Perfect competition

July 27, 2023
10 MIN READ
60 VIEWS
A hypothetical market system is called perfect competition. Perfect competition is a valuable model for illustrating how supply and demand influence pricing and behavior in a market economy, despite seldom occurring in actual markets. There are numerous buyers and sellers in need with perfect competition, and prices always reflect supply and demand. Companies only make as much money as is necessary to continue in operation. Other businesses would enter the market and reduce revenues if they made excessive profits.

What is perfect competition?

A perfect competition market is one in which there are many buyers and sellers, all of whom take part in the simultaneous purchase and sale of a single, homogenous good without the use of artificial limitations. In a perfect market system, sellers and buyers have complete and symmetrical information and no transaction costs. In this scenario, many manufacturers and consumers compete with one another. Logically, a market with perfect competition is not monopolistic.

How the perfect competition operates

One standard or desirable kind to which actual market systems might be contrasted is perfect competition. Theoretically, monopolies are when only one company provides an item or service. That company is free to set its prices since customers have no other options, and potential rivals can't enter the market, which is the reverse of perfect competition. There are no cartels under a scenario of an ideal match. A few essential traits of this type of structure include:

   i. Each company sells the same thing: a homogenous or commodity product.

   ii. All businesses are price takers (they cannot change the price of their goods on the open market).

   iii. Price changes are unaffected by market share.

   iv. Consumers have an in-depth understanding of the goods being offered and the prices each company is asking.

   v. Labor, as well as financial resources, are entirely portable.

   vi. Companies are not charged to join or leave the market.

   vii. One can compare this with the more grounded imperfect competition that arises whenever a hypothetical or actual market deviates from the idealized principles of perfect competition.

The perfect competition qualities

The following characteristics identify a market as being perfectly competitive:

A vast and uniform market

There are many consumers and vendors in a very competitive market. Instead of giant companies that may regulate pricing through changes in supply, the vendors are smaller businesses. There aren't many distinctions in the skills, characteristics, and prices of the things they sell. It ensures consumers cannot differentiate between items based on concrete qualities like size or color or intangible qualities like branding. Plenty of buyers and sellers in this market ensure stable supply and demand. Customers may readily switch out items made by one company for those made by another.

Full access to information 

A critical competitive edge is knowledge of a business's ecology and competitors. For certain businesses, understanding supplier price and product sourcing, for instance, can determine the fate of their business. Details on copyrights and research projects at rival businesses may help businesses establish competitive strategies and create a defensive barrier around their goods in some knowledge- and research-intensive industries, such as technology and the pharmaceutical industry.

Lack of controls 

Governments play a crucial role in developing the market for goods by enforcing rules and regulating prices. However, by establishing guidelines for the market's operation, they may regulate the admission and departure of businesses. For instance, the creation, manufacture, and sale of medications are subject to several regulations the pharmaceutical sector must follow. As a result, these regulations need significant capital expenditures in the form of persons (lawyers, quality assurance staff, etc.) and infrastructure (medicine manufacturing equipment). The total expenditures pile up, making it quite pricey for businesses to release a medicine on the market.

In contrast to its pharma equivalent, the technology sector operates with far less regulation. As a result, business owners in this sector may launch organizations with little to no cash, making it simple for anyone to launch a company in the sector. In a very competitive market, such regulations don't exist. Since there are no limits on a company's entry or exit from such a market, it can freely invest in labor and capital assets and alter production in response to market needs.

Affordable and effective transportation

Another aspect of perfect competition is affordable and adequate transportation. Businesses do not suffer considerable fees for product transportation in this kind of market. It lowers the cost of the item and shortens the time it takes to deliver the items.

Balance in perfect competition

The market will be balanced when supply and demand are equal and when there is perfect competition. At this moment, a business's pricing will be established. Demand will have an impact on balance in the short term. Demand and supply for a commodity will eventually impact the balance of power under perfect competition. A corporation will ultimately only see a regular profit at a balance point. The slope of a business's cost curve amid perfect competition must rise when a specific amount is produced, as is widely known. For any given total production in the sector, this quantity is sufficiently low to allow an adequate number of enterprises to remain in the market to maintain the ideal circumstances of perfect competition. In the short run, it is believed that the availability of some elements is constant. When the cost of other variables is determined, expenses per unit must inevitably increase at some point. From a theoretical perspective, long-term static equilibrium and perfect competition could not be compatible given the assumption that there would be a continual expansion trend in enterprises' size.

