After you have worked through this section of the learning unit, you should be able to:
- identify the requirements of perfect competition
The following are the requirements which must exist in a market for it to be considered perfectly competitive:
- There must be a large number of buyers (consumers) in the market.
- There must be a large number of sellers (suppliers) in the market.
- There should be no collusion between sellers.
- All goods sold in the market must be homogeneous.
- Buyers and sellers must have complete freedom of entry and exit into and out of the market.
- All buyers and sellers must have perfect knowledge of market conditions.
- There must be no government intervention.
- All factors of production must be perfectly mobile.
While it will be difficult to find a market that meets all of the above requirements, most markets have elements of a perfectly competitive market.
Select all the elements of perfect competition you think the South African telecommunications market (Cell C, Vodacom, Telkom, MTN etc.) has?
- Large number of buyers
- Large number of sellers
- No collusion between sellers
- Homogeneous goods
- Complete freedom to enter and exit
- Perfect knowledge of market conditions
- No government intervention
- Perfectly mobile factors of production
From the following discussion, you will see that there are many buyers, a fairly homogenous product and no collusion.
It is estimated that there are 59 million cell phones in use in South Africa, which means that there are definitely a huge number of buyers in the market. The reason for the requirement of having many buyers is to ensure that a buyer or a group of buyers cannot manipulate the market price. For perfect competition to exist, buyers must be price takers.
Collusion occurs when rival firms cooperate to their advantage. This usually involves price fixing between rival firms. There is currently no evidence of this having occurred in the telecommunications market. A requirement for a perfect market is then also that there must be many suppliers to ensure that a supplier or group of suppliers cannot manipulate the market price through their actions. In a perfect competitive market, sellers have small market shares and are also price takers.
While the quality of service may differ between the operators, they provide a fairly homogeneous good to the market. What happens here is that suppliers try to differentiate their product through advertising and offering contracts that are different from those of their competitors. This gives them some control over the price they can charge. In perfect competition, there is no product differentiation in that the product is perfectly homogeneous. The product of one supplier cannot be distinguished for another supplier in that the product has the same characteristics and quality.
Which elements of perfect competition do you think the following market for tomatoes has?
- Large number of buyers
- Large number of sellers
- No collusion between sellers
- Homogeneous goods
- Complete freedom to enter and exit
- Perfect knowledge of market conditions
- No government intervention
- Perfectly mobile factors of production
What one finds in this market is that there are probably many buyers and many sellers and that the product that is sold is homogeneous.
Complete freedom of entry and exit requires that it must be possible for firms and buyers to easily enter and exit a market. There are no barriers to entry in the form of legal, financial, technological, physical or other restrictions that inhibit the free movement of buyers, sellers and producers. This means that new firms can enter the market to compete with existing firms.
Perfect knowledge of market conditions requires that buyers are aware of the price charged by sellers and that sellers are aware of the price charge by other sellers. This ensures that a seller cannot charge a buyer a higher price than the other sellers, and sellers will not sell at a price lower than other sellers. This requirement of perfect knowledge also extends to issues such as use of technology, different production techniques and availability and the cost of factors of productions. Under perfect competition, all firms have access to the same information.
Perfect mobility of the factors of production implies that land, labour and capital can be moved according to changing market conditions. This ensures that the factors of production are allocated in the most efficient manner.
Perfect completion also requires that there is no government intervention in the market. It is left to the forces of demand and supply to sort out the economic problem of what to produce, how to produce and for whom to produce.
While some markets are closer to perfect competition than others, there is no market in the real world that satisfies all the requirements. For instance, while the stock exchange market and the foreign exchange market closely resembles perfection competition there are however restrictions on entering and information might be costly to acquire and can be complex to understand.
In South Africa, the market for electricity is dominated by only one supplier and therefore violates the principle of many sellers. To enter the maize market as a supplier might also be difficult.
At this stage, you are probably asking why one needs to study perfect competition if it is only a theoretical ideal. We can still learn a lot about how a firm operates and what motivates an entrepreneur’s decisions. Once we understand the basic principles underlying the theory of the firm under perfect competition, we can start to explore how a firm operates in a more complex environment.
Activity
Indicate whether the following statements relating to perfect competition is true or false: