What is perfect competition?

In economics, perfect competition is a theoretical market structure in which there is no direct competition between firms or sellers because there are a large number of sellers (also buyers) present in the market simultaneously selling an identical product at the market price. Thus, each seller has a very small share of the market with negligible control over market prices.

Perfect competition is considered to be the ideal market scenario as it allocates available resources in the most efficient manner and is therefore also called as pure competition. However, the important point to note from the above definition is that perfectly competitive market structures do not exist in the real world. In economics it is used as a reference to carry out a comparative analysis with real markets.

History of perfect competition

Early economists such as Adam Smith and David Ricardo proposed the notion that we now call perfect competition, seeing it as the ideal to which an economic system should aspire. In the late 18th and early 19th centuries, when these and other classical economists were writing, government intervention, especially in matters of international trade, openly restricted the functioning of supply and demand.

If the government refrained from manipulating the economy, if buyers and sellers were aware of the markets in which they participate, and if those markets allowed buyers and sellers to interact freely, then no seller or buyer acting alone should be able to affect the trading system. prices.

The practical limitations of this early model of perfect competition became apparent in the mid-19th century, when large firms and combinations of firms, seeking profit without any government interference, were able to dominate their industries and structure markets for their own benefit.

Unions—worker organizations that were able to appeal for better working conditions more effectively than individual employees—also sprang up during this time, further complicating any hope that perfect competition could occur naturally.

In the late 19th and early 20th centuries, governments began to move to restrict companies that monopolized their industries and took advantage of workers and consumers, partly in an attempt to create more competition in the economy.

Despite clear evidence that markets were actually far from perfectly competitive, the leading economists of the 19th and 20th centuries continued to base most of their theories on ideas about how markets behaved under conditions of perfect competition.

The idea retained its theoretical power in part because it was easier to theorize about markets under conditions of perfect competition than about imperfect, disorderly, and unpredictable markets. But economists continue to study and teach theories about perfectly competitive markets because, although these theories are based on a simplified idea of competition, they can shed light on many complex economic questions.

Characteristics of perfect competition

big market

A large population of economic agents, as suppliers and applicants, are present in the market. The sellers are unorganized, small or medium-sized companies, owned by natural persons. However, a large number of sellers and buyers maintain the constancy of the supply and demand chain in the market. That is, the buyer can easily substitute companies to buy their product and the seller also has a large availability of buyers.

Homogeneous market

Companies sell identical products with similar features and prices, therefore the buyer cannot differentiate between available products based on features and generally has no preference in selecting a particular product or vendor over others.

Freedom to enter or exit the market

In perfect competition, the initial cost and production cost are very low and the demand for products is high, so market entry is easy. In case any company incurs losses and survival in the market becomes difficult due to strong competition, then it is free to exit and other players take its place to meet supply requirements.

Lower restrictions and obligations of governments

For sellers, government barriers are lower. Vendors are free to sell their products on the market. Similarly, buyers are also free to purchase goods and services offered by sellers. Prices are not regulated, but fluctuate based on demand and the supply chain.

Perfect availability of information

The sellers have complete knowledge of the market such as required costs, technology requirements, marketing tactics, and supply levels as per market demands. The buyer is fully informed about the availability of the products, their characteristics, quality and prices. Therefore, it is not possible to influence or manipulate the market by either party.

Economic and Efficient Transportation

Transportation is a very important part of any business and in a perfectly competitive market the cost of transportation for the seller is low and therefore the prices of the products decrease. Furthermore, efficient transportation is readily available and reduces delays in the transportation of goods.

Perfect Competition vs Monopoly

To better understand perfect competition, one must refer to a popular market structure called a monopoly. A monopoly is theoretically opposed to perfect competition characterized by a single seller of a product with no close substitutes.

The monopoly gives full power over prices and consumers cannot switch to another seller in the event of higher prices because no other option may be available. High barriers to entry and exit result in negligible competition. Some examples are Microsoft, Apple, PDVSA, AENA, among others.

Advantages of perfect competition

The following are the advantages of perfect competition:

Perfectly competitive markets are theoretically ideal market structures. Perfectly competitive market structures are consumer oriented. Consumers have readily available substitutes for both products and sellers and can easily switch to others if necessary.

That is to say, there are not few participants, but on the contrary, there are several; which represents for the consumer an economic advantage and other benefits.

Sellers have no power to influence price, as in a monopoly market, and all control of prices remains with the demand and supply chain. Therefore, the probability of exploiting consumers becomes negligible.

Product features, quality, and rate remain similar everywhere for perfectly competitive products.

In perfect competition, start-up costs, production costs, advertising, and marketing costs are all very low. Thus, entry, production and sales become easy for the seller.

Disadvantages of perfect competition

The following are the disadvantages of perfect competition:

The biggest disadvantage of perfect competition is that, being the most ideal market structure, it is only a hypothetical or theoretical concept of the economy with negligible existence in the real world.

Sellers cannot add value to their product because adding value or features to products does not increase prices, which are fully determined and controlled by the supply and demand system.

Thus, the cost to the seller increases, but the revenue remains the same, and ultimately the profit margin decreases. If sellers increase their prices for better products, consumers may switch to other sellers or consider other products.

Strong competition is another disadvantage for sellers due to low barriers and great freedom of entry and exit. That is, every time a new player can enter the market and start offering similar products or services to the consumer at similar prices.

Existing sellers always have an advantage over new competitors because they are well established in the market, have created goodwill between producers and consumers, and are located in prime locations. But new sellers have to struggle and sometimes incur losses and are ultimately driven out of the market.