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Perfect Competition: Categories and Uses

Sangita Kalita
Jul 19, 2022

“Perfect competition is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand.”

- Peter Thiel

As more businesses have entered the market and are experiencing economic success, competition will continue to grow. Firms will begin to leave the market if they start to suffer financial losses.

Perfectly competitive marketplaces at one point of time will reach long-run equilibrium when there are no new firms that are seeking to enter the market and no existing firms that are seeking to exit it, as long as economic profits are reduced to zero. In this blog, you will learn more about Perfect Competition.

In a market system where perfect competition exists, several businesses sell similar goods while making little profit due to the intense competition. With that said, it's important to understand that the concept of perfect competition is a theoretical one that is intended to contrast with the actual markets.

Although perfect competition is predicted on a variety of hypotheses that hardly ever comes true in reality, there are comparable cases.

Also Read | Simple Guide to Perfect and Imperfect Competition

Perfect Competition vs Monopolistic Competition

In a market with perfect competition, there are many rivals, the products sold are identical and uniform, entry barriers are very low, and there is no non-price competition.

On the other hand, in monopolistic competition, it is dominated by a single seller and in which there exists no competition, non-price competition is present and the entry barriers are relatively low.

In perfect competition, many small businesses produce and provide similar products to the consumer (or ideal replacements). Small businesses are those businesses with too little market power to actually affect the price of the product.

When there are only a few retailers that offer a specific product, there is little competition and as a result monopolistic competition occurs. The variations and product quality might vary a little bit between each seller, though.

The key differences between Perfect Competition and Monopolistic Competition are given below.

In a market with perfect competition, every business sells the same or similar product (or a perfect replacement), however in a market with monopolistic competition, each business would produce somewhat different goods from each other.

Since items in the monopolistic market differ slightly from each other, non-price competition, such as marketing and advertising exists to let customers know about the quality of the product.

Since the items in a monopolistic market differ from one another, pricing power develops quickly until other competitors enter the market to take advantage of it.

Marginal revenue and average revenue are identical in a market where perfect competition exists. Price per unit times the number of units sold equals to the total revenue. As a result, the average revenue will be comparable to it when divided by the number of units sold.

By selling one additional unit, you will be able to change your overall revenue, which is what marginal revenue means. In the perfect competition, where each team is sold equally, the average revenue is equal to the marginal revenue.

Any business under monopolistic competition has a very limited pricing power since any indication of above-average profit would bring in rival companies who want to enter the market. In order to increase sales of a product in a monopolistic market, a company will need to lower its price.

Therefore, when more products are being sold, the average revenue will eventually decline. Additionally, the demand curve will slope downward from left to right, meaning that the company will have to lower the product's price in order to move more of it. The marginal revenue is therefore diverging more widely and is lower than the average revenue of the monopolistic market.

Also Read | Economic Value vs Market Value

Characteristics of Perfect Competition

The characteristics of Perfect Competition are given below :

Characteristics of Perfect Competition

Numerous Competing Firms

There are several buyers and sellers in a perfectly competitive market. Businesses are referred to as "price takers" as a result. To put it another way, the company must sell at the exact price at which the supply and demand are in balance, or at the "equilibrium" price.

If not, then they will cease operations as there are several other companies who are willing to offer the same product at a lesser price. Customers can move to a replacement product that has a low cost.

Businesses are unable to raise prices because of the huge amount of competitors in the market. If they choose to do this, the buyers are willing to switch to less expensive alternatives, which will drive them off the market.

Similarity in Products Sold

Competitors supply similar goods in a perfect market. In economic language, this can be referred to as "homogenous." Simply said, it signifies that the products are comparable.

The typical customer might not be able to tell how to differentiate one business from another. Therefore, switching is easy and inexpensive too, if you're willing to do so.

One prominent example is the dairy industry. For instance, a lot of farmers sell milk to different grocery stores, although the product is extremely similar. In fact, supermarkets frequently alter their agreements with the dairy producers without the general public knowing.

Equality in Market Share

Because businesses can't compete based on pricing, competitors generally have the same market share. Prices cannot be lowered as long as the businesses produce at a margin where the marginal revenue equals marginal cost.

When a company lowers prices, it begins to lose money since the product becomes more expensive to produce than to sell, which results in the company going out of business.

In addition, if any company raises the prices, there is enough competition to lure the customers away from that shop and drive it out of business. This might limit a company's capacity to expand its market share as a result.

Buyers have Full Information

This is known as "Perfect Information" in the language of economics. The customer is well aware at this point about which stores might offer the identical thing for less money. Businesses are therefore hesitant to boost their prices before a rival.

Additionally, customers are also aware of a product's quality. To deliver a product of poorer quality and then increase profit, a company might reduce expenditures.

Customers will be fully informed and will be able to recognise the product's shortcomings. The original company will then go out of business as a result of the customers switching to competitors.

