Perfect Competition Definition Characteristics Example

Perfect Competition Definition

Perfect competition is a type of market where there are many buyers and sellers, and all of them initiate the buying and selling mechanism. There are no restrictions and no direct competition in the market. 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. Instead, many sellers (also buyers) are present in the market that simultaneously sell an identical product at the market price. Thus, each seller has a very small share in the market with limited control over market prices.

Perfect competition is considered the ideal market scenario as it allocates the available resources most efficiently. It is also referred to as pure competition.

Note: The important point to note from the above definition is that perfectly competitive market structures do not exist in the real world. It is used as a benchmark to make a comparative analysis with real markets in economics.

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Example

There are no real-world examples of perfectly competitive markets. But the nearest approximations may include agricultural markets like many farmers producing similar crops such as wheat or mango.

Another example may consist of street food vendors. Various vendorsVendorsA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers.read more (sellers) exist selling almost identical (homogeneous) products, e.g., burgers. The consumer has full information about the product (burger here) and its prices. Let us assume a burger costs around $5. A vendor cannot sell his burgers at higher prices (i.e., negligible pricing powerPricing PowerPricing power refers to the power of an entity to choose the desired price for its product or service without the risk of losing its demand or customer base. Generally, it is an attribute of companies that are market leaders or monopolies.read more). Customers are free to purchase their burgers from any vendor of their choice. Also, barriers to entry and exit for vendors in the market are virtually negligible; hence competition is very high.

Characteristics of Perfect Competition

The following is the list of characteristics of perfect competition:

#1 – Large Market

A large population of buyers and sellers is present in the market. Sellers are unorganized, small, or medium enterprises owned by individuals. However, a large number of both sellers and buyers maintain the constancy of the demand and supply chainSupply ChainA supply chain refers to a process beginning with the procurement of raw materials and the production of finished goods and ending with their distribution and sale.read more in the market. i.e., a buyer can easily substitute firms to buy its product, and the seller also has a large availability of buyers.

#2 – Homogeneous Market

Firms sell identical products with similar features and pricing. Hence, the buyer cannot 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 start-up and production costs are very low, and the demand for products is high. Thus, entry into the market is easy. However, suppose some enterprise incurs losses, and survival in the market becomes 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 sell their products in the market freely. 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 supply levels as per demands in the market. On the other hand, the buyer is fully informed about products’ availability, features, quality, and prices. Hence, manipulating the market by either party is not possible.

#6 – Cheap and Efficient Transportation

Transportation is an important part of every business, and in a perfectly competitive market, transportation for the seller is low. Thus, the product prices decrease. Also, an efficient vehicle is easily available, causing a reduction in delays in transporting goods.

Perfect Competition vs Monopoly

We refer to a popular market structure called a monopoly to understand perfect competition better. A monopoly is theoretically opposed to perfect competition, characterized by a single product seller with no close substitutes. Monopoly provides full power over prices, and consumers cannot shift to another seller in case of a price rise because there might be no other option available. High barriers to entry High 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 result in a 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.

Advantages

The following are the advantages of perfect competition: –

Perfect competition markets are theoretically ideal market structures.Perfectly competitive market structures are consumer-oriented. It is said that the “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 absolute control of pricing remains under demand and supply chain. Thus, the probability of exploiting consumers becomes negligible.The product features, quality, and rate remain similar everywhere for perfectly competitive products. E.g., the quality and rates of toothpaste in New York City or South Dakota remain almost the same, and consumers everywhere get standardized products.In perfect competition, start-up costs, production, advertising, and marketing costs 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 the ideal market structure. It is just a hypothetical or theoretical concept of economicsEconomicsEconomics is an area of social science that studies the production, distribution, and consumption of limited resources within a society.read more with negligible existence in the real world.Sellers cannot add value to their product because adding value or features does not increase prices fully determined and controlled by the demand and supply system. Hence, the cost to the seller increases, but revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more remains the same. 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 start 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, and have already created goodwill Created 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, and are located at prime locations. But new sellers have to struggle and sometimes incur losses and are ultimately thrown out of the market.