Perfect Competition Explained

Perfect competition is a hypothetical market where there is a cut-throat competition, all firms are price-takers and market share has no influence on prices.

By the way, make sure you read our recent blog on “Monopoly, Monopsony, Oligopoly and Free Market” to have insightful information on these various forms of market structures

Let us have a better understanding of the topic by discussing its characteristics.

  1. There are an end number of buyers and sellers.
  2. The homogeneity of products is maintained- all firms sell the same products. They sell products with minimal differences in capabilities, features, and pricing. This ensures that buyers cannot distinguish between products based on physical attributes, such as size or color, or intangible values, such as branding. This implies that there is no, or little product differentiation.
  3. Firms do not decide their own prices as products have proper substitutes.
  4. There are no barriers to entry or exit.
  5. Firms only earn sufficient to stay in the business. There are no super normal profits.
  6. Firms have perfect knowledge about the ecosystem and competition in the industry. In industries such as pharmaceuticals and technology, information about patents and research initiatives at competitors can help companies develop competitive strategies and build a moat around its products. However, in perfect competition, information is equally and freely available to all market participants. This safeguards that each firm can produce its goods or services at an identical rate and with the same production techniques as another one in the market.
  7. All the factors of production, viz. labor, capital, etc, have perfect mobility in the market and are not hindered by any market factors or market forces.
  8. Costs or benefits of an activity do not affect third parties. This criteria also excludes any government intervention.
  9. There are no advertisements or transportation costs.
  10. In theoretical sense, perfect competition is simply the opposite of Monopoly market.
  11. Examples:
  • Foreign Exchange Markets: Currency is homogeneous, there is unlimited access of buyers and sellers, and perfect information about relative prices is available.

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.