Perfect competition in theory and reality

The main reason real-world competition deviates from this ideal is due to manufacturing, marketing, and sales variation. For instance, the proprietor of a small organic goods store can differentiate their goods from rivals by heavily publicizing the grain fed to the cows that produced the dung that fertilized the non-GMO soybeans. Differentiation relates to this. The first two requirements, homogenous goods and price takers, are rarely accurate. However, the global tech and commerce transformation increases information and resource flexibility for the second pair of requirements (information and mobility). Although this theoretical model is distant from reality, it is helpful since it may explain various behaviors that occur in the real world.

Entry barriers prevent perfect competition

Several industries also have significant entrance barriers, which restrict the ability of companies to enter and depart such areas. Examples of these barriers include high beginning costs (as in the auto manufacturing industry) or rigorous government constraints (as in the utilities industry). And even while the digital age has boosted consumer knowledge, there are still few markets where consumers are always aware of all possible choices and pricing. In the economy, ideal competition cannot emerge due to significant barriers. Considering that there are so many small producers in the agricultural sector and they have so little control over the selling prices of their goods, this sector arguably exhibits the closest thing to perfect competition.

The benefits and drawbacks of perfect competition

A market economy's desired structure is one of perfect competition. Although it offers a helpful framework to illustrate how an economy functions, it frequently differs significantly from the real economy. The value of a perfect competition model is only correct to the extent that it represents real-world circumstances, much like other models.

Narrow earnings margins are a significant characteristic of perfect competition. All customers have access to similar items. Therefore they inevitably look for the best deals. Businesses cannot differentiate themselves by charging more for superior goods and services.

The lack of creativity is another. Businesses are encouraged to innovate and produce better goods by the possibility of gaining a larger market share and differentiating themselves from the competition. In perfect competition, however, no company has a dominant market share; therefore, their activities have no long-term profitability.

The lack of economies of scale is another drawback. Companies will have less money to spend on increasing their production capacity if profit margins are limited to zero. Increased production capacity may result in lower consumer prices and business profit margins. However, several small businesses competing for the same market share prevent this from happening and ensure that the average company size stays modest.

Monopoly vs perfect competition

A monopoly, in which one business controls the supply of a particular good, is the reverse of perfect competition. When there is a monopoly, customers who feel that the cost is overpriced can only choose not to purchase the good. It implies that the monopolistic corporation may establish a price point that optimizes its profits rather than base pricing on supply and demand. Certain business models are natural monopolies because they have a sizable first-mover advantage that deters rivals from joining the market. Other monopolies could be created by the government or by cartels.

Perfect competition scenarios

As previously stated, perfect competition is a theoretical idea that does not exist. As a result, it is challenging to identify examples of ideal competition in daily life. However, there are some variations.

Produce

Consider what happens in a farmer's market when many small sellers and purchasers exist. From one farmer's market to another, items and pricing usually don't change significantly. There is virtually slight variation in how produce is packed or marketed, and it does not matter how it is grown (unless it is considered organic). Therefore, the average pricing won't change even if one of the farms supplying commodities for the market closes.

Technology

In some ways, the growth of new industries in the technology sector is similar to perfect competition. For instance, during the very beginnings of social media networks, there were a large number of websites providing comparable services. These websites include Asianave.com, Blackplanet.com, and Sixdegrees.com. The majority of the sites were free, and none of them had a significant market share. They were the market's vendors, and the purchasers were the users of these websites, primarily youthful individuals. Due to the low beginning costs for businesses in this industry, startups, and established businesses can readily join and depart these marketplaces.

Knockoffs

Product knockoffs typically have comparable prices and nothing that sets them apart. If one of the businesses producing such a product falls out of business, a different company steps in to take its place.

Supermarkets

The scenario may also be very comparable in the instance of two rival supermarkets that supply their aisles from the same group of businesses. Once more, there are little differences between the items at the two stores, and their prices are essentially the same. The market for unbranded goods, which offers less expensive variations of popular brands, is another illustration of perfect competition.

Perfect competition most asked questions

What sets perfect competition apart from the imperfect competition?

Imperfect competition may be seen in monopolies and real-world instances, whereas perfect competition is an idealistic market system where equal and identical items are sold. For example, imperfect competition entails businesses vying for market share, significant entry obstacles, and consumers who lack comprehensive knowledge of a good or service. Contrary to ideal competition, this fosters innovation and produces better goods and higher profit margins due to supply and demand.

Conclusion

A hypothetical market environment where all customers can access the same goods and information is described as having perfect competition. Every business in this economy must provide the lowest price feasible or run the danger of being undercut by rivals. Despite being simply a theoretical model, perfect competition helps to illustrate how economic players operate in a free market.