Perfect Competition

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Perfect Competition

Perfect competition is an idealised market structure theory used in economics to show the market under a high degree of competition given certain conditions. This essay aims to outline the assumptions and distinctive features that form the perfectly competitive model and how this model can be used to explain short term and long term behaviour of a perfectly competitive firm aiming to maximise profits and the implications of enhancing these profits further.

In a perfectly competitive market each firm is a “Price Taker” , i.e. the prices and wages are determined by the market and the firm is so small relative to the size of the market that they can have no influence over the market price. For a market to be perfectly competitive there are certain conditions that have to be met.

The first set of conditions for perfect competition applies to the market structure. There are many small buyers and firms (suppliers), where none have an influence over the market price as they are small relative to the market as a whole. This means that each of the suppliers in the industry is a price taker. One firm’s change in output will not affect the total market supply. Products supplied in this market structure are homogenous, meaning that they are perfect substitutes for each other. This is another condition that makes each of the firms a price taker, as any rise in their price would lead to the buyer going to the next perfect substitute. For this condition to apply it further assumes that in the market there is perfect information for buyers so that they are aware of each firm’s price in the industry.

These market structure conditions allow the assumptions for perfect competition to be met. The first assumption is ...

... middle of paper ...

...nt if a business in a perfectly competitive industry sets a strategy to enhance profit. The assumptions and conditions of perfect competition take away the fundamental requirement of effective business strategy; innovation and entry deterrence.

Bibliography

KATZ, M.L. & ROSEN, H.S. (Third Edition, 2005) Microeconomics (New York: McGraw-Hill)

BEGG, D., FISHER, S. & DORNBUSCH, R. (Eighth Edition, 2005) Economics (Berkshire: McGraw-Hill)

FRANK, R.H. (Sixth Edition, 2006) Microeconomics and Behaviour (New York: McGraw-Hill)

NELLIS, J.G. & PARKER, D. (Second Edition, 1997) The Essence of Business Economics (Essex: Prentice Hall)

NICHOLSON, W. (Eighth Edition, 2002) Microeconomic Theory: Basic Principle and Extensions (USA: Thomson Learning)

WIKIPEDIA. Perfect Competition. (Available from World Wide Web): http://en.wikipedia.org/wiki/Perfect_competition

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