What is Perfect Competition?

Perfect competition is a type of market structure where all companies or firms are selling the same product, and because of having no control over their product prices, they tend to be price takers. In this market, consumers have full or perfect knowledge about the product that is on sale. They know what firm charges what price for a specific product. There is a perfect mobility in terms of resources including labor, and there are no barriers to entry and exit involved for such firms.

1. Perfect competition refers to a particular type of market model that involves a huge number of buyers and sellers having perfect or complete information of homogenous products.
2. Perfect competition and monopoly are completely in contrast to each other.
3. Real markets prevail beyond the boundaries of perfect competition market, and hence are referred to as imperfect.

Back to:ECONOMIC ANALYSIS & MONETARY POLICY

How does Perfect Competition Work? 

The concept of perfect competition is different from the practical imperfect competition. The latter takes place when there is a violation of principles associated with the former. As all real markets prevail on the outer boundaries of the perfect competition approach, they can be considered as imperfect. The Cambridge tradition of post-classical economic thought gave origin to the modern theory of perfect vs imperfect competition. (Note: In the real world, there is no such thing like perfect competition. Firms with huge competition existing in liquid markets for homogenous products like wheat, can be considered as the nearest practical examples).

How is the principle of Perfect Competition Used?

Perfect competition refers to a standard that enables the comparison of different market models. In theoretical language, it is totally the antonym of a monopoly where there is only one firm selling a product or service. Being the sole supplier and because of no competition, the firm becomes the price maker and has the ability to set any price for their products. They know that customers will buy their product no matter how high they set the prices. However, in perfect competition, there are lots of buyers and sellers for homogenous products, and this regulates the market demand and supply. Firms manage to stay in a profitable position so as to keep their business going. Because of no barrier to entry, new firms can enter the market at any time, and affect the profitability of the existing firms. A market that is perfectly competitive has the following features:

• All companies sell homogenous products.
• All companies are price takers and not price makers.
• All companies enjoy lesser market share.
• Buyers already have knowledge about the type of product being sold followed by its prices.
• The firms can enter or exit the industry any time they want.

A large and homogenous market 

A market with perfect competition has lots of buyers and sellers involved. The sellers include small-scale firms rather than giant-sized companies that can control prices by making variations in the supply. The products sold by these small firms are almost same in terms of attributes, prices, and functions. This makes it difficult for buyers to differentiate products based on tangible and intangible attributes. This market model keeps the market demand and supply in balance with each other. Here, customers can easily make a switch between products produced by different companies. 

Availability of perfect information 

Information regarding the competitors strategies and environment can play a huge role for an industry. For instance, if people and firms already knew about the pricing strategies of their competitors, it can be a disadvantage for others. Many pharmaceutical and technology-based firms patent their products to save them from being exploited. In case, the competitors are able to trace such crucial information, they can build their own strategies for making their products stand out from others. However, perfect competition doesnt offer such privileges. Buyers and sellers dont have to dig deep inside for getting information as it is readily available for all. This helps one firm in adopting the same production and pricing strategy like that of its competitors in order to sell its products. 

Lack of Control 

Government authorities have a huge role to play in formulating and controlling markets, and managing the demand and supply. They have the authority to put barriers on the entry and exit of companies by enforcing rules and regulations. For instance, a firm that is in pharmaceutical sector needs to go through a lot of rules related to research, manufacturing, and sale of medicines. Such firms need to invest a lot of capital in terms of employees, infrastructure, etc. Such huge costs when added up make it hard for firms to launch a new pharma product in the market. However, the tech industry has comparatively lesser rules to follow in comparison to the pharma industry. Hence, entrepreneurs who plan to start something in the tech industry can do so by making minute investments, thereby making it easier to enter the market, and growth in the coming years. 

Cheap and Efficient Transportation 

The presence of inexpensive mobility is one of the main features of perfect competition. Here, firms dont have to spend a lot on transport, which further lessens the price of the product, and smoothens up the delivery of goods. 

Examples of perfect competition

As stated above, the concept of perfect competition is far from reality. Though it can be difficult to figure out practical examples of perfect competition, but one can find several variants available in their day-to-day life. Lets take an example of a farmers market that has a huge number of sellers and buyers selling and buying goods. Here, you will see a very less difference in the goods and the rates at which they are made available to buyers. Because of the similarity in nature of the products, the main source of produce wont be important, and there will be a small amount of variation in their packaging or branding approach. Hence, the exit or closure of one agricultural firm wont have any impact on the entire market. Also, the average prices wont face any fluctuations due to such exits. Another example could be that of 2 supermarket stores where the same types of products from similar firms are stocked in aisles. These products would seem to be similar in terms of appearance, and prices, and will offer the same type of features too. Also, products that are not branded fall under the perfect competition. They are again homogenous, and are available at cheaper rates. Furthermore, the pricing strategy for product knockoffs is same, and they are hard to be differentiated easily. In case, an organization producing such product becomes non-operative, it gets replaced by some other firm. As new firms are growing and entering the tech industry nowadays, we can relate it to the scenario of perfect competition. For instance, a big number of websites such as Sixdegrees.com, Asianave.com, Blackplanet.com, etc. used to provide same services when social media networking was completely new. There were no costs associated with these sites, and they didnt have any huge market share. The users of these sites were generally school and college going students. As these organizations had minimal startup costs, it was easier for them to enter and exit the market. Technologies like Java were made available for public use. Also, there were no capital expenses involved.

Drawbacks of Perfect competition models?

