essay about perfect competition

Perfect Competition as a Market Structure

Introduction.

A market or an industry is said to be competitive depending on the key market players, that is, suppliers and consumers. The number of suppliers seeking the demand of consumers in the market determines the competition in the market. The other factor that determines the competitiveness of a market is the barriers to entry and exit into the market in the long run.

The nature of competition in the market depends on the number of buyers and sellers in the market such that when both are many, the market assumes a perfect competition nature or monopoly if there is only one seller. The difference between the two extreme market structures is that industries operating in a purely competitive market have no power to set prices, and therefore, they operate at the prevailing price in the market.

On the other hand, a firm operating in a pure monopoly market enjoys full power to determine the price they charge in the market. A perfectly competitive market or perfect monopoly may be nonexistent in real-world markets, but they are very useful in gauging the level of competition in any given market.

The Meaning of Perfect Competition

According to Aumann (1996, 7), Perfect competition is a market structure that assumes the optimum allocation of resources. The market is theoretical and nonexistent in real life. A perfectly competitive market is defined as a market structure in which there are many buyers and sellers such that no one has the power to set or control market prices.

Firms operating in a competitive market are price takers as they operate on the price that is prevailing in the market. There is no competition concerning price. The competition is determined by the quality of the products sold by a particular seller and the preferences of the buyers.

Characteristic of Perfect Competition

A market is considered to have perfect competition if it is characterized by a number of factors. Firstly, all parties in the market have perfect knowledge of the products offered in the market and the prices attached to them. Secondly, there are many buyers and sellers in the market, and therefore no one is obligated to set the prices, but all take the prevailing price (CliffsNotes, 2010, p. 1). Market entry is also free such that firms could join or leave the market any time they decide, depending on the prevailing condition.

The suppliers can sell as much as they can in the market but only at the market price. They have no authority to make prices. There is also a homogeneity of products that are produced by the firms (Aumann, 1996, 7). There is no advertisement in the market because all parties are price takers, and products are perfect substitutes. The perfect knowledge of prices and products also makes advertisement unnecessary.

Normal and Supernormal Profits in Perfect Competition

Normal profits in perfect competition are earned when a firm reaches an economic equilibrium where average cost equals marginal revenue at the point where the firm maximizes profit (Stigler, 1987, 539). Marginal revenue, price, average cost, and marginal cost are always the same when the firms are at their optimum level of production. Normal profit is the profit that is just enough to enable the firm to continue producing and stay in business because it can cover its costs.

In case the average cost falls below the price, the firm earns a supernormal profit. This happens at a profit-maximizing output but does not occur in the long run. Any amount of profit that exceeds the normal profits is categorized under supernormal profits and is earned in the short run.

Short and Long Run Perfect Competitor Price/Output Diagrams

In the short run, there may be high demand for commodities in the market. This causes the increase in the price of the commodities above the average cost making the firm earn supernormal profits. This attracts many firms into the industry/market. This shifts the supply level in the market higher, causing the price to go down (Aumann, 1996, 7).

The profit earned by the new and the existing firms reduces, thus completing away the supernormal profits. The firm can also earn supernormal loss in the short run if the average cost increases above the price. The situation will be corrected when new firms will leave the market, causing supply to go down.

Based on the diagrams above, we see that it is possible for a firm to earn normal and supernormal profits. In the first diagram, the average cost is below the price, meaning that the firm can make a supernormal profit that is equivalent to the shaded region. This can be represented by Q* (a – b) .

The firm is also earning a normal profit at the point where P=MR=MC . This is the equilibrium level of the firm where normal profits are experienced at the point where marginal cost = marginal revenue at the minimum point of the average cost, as shown in the second diagram.

Perfect Competition and Public Interest

The perfect competition will have a great impact on public interest in some respects. For example, consumers may end up getting poor-quality products or services at high prices.

There is also a lack of product variety, showing that consumers have low sovereignty in choosing what best suits them. This is due to the lack of product differentiation. Poor quality is contributed by the fact that there is no competition concerning commodity design and specification because the price in the market is the same.

Allocative and Productive Efficiency

A firm is said to be efficient if it attains the optimum production level and also the optimum distribution of scarce resources (CliffsNotes, 2010, p. 1). Allocative efficiency in perfect competition occurs when the firm distributes goods and services according to the consumers’ preferences. It occurs at the point where P=MC , that is, price equals marginal cost.

Productive efficiency, on the other hand, occurs when a given amount of inputs produces a maximum volume of commodities. In this case, the output is achieved at minimum average cost and can occur in the long or short run. In this diagram, both allocative and productive efficiency is achieved at the point (Q, P), where P=MC=AC . At this point, AV (average cost is at its minimum) means that productive efficiency is achieved. Allocative efficiency is also achieved at the same point because of P=MC (price = marginal cost)

Perfect competition as a market structure does not exist in a real market situation. However, its characteristics are very useful in measuring the nature of competition in other market structures like an oligopoly, monopsony, et cetera.

Reference List

Aumann, R. J., 1996. Existence of Competitive Equilibrium in Markets with a Continuum of Traders. Econometrical , V. 34, N. 1 (1966): pp. 1-17.

CliffsNotes. 2010. CliffsNotes.com. Conditions for Perfect Competition . USA: Wiley Publishing, Inc. Web.

Stigler, J. G. , 1987. Competition, The New Palgrave: a Dictionary of Economics , First edition, vol. 3, pp. 531–46.

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Perfect competition

Perfect competition is a market structure where many firms offer a homogeneous product. Because there is freedom of entry and exit and perfect information, firms will make normal profits and prices will be kept low by competitive pressures.

Features of perfect competition

• Many firms.
• Freedom of entry and exit; this will require low sunk costs.
• All firms produce an identical or homogeneous product.
• All firms are price takers, therefore the firm’s demand curve is perfectly elastic.
• There is perfect information and knowledge.

Diagram for perfect competition

• The industry price is determined by the interaction of Supply and Demand, leading to a price of Pe.
• The individual firm will maximise output where MR = MC at Q1
• In the long run firms will make normal profits.

What happens if supernormal profits are made?

If supernormal profits are made new firms will be attracted into the industry causing prices to fall. If firms are making a loss then firms will leave the industry causing price to rise

The features of perfect competition are very rare in the real world. However perfect competition is as important economic model to compare other models. It is often argued that competitive markets have many benefits which stem from this theoretical model.

Changes in long run equilibrium

1. The effect of an increase in demand for the industry.

If there is an increase in demand there will be an increase in price Therefore the demand curve and hence AR will shift upwards. This will cause firms to make supernormal profits.

This will attract new firms into the market causing price to fall back to the equilibrium of Pe

2. An increase in firms costs

• The AC curve will increase therefore AR< AC
• Firms will now start making a loss and therefore firms will go out of business. This will cause supply to fall causing prices to increase.

Efficiency of perfect competition

• Firms will be allocatively efficient P=MC
• Firms will be productively efficient . Lowest point on AC curve.
• Firms have to remain efficient otherwise they will go out of business. ( X-efficiency )
• Firms are unlikely to be dynamically efficient because they have no profits to invest in research and development.
• If there are high fixed costs , firms will not benefit from efficiencies of scale.
• see more: efficiency of perfect competition

Examples of perfect competition

In the real world, it is hard to find examples of industries which fit all the criteria of ‘perfect knowledge’ and ‘perfect information’. However, some industries are close.

• Foreign exchange markets . Here currency is all homogeneous. Also, traders will have access to many different buyers and sellers. There will be good information about relative prices. When buying currency it is easy to compare prices
• Agricultural markets . In some cases, there are several farmers selling identical products to the market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect competition.
• Internet related industries . The internet has made many markets closer to perfect competition because the internet has made it very easy to compare prices, quickly and efficiently (perfect information). Also, the internet has made barriers to entry lower. For example, selling a popular good on the internet through a service like e-bay is close to perfect competition. It is easy to compare the prices of books and buy from the cheapest. The internet has enabled the price of many books to fall in price so that firms selling books on the internet are only making normal profits.

Related pages

• eBay and perfect competition
• Different types of market structure

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Microeconomics

Course: microeconomics   >   unit 7.

• Introduction to perfect competition
• Perfect competition and why it matters
• Economic profit for firms in perfectly competitive markets
• How perfectly competitive firms make output decisions

Efficiency in perfectly competitive markets

• Perfect competition foundational concepts
• Long-run economic profit for perfectly competitive firms
• Long-run supply curve in constant cost perfectly competitive markets
• Long run supply when industry costs aren't constant
• Free response question (FRQ) on perfect competition
• Perfect competition in the short run and long run
• Increasing, decreasing, and constant cost industries
• Efficiency and perfect competition
• Long-run equilibrium in perfectly competitive markets meets two important conditions: allocative efficiency and productive efficiency.
• These two conditions have important implications. First, resources are allocated to their best alternative use. Second, they provide the maximum satisfaction attainable by society.

Self-check questions

Review questions.

• Will a perfectly competitive market display productive efficiency? Why or why not?
• Will a perfectly competitive market display allocative efficiency? Why or why not?

Critical-thinking questions

• Assuming that the market for cigarettes is in perfect competition, what do allocative and productive efficiency imply in this case? What do they not imply?
• In the argument for why perfect competition is allocatively efficient, the price that people are willing to pay represents the gains to society and the marginal cost to the firm represents the costs to society. Can you think of some social costs or issues that are not included in the marginal cost to the firm? Or some social gains that are not included in what people pay for a good?

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Free Markets, Perfect Competition and Globalization Essay

Any time we talk about perfection, we present ourselves with a big problem. This is especially because we are living in a world that has so much been tainted by human selfishness that it is almost impossible to attain perfection especially in the business field. Nevertheless, we can talk about perfect competition in business by considering several parameters. Generally, perfect competition can be said to occur when there is no participant involved in the business that has power to influence the market. In this kind of a scenario, no one has the power to influence the price or the quality of goods or services provided on the market. The market should be governed only by demand and supply which is not influenced or controlled intentionally by anyone.

Several determinants can be used to describe a perfect market. Some of those determinants include the following. One, there should exist a very large number (almost infinite) of buyers as well as sellers. Two, there should be no barriers that can prevent someone from entering or leaving the market. Besides, every participant in the market should have all the information that is needed to participate in the market. It is also important that there should be no costs incurred in transaction processes. Another characteristic that can be seen in a perfect market is the presence of products with similar characteristics and quality.

A stock market is a classic example of perfect competition provided firms do not influence the price of stocks intentionally. This market has an infinite number of buyers and sellers apart from exhibiting all the other characterized of a perfect market model. Another example of a perfect market can be seen in third world countries food market in the streets. This market has a large number of buyers and sellers, has no entry and exit barriers and has products with similar quality and characteristics among other desirable characteristics displayed in perfect competition.

Globalization, which is the integration of global economies and markets, is affecting competition significantly. A perfect way to look at how globalization is affecting markets is by looking at trade agreements like NAFTA that allow goods to move across borders tax free as markets are merged. One result of these agreements is unfair competition especially to poorer countries where producers as farmers in countries like the United States are given government subsidies. This makes it impossible for their counterparts in other countries to compete with them. This has for example led to loss of jobs for farmers in Mexico and other countries.

Globalization can avail a larger market of buyers and sellers scattered all over the globe. This can help to create jobs, expand economies and generally reduce poverty. For example, some world countries have really benefited from agreements like AGOA, which has allowed goods produced in third world countries to reach developed economies. On the other hand, emerging economic powerhouses like China and India are growing rapidly as a result of opening to the global economy. Globalization can therefore avail better prices for producers and expand markets for people all over the world expanding the global economy in general. Producers all over the globe can therefore compete fairly. This however depends on the model of globalization that the world is adopting, as has been seen, trade agreements like NAFTA are really hurting producers in developing nations.

Perfect competition is elusive in our world today. This can however be achieved by structuring globalization in such a form that it allows perfect competition to occur. As has been seen, globalization in itself provides some requirements for a perfect market like an infinite number of sellers and buyers. However, other requirements like market influence for example need to be worked on.

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IvyPanda. (2021, December 12). Free Markets, Perfect Competition and Globalization. https://ivypanda.com/essays/perfect-competition-and-globalization/

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IvyPanda . 2021. "Free Markets, Perfect Competition and Globalization." December 12, 2021. https://ivypanda.com/essays/perfect-competition-and-globalization/.

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Bibliography

IvyPanda . "Free Markets, Perfect Competition and Globalization." December 12, 2021. https://ivypanda.com/essays/perfect-competition-and-globalization/.

• The International Free Trade in NAFTA Countries
• NAFTA's Effects on the US-Mexico Border Economy
• North American Free Trade Agreement (NAFTA)
• The NAFTA Treaty Between the US and Mexico
• The Impact of NAFTA on the United States
• Pat Buchanan and Ralph Nader: Agreements on NAFTA
• North American Free Trade
• North American Free Trade Agreement and the EU
• Trucking provisions in NAFTA
• Mexican Economy and North American Free Trade Agreement
• Effects of Global Networks of Global Commodity Exchange
• Global Integration: Globalization Effects and Access to Funds
• Globalization a Dynamic Force in International Business
• MNCs in Asia Have Been Engaged With SMEs of the Host Countries
• World Dynamics: Globalization of Global Economies

Understanding Perfect and Imperfect Competition

Alexandra L.

Checked : T. M. H. , Luis G.

Latest Update 20 Jan, 2024

12 min read

Table of content

Perfect competition

How does the perfect competition work, large, homogeneous markets, perfect information, no controls, transportation is cheap and efficient, example of a perfectly competitive market, do perfect competition models have disadvantages, imperfect competition.

Perfect competition is a thought of microeconomics that looks at a market system where market forces have a monopolistic control. As long as these forces are met, the market is said to be in perfect competition. But, there has been no market that clearly defines ideal competition. In the real world, getting forces that work in perfect control is not possible; hence, all markets are classified as imperfect. A perfect market is simply a standard that measures how practical and real-world markets operate.

In   microeconomics , the study of perfectly competitive and not perfectly competitive markets is paramount. The subject affects most of the aspects of a real market in the economy, including decision making, supply, demand, pricing, and many other variables as you may already know, microeconomics one of the two major branches of economics and deal with the study of decisions made by individuals and firms. We are all faced with choices in our daily life. When it comes to fulfilling personal needs, for instance, one must forego one thing to achieve the other. And as you will discover throughout this article, these decisions affect and are equally affected by the economy. We shall, therefore, be looking perfect and imperfect competition as principles of microeconomics.

Perfect competition is only theoretical. This means you will only read about a perfectly competitive market structure in books and texts, but you will never experience it in real life.

A market is said to be in perfect competition when:

• All the firms involved in the market sell an identical product. The product is said to be a ‘commodity’ or ‘homogeneous.’ Every player is aware of what they and others are giving to or getting from the market.
• The firms are price takers. Since they are selling the same product, they cannot influence the market price of their individual products.
• Market share does not influence the price. However, small or big a firm is, they share similar pricing with others. In any case, they are only price takers.
• Buyers have complete information. Perfect information means buyers already know the past, future, and present of the product being sold and what each firm is charging.
• There are entirely free resources for this information.
• There is no barrier to entry into or exit from the market.

In contrast to this, perfect competition is the imperfect competition where a market violates the abstract tenets of perfectly competitive environments. All markets exist beyond the boundaries of ideal competition; hence they are categorized as imperfect. The modern concept of imperfect vs. perfect competition comes from the Cambridge classical culture of post-classical economic thought.

As stated, completely perfect competition does not exist. However, markets like commodities, such as oil or wheat, are highly competitive and liquid. They are, therefore, the closes the world can get to perfectly competitive markets.

This market is considered an “ideal type” or a market that bears the comparison for real-market structures. Theoretically, perfect competition is the direct opposite of a monopoly. For the case of monopoly, there is only a single firm in charge of producing and supplying a product or service, and they can price it any way they want. The consumer has no alternative, and would-be competitors cannot enter the market.

In perfect competition, there is equilibrium between demand and supply. In other words, there are many buyers and sellers; hence the price is determined by these variables. Companies don’t reap much profit, but just enough to stay in business. Any attempt to gain excess profits will attract other firms in the market, driving profits even lower.

In a perfect competition setting, there is enough supply and demand. The sellers are mostly small companies, as opposed to large corporations that can control prices. The product has minimal differences in terms of capabilities, features, and prices. Hence, buyers cannot differentiate between the products by only looking at the physical appearance like size and color or intangible values like the brand. And because there is a large population of both buyers and suppliers, supply and demand remain fairly constant within the market. Also, a buyer has a chance to substitute specific products from one firm for another's easily.

