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Pure Competition
Introduction
In microeconomics, market structure is the main determinant of the behaviour of firms in terms of the price they charge and the output they produce and sell. In this article, we will explain pure competition in detail.
What is Pure Competition?
Pure competition refers to a market structure in which there are a large number of small firms selling homogenous products. The following are the main features of pure competition:
- There are a large number of small firms.
- There are many buyers.
- Buyers and sellers have perfect knowledge.
- There are no entry barriers. The easy entry of new firms is the reason due to which there are many firms in pure competition.
- There are no exit barriers.
- The products are homogeneous. If a buyer buys products from different sellers and mixes them up, he/she cannot separate the products bought from different sellers.
- There are many perfect substitutes of the product.
- Firms have no market power, which means that an individual firm cannot influence market price.
- Firms are price-takers.
Pure competition is also known as perfect competition or atomistic competition.
Characteristics of Pure Competition
Let’s explain the following characteristics of pure competition:
Homogeneous Products
In pure competition, there are homogenous or identical products that are available to consumers and all the sellers offer the same products, such as agricultural products (wheat, rice, and corn) available in the villages.
Many Buyers
A characteristic of pure competition is the large audience, as a large number of buyers are readily available to buy the product. For example, there are many buyers of agricultural products.
Perfect Knowledge
In pure competition, buyers and sellers have access to all the information available. Buyers know about sellers, product quality, features, price, availability, etc. There are no production secrets and even the new firms have access to all the information.
No Barriers to Entry
In pure competition, there are no entry barriers. It means that it is very easy for new firms to start business and enter the market.
Price Taking
In pure competition, an individual firm cannot influence the market price. That is why all the firms are price-takers. This price-taking is a key feature of pure competition and is illustrated in the following diagram.
In the above diagram, we have quantity on the horizontal axis (x-axis) and price on the vertical axis (y-axis). The graph on the left is for the whole market, while the graph on the right is for firm A. The forces of demand and supply determine the market price, which is P0 in the graph on the left. This price belongs to the point of intersection of the demand curve and the supply curve. The same price is taken by firm A (PA=P0). This determines the shape of average revenue/marginal revenue (AR/MR) curve for the firm A. This also determines the perfectly price elastic demand for firm A.
Firm A can sell any quantity at price PA which is taken from the market. Now, what can firm A do if it does not like this price? In that case, firm A has two options and both are not viable.
Firm A can increase the price. In that case, due to perfectly price elastic demand, the quantity demanded will be zero and it will go out of the market.
Firm A can increase the price. In that case, demand of the whole market comes to firm A, its costs will skyrocket and firm A will shut down.
So the only option for firm A is to take the price from the market and sell its products at the same price.
Profit of Firms in Pure Competition
In pure competition, firms can earn abnormal profits, supernormal profits or even losses in the short run. However, firms can only earn normal profits in the long run. This is the minimum economic profit which firms need to remain in the market. This is illustrated by the following diagram.
In the above diagram, firms long-run equilibrium point or profit maximization point is at E0 where marginal revenue is equal to marginal cost (MR=MC). At this point the price and average cost are the same (P=ATC) leading to normal profit.
If some firms earn abnormal or supernormal profits in the short run, everyone will come to know about this profit due to perfect knowledge. This abnormal profit will become an incentive for new firms to enter the market. Due to no entry barriers, many new firms will enter the market, leading to a rise in market supply and a fall in price. This fall in price will shift the MR/AR curve downward, and the short run abnormal profit will become normal profit in the long run.
Similarly, if some firms earn a subnormal profit or loss in the short run, everyone will know about this loss due to perfect knowledge. Firms will start leaving the market due to no exit barriers, leading to a fall in market supply and a rise in price. This rise in price will shift the MR/AR curve upward, and the short run loss will become normal profit in the long run.
Economic Efficiency in Pure Competition
Economic efficiency is achieved by firms when they have productive efficiency and allocative efficiency. Productive efficiency exists when firms are producing output at the lowest point of average total cost (ATC) curve (MC=AC). Allocative efficiency exists when price is equal to marginal cost (P=MC). These two conditions are satisfied in a perfectly competitive market of pure competition, as illustrated by the above diagram. Point E0 illustrates the minimum ATC and price is equal to marginal cost because the average revenue curve is intersecting the marginal cost curve at this point. Hence, economic efficiency exists in pure competition in the long run.
Examples of Pure Competition
It is difficult to find the perfect examples of pure competition. However, the following are some real-world examples which are close to pure competition:
Agricultural Market
The pure competition can be seen in local agricultural markets. There are many small local wheat farmers selling the same homogenous wheat. Similarly, there are many buyers and sellers in the market for rice, cotton and corn.
FOREX Market
FOREX market or foreign exchange market, is the collection of buyers and sellers of currencies and is a good example of pure competition. There are many buyers and sellers involved in trading currencies, which are homogenous products.
Differences between Pure Competition and Imperfect Competition
The following table contains the main points of difference between pure competition and imperfect competition.
Pure Competition, Monopoly, and Monopolistic Competition
The following table compares the main features of pure competition with those of monopoly and monopolistic competition.
Advantages of Pure Competition
The following are some advantages of pure competition:
Economic Efficiency
Economic efficiency means the best possible use of resources. This is always desirable because resources are scarce and should be utilised in the best possible way to reduce scarcity. Firms in pure competition have economic efficiency because they are productively and allocatively efficient in the long run. This shows the best possible use of resources in pure competition.
Intense Competition
The presence of a large number of firms and a high level of competition serve as fuel for cost reduction. The inefficient, high-cost firms will be kicked out of the market. Only low-cost, efficient firms can survive in the market. This benefits consumers in the form of a low price and the availability of many perfect substitutes.
Quick Response
Due to high competition among a large number of sellers, firms in pure competition respond to market changes quickly. This increases dynamism in the market. Firms in pure competition quickly adjust when there are changes in the market price or in the taste of customers.
Disadvantages of Pure Competition
The following are some disadvantages of pure competition, which are explained as follows:
No Economies of Scale
Firms in pure competition are small, and they produce low output, which is an insignificant proportion of the output of the whole market. This means that the firms will not benefit from economies of scale.
Idealised Framework
The concept of pure competition is an idealised framework with many strict assumptions which are not true in real life. For example, the condition of perfect knowledge does not fully exist in real life. This decreases the usefulness of pure competition.
Absence of Innovation
Firms in pure competition earn normal profits, which may not be enough to invest in research and development, and innovation. This can lead to a lack of dynamic efficiency in pure competition.
Conclusion
In conclusion, pure competition is a form of an idealized market structure with many buyers and sellers. There are no entry or exit barriers and no asymmetric information exists in pure competition. This model serves as a good reference point to improve the workings of free markets.
