Perfect Competition Definition
Perfect competition is a type of market where there is an extensive number of buyers and sellers and all of them initiate the buying and selling mechanism and there are no restrictions and there is an absence of direct competition in the market and it is assumed that all the sellers are selling identical or homogenous products.
Explanation
In economics, perfect competition is a theoretical market structure where direct competition does not exist between firms or sellers because a large number of sellers (also buyers) are present in the market that all simultaneously sell an identical product at the market price. Thus each seller has a very small share in the market with negligible control over market prices.
Perfect competition is considered to be the ideal market scenario as it allocates the available resources in the most efficient way and thus also referred to as pure competition.
Note: The important point to note from the above definition is that perfectly competitive market structures do not actually exist in the real world. In economics, it is used as a benchmark to make a comparative analysis with real markets.
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Example
There are no real-world examples for perfectly competitive markets but the nearest approximations may include agricultural markets. Like a large number of farmers producing similar crops say wheat or mango.
Another example may include street food vendors. Various vendors (sellers) exist who are selling almost identical (homogeneous in nature) products e.g. burgers. The consumer has full information about the product (burger here) and its prices, let’s say a burger costs around $5. A vendor cannot sell his burgers at higher prices (i.e. has negligible pricing power). Customers are free to purchase their burgers from any vendor of their choice. Also, barriers to enter and exit for vendors in the market are virtually negligible, hence competition is very high.
Characteristics of Perfect Competition
Here is the list of characteristics of Perfect Competition –
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#1 – Large Market
A large population of buyers and sellers are present in the market. Sellers are unorganized, small or medium enterprises owned by individuals. However, a large number of both seller and buyer maintain the constancy of the demand and supply chain in the market. I.e. buyer can easily substitute firms to buy its product and seller also have a large availability of buyers.
#2 – Homogeneous Market
Firms sell identical products with similar features and pricing, hence buyer is not able to differentiate between available products based on features and generally has no preference to select a particular product or seller over others.
#3 – Freedom to Enter or Exit the Market
In perfect competition, the startup cost and cost of production are very less and the demand for products is high, thus entry into the market is easy. In case some enterprise incurs losses and survival in the market become difficult due to the heavy competition then it is free to exit and other players’ take their place to fulfill the supply requirements.
#4 – Lower Restrictions and Obligations from Governments
For sellers, governmental barriers are less. Sellers are allowed to freely sell their products in the market. Similarly, buyers are also free to buy goods and services offered by sellers. Prices are not regulated but fluctuate according to demand and supply chain.
#5 – Perfect Information Availability
Sellers have full market knowledge like required costs, technological requirements, marketing tactics, and levels of supply as per demands in the market. The buyer is fully informed about the availability of products, its features, quality, and prices. Hence manipulating the market by either party is not possible.
#6 – Cheap and Efficient Transportation
Transportation is a very important part of every business and in a perfectly competitive market the cost of transportation for the seller is low and thus the product prices decrease. Also, efficient transportation is easily available cause a reduction in delays to transport goods.
Perfect Competition vs Monopoly
To better understand perfect competition, we refer to a popular market structure called a monopoly. A monopoly is theoretically opposed to the perfect competition which is characterized by a single seller of a product with no close substitutes. Monopoly provides full power over prices and consumers cannot shift to another seller in case of price rise because there might be no other option available. High barriers to entryHigh Barriers To EntryBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more and exit results in negligible competition. E.g. Intel in the microprocessor industry has a 90% market share.
Let us compare the key characteristics of Perfect Competition and Monopoly
| Basis | Perfect Competition | Monopoly |
|---|---|---|
| Number of Sellers | A large Number of Firms | Single Firm |
| Barriers to Entry | Very Low | Very High |
| Nature and availability of Substitute Products | Very good substitutes are readily available | No good substitutes are available |
| Firms compete through | Prices only | Product features and quality, advertising, and marketing. |
| Pricing Power | Negligible. Dependent on demand and supply | Significant. Companies can manipulate prices as they want |
Advantages
The following are the advantages of perfect competition
- Perfect competition markets are theoretically ideal market structures.
- Perfectly Competition market structures are consumer-oriented. It is said that “consumer is the king” in such market situations. Consumers have readily available substitutes for both products and sellers and can easily switch to others if required.
- Sellers have no pricing power as in the case with a monopoly market and the whole control of pricing remains under demand and supply chain. Thus probability to exploit consumers becomes negligible.
- The product features, quality, and rate remain similar everywhere for perfectly competitive products. E.g. quality and rates of toothpaste in New York City or South Dakota remain almost same and consumer everywhere gets standardized products.
- In perfect competition start-up costs, cost of production, advertising, and marketing costs all are very low. Thus entry, production, and sales get easy for the seller.
Disadvantages
The following are the disadvantages of perfect competition
- The biggest disadvantage of perfect competition is that being the most ideal market structure, it is just a hypothetical or theoretical concept of economics with negligible existence in the real world.
- Sellers can not add value to their product because adding value or features to the products does not increase prices which are fully determined and controlled by demand and supply system. Hence cost to seller increases but revenue remains the same and ultimately profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more decreases. If sellers increase their prices for better products, consumers may get shifted to other sellers or consider other products.
- Heavy competition is another disadvantage for sellers due to low barriers and high freedom to entry and exit. I.e. anytime a new player can enter the market and starts offering similar products or services to the consumer at similar rates.
- Existing sellers always have an advantage over new players because they are well established in the market, created goodwillCreated GoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more among suppliers and consumers, are located at prime locations. But new sellers have to struggle and sometimes incur losses and ultimately thrown out of the market.
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