Easy Entry and Exit

Companies can enter and leave the market at a low cost. Money, time, or information may be used to achieve this. For instance, a significant amount of money must be invested up front in the oil and gas sector. This makes it difficult for any rivals to enter the market. These expenses do not exist or are very small in the case of a perfect competitive environment.

Under perfect competition, the businesses can easily exit the market as well. A business can, for example, have a lengthy contract. However, they cannot leave the market without incurring high fees.

Also Read | Determinants of Demand and Supply

Examples of Perfect Competition

It is frequently said that the real world does not support perfect competition. This claim is truly accurate in certain respects. Perfect competition might have prevailed in earlier times when the commodities served as the principal drivers of economic activity in the world.

In particular, the economies of coal, metal, oil, and corn all played significant roles. They possessed all the five characteristics and were homogeneous at the same time. We will be able to discover several buyers and countless sellers of the same goods if we traveled back in time to centuries-old markets.

For instance, there can be a huge number of bakeries selling bread in the market. A uniform product is one that can be purchased or can be sold by a large number of customers and vendors.

The times have evolved since then. Today's economy is one where the businesses can compete by providing a variety of goods. Brands are now becoming the go-to source for information for consumers. Since we purchase so many items, "perfect information" is not completely attainable.

Because there were so few things accessible earlier, it was simpler to obtain "perfect information." But nowadays there are millions. However, despite their rarity, there are still a few noteworthy instances that can be found today.

Agriculture

Products in this market are quite similar to each other. Generic crops produced by numerous supplies include potatoes, grains, and carrots. It is simple to purchase land and farm it since the product is homogeneous.

Furthermore, leaving the market is quite simple as well. The market therefore exhibits important indicators of perfect competition.

Foreign Exchange Market

Currency transactions take place in this market. The product is homogeneous since there is just one each of the British Pound, US Dollar, European Euro and other currencies. In addition to this, there are a lot of buyers and sellers in the market.

Furthermore, purchasing cash is easy, and selling it is straightforward as well. However, there is an exemption because some traders might not have the "perfect information." The regular buyers and sellers might be at a disadvantage compared to the professional traders who make their living from it. Even so, it is amongst the closest representations of perfect competition that we have at our disposal.

Online Shopping

The internet might not stand out to people as a different market. However, both the buyers and the sellers can be found online in huge numbers. For instance, despite not being a truly physical market, eBay can still be called a market.

Customers may research and compare different products online with "perfect information" at their fingertips. Let's take a particular book as an example. It has countless distributors and buyers. It can be Amazon, Barnes & Noble, or Waterstones. The price variations are typically negligible in these places at the same time.

There are therefore several buyers and suppliers of similar goods. Additionally, entry and exit are also simple and inexpensive. Amazon might be the closest example to actual life, disregarding the fact that it has a large market share.

Also Read | What is the Consumer Market?

Advantages and Disadvantages of Perfect Competition

The advantages of Perfect Competition are given below.

The ideal market structure is said to be one where there is perfect competition.

Consumers are the focus of such market arrangements that are perfectly competitive. In these kinds of markets, the saying "the consumer is king" is true. Both the products and sellers are easily replaceable, and the consumers can easily switch to others if they feel so.

Sellers lack the price power, as in a monopoly market, and the chain of demand and supply continues to have complete control over the pricing. As a result, there is very little chance of taking advantage of the customers.

For absolutely comparable products, the quality, price, and features stay the same worldwide.

In an environment where perfect competition exists, the costs of production, marketing and promotion are relatively cheap. Therefore, entry, production, and sales become simple for the seller.

The disadvantages of Perfect Competition are given below.

The optimum market structure can be considered to be the main drawback of perfect competition. It is simply a fictitious or theoretical economic idea with very little usage in actual life.

Since adding features or value does not boost the prices that are fully determined and regulated by the demand and supply system, the sellers are unable to add value to their products. As a result, the seller's costs might rise, but their income does not. The profit margin eventually gets smaller. If the retailers raise their pricing for superior goods, the customers might switch to other retailers or start looking for other products.

Due to the low entrance barriers and high freedom to exit, fierce competition is yet another drawback for the sellers. In other words, if a new competitor enters the market and begins providing similar goods or services to the consumers at similar prices then competition increases.

Since they are already well-established in the market, have built a certain amount of trust among the suppliers and the customers, and are situated in the most desirable areas, existing sellers are constantly at an advantage over the new competitors. New sellers, however, face many challenges, occasionally suffer losses, and are thus driven off the market.

Also Read | What is a Competitive Market?

In the actual world, there exists no perfectly competitive market structures. In economics, it might serve as a standard against which to compare the hypothetical markets.

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Perfect Competition: Categories and Uses

Perfect Competition vs Monopolistic Competition

Characteristics of Perfect Competition

Numerous Competing Firms

Similarity in Products Sold

Equality in Market Share

Buyers have Full Information

Easy Entry and Exit

Examples of Perfect Competition

Agriculture

Foreign Exchange Market

Online Shopping

Advantages and Disadvantages of Perfect Competition

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