People and firms make decide based on available information. And in this case, there is information about the ecosystem and competition in a market that creates a significant advantage. For example, when there is knowledge about component sourcing and supplier pricing, individual firms may grow faster. Information about patents and researcher plans can have companies in pharmaceutical and technology initiate strategies that beat their competition.

Such issues are not in a perfectly competitive market. This is because the information is equally and freely available. This means, every firm produces its goods and serves at precisely the same rate and using the same techniques as the other companies in the same market.

In many instances, governments play a significant role in market systems. They impose regulations and price controls that shield both suppliers and consumers. Hence, they can control how firms enter or exit the markets. For instance, there are laws governing how the pharmaceutical industry does its research, product, and sale of drums.

These rules call for hefty capital   investments, including employees such as legal advisors and quality assurance, as well as infrastructure like machinery. When the costs are put together, it becomes costly for a company to bring a drug on the market.

The technology industry, on the other hand, works with less oversight. This means starting a company in technology is much easier and cheaper, and doing so in the pharmaceutical industry.

In a perfectly competitive environment, these controls do not exist. There is no restriction on how firms enter and exit the market.

In perfect competition, there are no issues with transport. Companies do not pay a lot for transport. As such, they can reduce the production costs as well as cut back the delays on transportation.

A perfectly competitive market is theoretical. Hence, finding an excellent example of real-life is not easy. But there are variants in the society that may bring out something close to perfect competition.

Think of a farmers’ market. Here, you will find many small buyers and sellers. There is often very little difference between their products, prices, and what others are selling. There is even no difference in the branding and packaging of the products. Thus, if one farm goes out of business, it may not leave any impact on the average price of the markets.

Also, consider supermarkets. In many cases, they stock the aisles in the same way from a set of companies. They all sell the same products, with little to no difference, including packaging, branding, and pricing.

Consider also the market for unbranded products. They are only cheaper versions of well-known products, and there no added value. Hence they retail at the same prices with no major differences generally.

Technology has also created another category of perfectly competitive markets. For instance, you will find all types of e-commerce sites offering similar products. Mostly, it is all about what they are selling. The internet is free and largely available; entry and exit are easy.

From an idealistic point of view, the perfect competition offers the perfect framework for the market establishment. However, the market is full of flaws and disadvantages. For instance, there is a lack of innovation. Firms are motivated to create better products and set themselves apart as an incentive to gain a more significant market share. For in perfect competition, a firm can possess dominance, hence no need for playing smart.

Demand and supply draw for fixed profit margins. Hence, a firm cannot charge premiums for their products and services. In such an environment, it would be very difficult for a company like Apple Inc to survive. Their phones are pricier than the competition.

This section introduces the student to how monopolies form (and) barriers to entry, the impact of output and price on profit-maximization, and monopolistic competition.

Before we go further, let's step back a bit into the history of monopoly. In 1773, one firm, East India Company, was on the verge of a big fail. It was going through a hard time for financial difficulties. But the British Parliament came to save the failing company by introducing the Tea Act. The law continued taxing tea and made the East India Company the only recognized tea supplier to American colonies. This step gave them legal monopoly power. But by November the same year, Boston citizens couldn’t take anymore. They refused tea unloading, stating, “no taxation without representation.” To cut the story short, things did not go very well.

A similar situation happened on the eve of the American Civil War in 1860 with the U.S cotton industry. The South was considering receding from the Union; hence they hoped to leverage on Britain imported coffee. But cotton –merchants refused to export their cotton; hence failing what was termed as “The King Cotton” strategy in 1861. Britain opted to other sources, but this affected the confederacy’s gold supply.

What we learn here is that monopoly sellers often don’t see a threat to their positions in the market. But it is all about the attribute of imperfect competition markets.

As we have learned above, a perfect competition environment is where no firm has market power. They only respond to market prices and changes. A monopolistic market is the opposite, where there is no competition at all. There is only one producer on the market, and they are responsible for changing the prices as they want. The consumer has no choice but to accept what they are given.

