Pure competition is another term for perfect competition. In this market structure, there are many producers and consumers, each not large enough to influence market supply and demand. Marketed goods are homogeneous and are a perfect substitute.
In such a market, the company tries to produce the largest output at the lowest price.
It is hard to find examples of perfectly competitive markets in the real world. But, perhaps the closest example of this market structure is the market for agricultural products, foreign exchange, stocks, and commodities.
The main characteristics of pure competition
The pure competition also offers a simplified economic market model. It is a basic market model in discussing other market structures such as monopolistic and oligopolistic competition.
Broadly speaking, pure markets are ideal markets. This market structure allows the efficient allocation of economic resources. It is assumed, there are no market failures, both from externalities and market forces.
The following are the main characteristics of pure competition:
- There are many producers and consumers in the market
- Producers and consumers do not have the market power to influence prices
- Standard or homogeneous product and is a perfect substitute
- There are no entry barriers and exit barriers
- Transition costs borne by consumers are zero
- Suppliers act as price takers.
Number of actors, entry barriers and exit barriers
In a pure competition market, there are many producers and consumers. Each is not enough to influence prices, demand, or supply. In other words, both producers and consumers do not have market power.
Low entry barriers are also related to a large number of producers in the market. When a company goes bankrupt, market supply decreases, this will raise prices in the short run. However, due to low entry barriers, any increase in profits will encourage new players to enter. As a result, economic benefits in a pure market do not last in the long run.
Homogeneous product and switching costs
Producers market homogeneous products. The company did not adopt a differentiation strategy for its offer. Therefore, there is no opportunity for them to apply a more premium price. Hence, competition in the market will be based on price and volume.
Also, products on the market completely replace each other. In a sense, when one producer raises prices, consumers will immediately move to other producers. Moreover, consumers do not bear substantial switching costs. Manufacturers can be free out when they are bankrupt.
Furthermore, when companies can adopt a differentiation strategy to a certain degree, the market structure changes into a monopolistic competition.
Producers as price takers
The producers in the pure competition market are price takers. In a sense, they take the market price as the price of their product. They do not have the market power to influence market prices, due to the relatively small size of individual supplies, homogeneous products, low entry and exit barriers, and low consumer switching costs.
Individually, producers face market demand that is really very elastic (horizontal demand curve), so there is no reason for them to sell prices above the market, even slightly above market prices. The idea is because consumers will immediately switch when they do it. Therefore, if each company charges a price somewhat above the market price, the company will not sell any product.
Companies can maximize their profits by producing goods until the marginal costs are equal to marginal revenue and market prices.