What is Perfect Competition in Economics
Answers
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Pure or perfect competition is a theoretical market structure in which the following criteria are met
All firms sell an identical product (the
product is a"commodity"or"homogeneous"); all firms are price takers (they cannot influence the market price of their product); market share has no influence on price; buyers
What Is Perfect Competition?
Pure or perfect competition is a theoretical market structure in which the following criteria are met: all firms sell an identical product (the product is a "commodity" or "homogeneous"); all firms are price takers (they cannot influence the market price of their product); market share has no influence on price; buyers have complete or "perfect" information – in the past, present and future – about the product being sold and the prices charged by each firm; resources such a labor are perfectly mobile; and firms can enter or exit the market without cost.
This can be contrasted with the more realistic imperfect competition, which exists whenever a market, hypothetical or real, violates the abstract tenets of neoclassical pure or perfect competition. Since all real markets exist outside of the plane of the perfect competition model, each can be classified as imperfect. The contemporary theory of imperfect versus perfect competition stems from the Cambridge tradition of post-classical economic thought.
How Perfect Competition Works
Perfect competition is a benchmark, or 'ideal type', to which real-life market structures can be compared. Perfect competition is theoretically the opposite of a monopoly, in which only a single firm supplies a good or service and that firm can charge whatever price it wants, since consumers have no alternatives and it is difficult for would-be competitors to enter the marketplace. Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down.
Competition is characterized by the following attributes:
- All firms sell an identical product.
- All firms are price-takers.
- All firms have a relatively small market share.
Buyers know the nature of the product being sold and the prices charged by each firm.
The industry is characterized by freedom of entry and exit (no barriers).
A Large And Homogeneous Market
There are a large number of buyers and sellers in a perfectly competitive market. The sellers are small firms, instead of large corporations capable of controlling prices through supply adjustments. They sell products with minimal differences in capabilities, features, and pricing. This ensures that buyers cannot distinguish between products based on physical attributes, such as size or color, or intangible values, such as branding. A large population of both buyers and sellers ensures that supply and demand remain constant in this market. As such, buyers can easily substitute products made by one firm for another.
Perfect Information Availability
Information about the ecosystem and competition in an industry constitutes a significant advantage. For example, knowledge about component sourcing and supplier pricing can make or break the market for certain companies. In certain knowledge- and research-intensive industries, such as pharmaceuticals and technology, information about patents and research initiatives at competitors can help companies develop competitive strategies and build a moat around its products. In a perfectly competitive market, however, such moats do not exist. Information is equally and freely available to all market participants. This ensures that each firm can produce its goods or services at exactly the same rate and with the same production techniques as another one in the market.
Absence of controls
Governments play a vital role in market formation for products by imposing regulation and price controls. They can control entry and exit of firms into a market by setting up rules to function in the market. For example, the pharmaceutical industry has to contend with a roster of rules pertaining to research, production, and sale of drugs. In turn, these rules require big capital investments in the form of employees, such as lawyers and quality assurance personnel, and infrastructure, such as machinery to manufacture medicines. The cumulative costs add up and make it extremely expensive for companies to bring a drug to the market. In comparison, the technology industry functions with relatively less oversight as compared to its pharma counterpart. Thus, entrepreneurs in this industry can start firms with less to zero capital, making it easy for individuals to start a company in the industry.
Such controls do not exist in a perfectly competitive market. The entry and exit of firms in such a market is unregulated and this frees them up to spend on labor and capital assets without restrictions and adjust their output in relation to market demands.