It is, however, important for a monopoly on being concerned about how the consumers will purchase their products. However, a monopolist never has to worry about the actions of other firms. They are not price-takers, as we saw with perfect competition.

In imperfect competition, the market violates tenets of the perfect competition. In other words, it allows some firms to have a stronger command on the market than others. It is an economic market that ignores the standards of purely competitive markets.

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In this case, companies come up with different products and services. They set their own price, and each fight for market dominance. Apart from monopolies, they are also found oligopolies, monopolistic, monopsonies, and oligopsonies.

A single-priced monopoly is a situation where a company must charge the same price to all consumers. In this case, the company majorly relies on aggregate demand.

Consider Oakley, Ray-Ban, and Persol sunglass companies. They are all owned by Luxottica, an eyewear company based in Italy that makes about 70% of all brand eyewear. This means the company dominates the market. But it is not a single-price monopoly. This is major because it bears different brands targeting different consumers; hence, they practice a form of price discrimination. If the company sold only a single category of glasses, they would have to sell at the same price, even if they owned 100% of the market. If they decided to lower the price, it would have to be for all consumers, and that would have a huge impact on their revenue. In a monopoly, price reduction leads to losing revenue, and the more sales they make, the greater the loss.

One of the drawbacks of imperfect competition is government intervention. Well, this may not be a limitation per se, considering that government regulations can help correct monopoly. They set policies that increase the quantity. But as we may already know taxes and price floors negatively affects quantity, which they will not work here. A subsidy, on the other hand, would increase market surplus, but it would be very difficult to implement. Perhaps the only option for this situation would be the price ceiling. Thus it will be reasonably applicable in reducing the deadweight loss. The most important thing here is sustaining the market equilibrium while protecting the consumers and the firm.

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Essays on Perfect Competition

Perfect competition in microeconomics: theory, main characteristics, and horizontal demand curve, market structure: perfect competition, oligopoly, and monopoly, perfect competition market versus monopolistic and oligopolistic competition, top similar topics.

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Perfect Competition Notes & Questions (A-Level, IB)

Relevant Exam Boards: A-Level (Edexcel, OCR, AQA, Eduqas, WJEC), IB, IAL, CIE Edexcel Economics Notes Directory | AQA Economics Notes Directory | IB Economics Notes Directory

Perfect Competition Definition: A market with Perfect Competition is defined as having an unlimited number of buyers and sellers, perfect information (eg. with regards to product pricing of all firms), no barriers to entry or exit, and all firms sell homogenous (the same) goods.

Perfect Competition Examples & Explanation: If you are one of many Ebay stores selling the same unbranded masks online during the Coronavirus epidemic , you are likely to charge a very similar market price. This is because if you sell at a higher price, consumers will buy from other stores. Hence, you are a price taker in the market. As a result, you will sell each mask for the same price to the unlimited number of buyers out there, causing your average and marginal revenues to be the same. As consumers have visibility over most stores and their listing prices, they have near perfect information of the market. There are also little to no barriers to entry/exit in the market, as it is extremely easy to set up or close a store on Ebay to sell masks. Perfect competition is the only market structure that has allocative efficiency by default, when compared to monopolistic competition , oligopoly or monopoly , where competition is imperfect. However, this form of market structure is unlikely to exist in reality due to its extreme competition and assumptions. Therefore, it is more of an Economic model for theoretical than practical purposes. Another close example is the currency exchange market where the service provided by firms is highly similar.

Perfect Competition Economics Notes

Perfect competition video explanation – econplusdal.

The left video explains the perfect competition market structure, the right illustrates perfect competition in the short-run.

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Perfect Competition Essay Examples

Critical review of perfect competition in markets with adverse selection.

The article “Perfect Competition in Markets with Adverse Selection” by Eduardo M. Azevedo and Daniel Gottlieb discusses the concept of competition within the market. Some of the unique characteristics of competitive markets include a large number of producers that rival each other in meeting the...

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Economic competition is one of the most important factors in which businesses can have an effect on one another and the economy. It involves competitiveness or rivalry among sellers to try to acquire more money and sell the best product; with the best quality. Due...

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• Brand Management Essays
• Marketing Strategy Essays
• Customer Essays
• Target Market Essays
• Marketing Plan Essays

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