Perfect competition creates a particular model for the commencement of a market. However, such market suffers from a few drawbacks. As firms are producing similar products, the sense of innovation and creativity somehow gets extinct in this process. The firms can be innovative to get a bigger market share, and be more competitive than other firms by offering premium quality products. However, no organization established in perfect competition has a significant share of market. The demand and supply of products ascertain the profitability of a firm. So, it is difficult for companies to be unique and offer products and services at a higher price to customers. For instance, companies like Apple wont find it feasible to operate in a perfectly competitive market. It is so because its iPhones are unique, and heavily priced in comparison to its competitors. The second drawback that perfect competition faces is the lack of economies of scale. If the companies just aim to receive enough profit margins so as to stay in the market, they wont have adequate funds for investing in further expansion and growth. If the firm increases its production capacity, it will lead to reduction in costs and increase in profit margins. However, due to the large size of companies existing in this market, it gets difficult to achieve the above objectives of cost minimization and profit maximization. Also, it makes sure that the average size of the company operating in the perfectly competitive market tends to be less.

Do firms make profits in a perfectly competitive market?

Firms operating in a perfectly competitive market dont make any profits. There can be some stages when firms make some profits. But the market conditions tend to nullify the impacts of positive or negative profits, and set them in an equilibrium position. Because of free information, other organizations will make variations in their production activities so as to arrive at uniformity with the organization that had a profit margin. In perfect competition, the average revenue and marginal revenue for companies is equivalent to the price of the product. This creates a situation of market equilibrium that was not present before. With the adjustment of demand and supply, the profits and losses of firms turn out to be zero in the long run.

Does perfect competition exist in the real world?

The competition prevailing in the actual world doesnt fit in the perfect competition model because of disparity in manufacturing, marketing, and selling approach. For instance, the owner who sells organic farm products can provide significant details about the type of food fed to cattle whose manure was used to produce the non-GMO soybeans. This is a part of differentiation. With the help of different marketing strategies, firms tend to have a higher pricing power, and more market share. Their objective is to create a brand identity in the market. Hence, the primary components including similar products and price takers seem to be vague in reality. The next couple of features including free information and mobility are still being worked upon by the tech and trade industries, so as to improve information and instill more flexibility in resources. Even though perfect competition is far from reality, it still helps in explaining a lot of reality based scenarios.

Barriers to Entry Prohibit Perfect Competition

There can be several barriers to entry that discourage a new firm to enter the perfectly competitive market. Some of them include more startup costs, stringent government rules and policies, and a lot more. The customer has become smarter with the advancement of technology. There are a few sectors where the customer has information about all products and their prices. There are many barriers that dont allow perfect competition to take place in todays world. For instance, in the agricultural sector, there are lots of small manufacturers who have no information or influence over the products prices. The commercial buyers, being aware of the market prices, take advantage of this situation. Though there can be some barriers to entry in the agricultural industry, it is not specifically hard to exploit the market being a producer.

Related Topics

• Market Structure
• Perfect Competition
• Bidding War
• Complements & Substitutes
• Substitution Effect
• Imperfect Competition
• Market Power
• Price Takers
• Price Makers 
• Perfect Competition and Decision Making
• X-Efficiency
• Captive Market
• Contestable Market Theory
• Highest Profit Point in a Perfectly Competitive Market
• Marginal Revenue
• Using Marginal Revenue and Marginal Costs to Maximize Profit
• Marginal Revenue Curve
• Profit Margin and Average Total Cost
• Break Even Point - Cost Curve
• Shutdown Point - Cost Curve
• Short-Run Decisions Based Upon Costs in a Perfectly Competitive Market
• Marginal Costs and the Supply Curve for a Perfectively Competitive Firm
• Long-Run Average Supply (LRAS)
• Decisions to Enter or Exit a Market in the Long Run
• Long-Run Equilibrium in a Perfectly Competitive Market
• Constant, Increasing, and Decreasing Cost Industries
• Productive and Allocative Efficiency in Perfectly Competitive Markets
• Market Efficiency
• Market Inefficiency
• Pareto Efficiency
• Market Failure 
• Search Theory
• Monopoly
• Natural Monopoly
• Legal Monopoly
• Bilateral Monopoly
• Promoting Innovation through Intellectual Property
• Predatory Pricing
• How Monopolists Set Price with the Demand Curve
• Total Cost and Total Revenue for a Monopolist
• Marginal Revenue and Marginal Cost for a Monopolist
• Inefficiency of Monopoly
• Perfectly Competitive Market
• Monopolistic Competition
• Duopoly
• Oligopoly
• Differentiated Products
• Perceived Demand for a Monopolistic Competitor
• Monopolistic Competitors Choose Price and Quantity
• Monopolistic Competitors and Entry
• Monopolistic Competition and Efficiency
• Cartel (Economics)
• Game Theory
• Traveler's Dilemma
• Prisoner's Dilemma
• Iterated Prisoner's Dilemma
• Nash Equilibrium
• Diner's Dilemma
• Trembling Hand Perfect Equilibrium
• Gambler's Fallacy
• Arrows Impossibility Theorem
• Backward Induction
• Tournament Theory
• Oligopoly and the Prisoner’s Dilemma
• Forcing Cooperation in a Prisoner’s Dilemma
• Cooperation and the Kinked Demand Curve
• Corporate Merger or Acquisition
• Antitrust Laws
• Herfindahl-Hirschman Index
• Concentration Ratio
• Other Approaches to Measuring Monopoly Power in an Industry
• Restrictive Practices under Antitrust Law
• Natural Monopoly
• Cost-Plus Regulation
• Price Cap Regulation
• Regulatory Capture