Perfect competition
Perfect competition is an
economic model that describes a hypothetical
market form in which no producer or consumer has the
market power to influence
prices. According to the standard economical definition of efficiency (
Pareto efficiency), perfect competition would lead to a completely efficient outcome. The analysis of perfectly competitive markets provides the foundation of the theory of
supply and demand.
Perfect competition requires that the following five parameters be fulfilled. In such a market, prices would normally move instantaneously to
equilibrium. However, perfect competition does not rule out
economic bubbles, in which the concept of equilibrium prices is not meaningful.
; Atomicity: An
atomistic market is one in which there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are
price takers, meaning that the market sets the price that they must choose.
Homogeneity: Goods and services are perfect substitutes; that is, there is no product differentiation.; Perfect and complete information: All firms and consumers know the prices set by all firms (see
perfect information and
complete information).
Equal access: All firms have access to production technologies, and resources (including information) are perfectly mobile.; Free entry: Any firm may enter or exit the market as it wishes (see
barriers to entry).
 |
Perfect competition: The horizontal demand curve touches the average total cost curve at the lowest point (see cost curve). |
The model is in most cases only a distant approximation of real markets, with the possible exception of certain large street markets. In general, few, if any of the conditions listed above will apply in real markets. For example, firms will never have perfect information about each other, and there will always be some transaction costs. In a perfectly competitive market, there will be both
allocative efficiency and
productive efficiency.
* Allocative efficiency occurs when price (P) is equal to
marginal cost (MC), at which point the good is available to the consumer at the lowest possible price.
* Productive efficiency occurs when the firm produces at the lowest point on the average cost curve (AC), implying it cannot produce the goods any more cheaply. This would be achieved in perfect competition, since if a firm was not doing it another firm would be able to undercut it by selling products at a lower price.
In contrast to a
monopoly or
oligopoly, it is impossible for a firm in perfect competition to earn
abnormal profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its costs. If a firm is earning abnormal profit in the short term, this will act as a trigger for other firms to enter the market. They will compete with the first firm, driving the market price down until all firms are earning normal profit. On the other hand, if firms are making a loss, then some firms will leave the industry, reduce the supply and increase the price. Therefore, all firms can only make
normal profit in the long run.
Some say that
agriculture, with a large amount of suppliers, and almost perfectly substitutable products, is an approximation to the perfect competition model. This may have been true in some places at certain times, but in modern economies the assertion is generally not true. For example, in the
global agriculture market, agricultural
subsidies are provided to
U.S. farmers, and to
European farmers via the
Common Agricultural Policy, whose products are exported (
dumped) at prices below the cost of production. Government intervention such as subsidies warps the market, meaning that perfect competition does not occur. In addition, buying a farm (or even renting one, together with equipment) is a rather substantial barrier to entry, which contradicts the perfect competition model.
Perhaps the closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. By design, a
stock exchange closely approximates this, though there is no way to guarantee atomicity (or even approach it). As perfect competition is a theoretical absolute, there are no real-world examples of a perfectly competitive market.
*
Imperfect competition*
Microeconomics*
Bertrand competition*
Cournot competitionPerhaps a more ideal example of a perfectly competitive market would be the area of web design.
* Luis M. B. Cabral.
Introduction to Industrial Organisation, Massachusetts Institute of Technology Press, 2000, page 84â€"85.
