which is increasing
in slope. It can be seen that, the slope of the total revenue curve and total cost curve are equal
for an output of but this gives relatively minimum profits since the slope total profit is
increasing and consequently Total cost curve, decreases. We can note two break even outputs

from the above graph, and at this level Total revenue covers only total cost. Also,
the positive stop of STC on the Y axis is fixed cost and the negative, is a loss that is equal to
the fixed cost.

Now lets look at the corresponding per unit cost curve. Please refer the graph below :-

At price P, in the short run, it’s a horizontal line depicting marginal revenue. The short run
marginal cost(SMC) and short run average cost(SAC) curves are U shaped.
The SMC=SMR at two levels of output, but the profit maximizing output or production to
that where SMC is increasing. The sellers profit is in the shaded area as shown in the graph.
Here, an output that minimizes the cost of production does not maximize the profits. This
output maximizes profits only when the market price is equal to the sellers average minimum
cost, where in the MR curve is said to be tangential to the SAC.

If the price in the market is more than or is equal to the SAC, the seller will supply, at an
increasing marginal cost , an output which is equal to the price of the product.

On the flip side, if the price in the market is less than the seller’s minimum AC of production,
the firm is not going to make profits at any given output.

Lets take another situation where in the seller is initially in a short run scenario(Graphical
representation below), which supplies and demands at S1 and D1 respectively, and that it is
producing an equilibrium output at X and selling P0 price. The seller manages to earn basic or
normal profits. Suppose the demand increases but the supply remains the same and X, the
price now rises to P2.
C) Long run in Perfect Competition :-
In the long run, more variations of supply can be seen because of the time period, it is easy to
make changes to all factors of production(FoPs) since all are variable in nature. In this
scenario, demand is less subjective to influence price.
Having been able to adjust the FoPs, it gives seller a better platform to adjust the quantity
supplied or output produced. However, depending on the industry’s operations on cost
conditions, which means if it is operating on increasing,decreasing or constant cost
conditions, the new price may not be directly propotional to the demand. Whereas, the new
price maybe more than, less than or even equal to the initial prices.

To bifurcate lets divide them in scenarios, with self explanatory graphical representation, of :-

i) Constant cost
ii) Increasing cost
iii) Decreasing cost.
Hence, the prices fluctuate depending on the conditions of supply of a particular industry.
To understand better, just as in the short run, lets assume the seller wants to maximize profits
in the long run, the seller should supply an output that equalizes its long run marginal cost to
its marginal revenue, unless it is not able to cover the long run average cost at a positive
output or production. In case this happens, the seller may cease the production of that product
and use the inputs to produce another product. Here the supply curve of the firm is equal to
the LRMC(Long Run Marginal Cost) and is also equal to the LRAC(Long Run Average
Cost)at its minimum. As shown in the graph below, the supply curve is within OA and BC.
BC is at par with the LRMC at and over the seller’s minimum LRAC.

At price lesser than OA the seller makes no supply of the product, X. At price OA, the seller
is may or may not produce amount of output. But at price above OA, positive output or
quantity is supplied as the LRMC is increasing. As seen on the graph, at price P0 the seller
produces of the product.
 In the longrun, the entry and exit of the sellers in the market is free. Under such scenarios, and
the factor prices are the same or unaffected by the industry’s supply variations, the longrun
Supply curve is a vertical straight line and no seller earns more than normal profits. So to say,
in the long run every seller working is marginal because in all FoPs are variable in nature.
Hence, a seller with better management may be able to be pertinent in the short run for some
extra returns but in the longrun, the salaries of the management will be affected depending on
the competiton of other sellers.
The long run cost curves are however derived on the basis of each factor receives benefit
equal to the opportunity cost. Also, in the LRAC of every seller is tangential to the marginal
revenue for the product. The long run equilibrium for a seller is shown in the graph below.

The long run optimum production is either at 0 or at , the profits operating for the industry
is just equal to what they would earn if they did not produce product X. The seller indeed is
marginal and is complacent about producing the product or not

To conclude, we may know that the model of the perfectly competitive market is a static
model. Nonetheless, a theoretical and policy point of view, the static nature of the market may
give misleading results since it is dynamic.

SELLERS AND BUYERS IN THE PERFECTLY COMPETITIVE MARKET –

 In a perfect competition, both sellers and buyers are price takers.

 It is the interaction of demand and supply, determines the market equilibrium, that
defines the price of a product.
 Being price takers in the competitive market, ensures the gains or profits are
exhausted.
 The transaction costs are zero in a perfectly competitive market.

When a seller is asked to choose between two buyers, the seller would choose a buyer
who is willing to pay a high price or even slightly higher price than the other seller.
On the flip side, a buyer would choose a seller selling the product at a lower price
than another seller selling at a little higher price. Hence the buyer or the seller cannot
influence the market price and carries no market power, as they are bound to choose
from the available sellers.

THE REVENUE CURVE AND COST CURVE :-

Revenue curve:
 Individual firm in perfect completion is price taker as the price is determined by market demand and
supply and cannot be influence by individual firm. As we know price remains same for all units of
commodity, the MR (Marginal Revenue) will be equal to AR (Average Revenue) i.e., AR=MR.

Below given is the revenue schedule for a firm

Units TR (Total Revenue) AR (Average Revenue) MR (Marginal revenue)

1 10 10 10
2 20 10 10
3 30 10 10
4 40 10 10
5 50 10 10

In the above table we can observe that TR increases at constant rate., which is 10. Marginal Revenue
remains same and it is equal to AR.

Thus,
TR= AR * Q, where ‘Q’ stands for quantity
And,
TR= MR * Q (Since AR=MR)

In the above figure, OP is the price and a firm can sell any amount of quantity.
The horizontal line is the average curve and the marginal revenue curve coincides with the average
revenue, It is happening because the price is constant. Although the point to be noted is that the OP
price is determined by demand and supply of industry
Cost Curve
Total cost under perfectly competitive markets constitutes of two costs namely, Fixed cost and
variable cost i.e. TC= FC + VC
Fixed costs (FC) are expenses that do not vary with the quantity of output produced. They are also
known as period cost. Examples of fixed cost include salary/Wages and Rentals

And, Variable cost are those cost which vary with the quantity of output produced. Piece rate wages
and cost incurred towards cost materials are some examples of variable costs

Average fixed cost (AFC) can be derived by dividing fixed costs with the total quantity of output
produced, AFC= FC/Q

Average variable cost (AVC) can be derived by dividing variable costs with the total quantity of
output produced, AVC= VC/Q

Average total cost (ATC) can be derived by dividing total cost with the total quantity of output
produced, ATC= TC/Q

Marginal cost (MC) can be defined as the additional cost incurred by producing one additional unit of
output,

The below graph depicts the cost curves for a firm in a perfectly competitive market
As you will observe in the diagram below, the Marginal Cost (MC) curve will always intersects both
the Average Variable cost (AVC) curve and the Average Total cost (ATC) curve at their respective
minimum point. Whenever MC is lower that average variable cost or average total cost, then AVC or
ATC must be decreasing. Alternatively, when marginal cost is greater than average variable or
average total cost, AVC or ATC must be increasing. Therefore, minimum point is the only point
where Marginal cost (MC)= Average variable cost or average total cost.