Updated October 18, 2023
Perfect Competition Definition
Perfect competition is a theoretical market structure where multiple firms sell the same or similar products at a uniform price, and no single firm can influence the market price. For example, all supermarkets sell identical items at the same prices.
In a perfectly competitive market, all firms produce identical products without much differentiation between the goods or services they offer. This means that if there is a shortage of products from one firm, buyers can purchase similar products from another firm. Furthermore, companies are free to enter or exit the market anytime without facing any barriers. However, companies earn no extra profits, i.e., they might earn just enough to cover their production costs.
Table of Contents
- Definition
- Characteristics
- Examples
- Graph
- Advantages & Disadvantages
- Perfect Competition Vs. Monopolistic Competition Vs. Monopoly
Characteristics
The perfect competition market has the following characteristics. However, it is important to note that perfect competition does not fit in real-world market scenarios.
1. Many players and a homogenous market
There are numerous buyers and sellers, typically small businesses run by an individual. All products are almost identical in features, performance, and price. As a result, consumers cannot distinguish between products based on physical attributes or brand reputation. Also, the supply and demand remain stable in this market, and consumers can easily substitute one product with another.
2. Transparency and market knowledge
Companies and consumers have access to the same product information. This ensures all businesses can produce their goods using similar techniques and consumers know the product’s prices and market conditions.
3. Easy market entry and exit
Sellers can easily enter or exit the market in a perfectly competitive environment. New firms can enter the market with minimal startup costs and a high product demand. In contrast, if a company is not producing profit, it can leave without significant hurdles.
4. No regulatory barriers or less government intervention
There is a lack of government interference. Thus, companies can freely operate without strict regulatory controls. Moreover, the demand and supply in the market determine product prices without any external regulation or interference.
Examples
Here are some examples that reflect the characteristics of a perfect competition:
Example #1
Consider a local farmer’s market where two farmers, Aaron and Thomas, sell corn. Aaron sells his corn at $5, whereas Thomas sells it at $4.50. Although both corn from Aaron and Thomas are almost the same in taste and quality, customers prefer the lower price and start buying from Thomas. Therefore, Aaron lowered his price to $4.50 to match Thomas’s price and retain his customers.
This farmer’s market, with two sellers selling the same corn and no one controlling the price, is a perfect example of a perfect competition market.
Example #2
On an online selling platform, two sellers, Sellers A and B, are selling the same toy. Seller A sets the toy price at $20, while Seller B sets the price at $18. Buyers typically go for the cheaper option and start purchasing from Seller B. In response, Seller A reduces the cost to $18 to attract buyers.
This scenario reflects a perfect competition market, where sellers offer similar products and buyers can easily compare prices. This leads the seller to adjust their prices to remain competitive in the marketplace.
Perfect Competition Graph
As we know, in a perfect competition market, the demand and supply of the market/industry determines the market price, and firms have no control over price. Let us see the demand curve graph to understand this.
1. Demand Curve for a Market in Perfect Competition
X-axis: Quantity produced
Y-axis: Price per UnitKey curves on the graph:
- Supply curve (S): It represents the total number of products sellers are willing to sell. Its slope is upward because as a product’s prices increase, companies produce more products to gain profit.
- Demand curve (D): It represents the total number of products consumers are willing to buy. Its slope is downward because as a product’s price decreases, company demand for that product increases.
How to interpret the graph?
The point where demand and supply curves intersect is known as the equilibrium price (P). This is the point where the quantity demanded by consumers equals the quantity supplied by firms. Thus, this is the price at which the product is sold in the market.
2. Demand Curve for a Firm in Perfect Competition
Where,
X-axis: Quantity produced
Y-axis: Price per Unit
Key curve on the graph:
Demand curve (D): It shows the total quantity consumers are demanding to buy in an economy.
How to interpret the graph?
The demand curve shows the price at which the firm sells the products. It is the market equilibrium price (as seen in Graph 1).
In perfect competition, the firm’s AR ( revenue a firm earns for each unit it sells) and MR (change in total revenue from selling additional units) are equal to the demand price, i.e., P=D=AR=MR.
What happens when firms set prices above the equilibrium point?
If a seller sets a higher price than the equilibrium price, buyers will purchase the same products from other sellers who sell at low prices. Thus, the first seller may face a loss. Thus, they will lower their prices to match the equilibrium price.
Advantages and Disadvantages of Perfect Competition
| Advantages | Disadvantages |
| Companies set lower prices, benefiting consumers. | All products are homogenous, leading to limited variety and options for consumers. |
| No single firm can control the market prices. | Firms make just enough profits to cover their costs in the long run. |
| Consumers have perfect knowledge about product details and prices, ensuring transparency. | Businesses remain small, preventing them from using the benefits of scale. |
| The market is self-regulating, and there is less government interference. | Firms may undergo cost-cutting by compromising product quality standards. |
Perfect Competition Vs. Monopolistic Competition Vs. Monopoly
Here is a basic differentiation between perfect competition, monopolistic competition, and monopoly. To understand more, you can also refer to our Perfect Competition vs Monopolistic Competition and Monopoly vs. Perfect Competition articles.
| Perfect Competition | Monopolistic Competition | Monopoly |
| Products are homogeneous with no differentiation | Products are heterogeneous and differentiated. | The product is unique, with no close substitutes. |
| Sellers have no control over price. | Sellers have minimal control over price. | Sellers have total control over market supply. |
| Consumers have perfect information about products and prices. | Consumers have imperfect information due to product differentiation. | Consumers have imperfect information. |
| Entry and exit are free in the market. | Entry and exit have some barriers. | Entries have high barriers, preventing other firms from entering. |
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