What Is Perfect Competition?
By Indeed Editorial Team
Updated August 26, 2021
Published February 4, 2020
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
A perfectly competitive market is achievable only when certain characteristics are present. Hypothetical conditions such as complete product information, zero cost to transact and no long-term profits are aspects of a theoretical market structure called perfect competition. Perfect competition requires a market in which competition exists always at a maximum level.
Is such a market state even possible? If you're seeking a career in economics, business or finance, you might need to consider that question to understand what perfect competition is. In this article, we define perfect competition, explain the requirements necessary for it to exist and explore the advantages and disadvantages of applying this model to the real world.
What is perfect competition?
Perfect competition represents the ideal scenario where a market in has so many highly informed buyers and sellers that monopolies cannot occur. As a result, the price of commodities is informed by demand and not influenced by buyers and sellers. The counter model is imperfect markets that happen whenever the standards of a perfect market are not met. That means every market is an imperfect market, by default. The concept of perfect versus imperfect competition is post-classical economic theory.
Perfect competition models are used as an ideal benchmark with which to compare any and all real markets. They are also the theoretical opposition of monopolies. Under monopolies the price is set solely by the sellers, in perfect competition it is set by supply and demand, allowing businesses to profit without inflating rates above what's reasonable.
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Requirements for perfect competition
Perfect competition is an ideal market and for it to be achieved, certain requirements have to be achieved. Surveying the requirements, you'll see how the conditions that need to come together to form perfect competition are vast, and unlikely to occur all at once in any given market. However, they are still useful for gauging how competition in a market is performing and drawing insights as to how to increase competition.
The following conditions must be met for perfect competition to occur:
Companies are always present: There are no economies of scale or other effects that would reduce the number of businesses that can be present. There are always businesses in this economic model.
Equal products: All products in the market can provide an even substitution for each other in that there are no suppliers that outperform others on the same product or service.
Everyone is a price taker: This means no participant can set the market prices
No barriers: Any business can enter or exit the market at any time.
No third party considerations: Excluding government agencies, benefits and costs don't impact third parties in this model.
No transactional costs: There are no costs to participate in this economic model.
Numerous buyers and sellers: The first tenet of this market model is to have a large quantity of buyers and sellers to participate.
Perfect information: All buyers and sellers have the knowledge of the cost of goods, production, utilities and more that go into making a product. Property rights: These are well defined rights that determine what can be sold and what responsibilities transfer to the buyer at purchase.
Perfect factor mobility: This occurs when all factors are aligned with growth, scalability and adjustment to long term market conditions.
Rational buyers model: Buyers are at liberty to make trades that impact economic utility.
Regulations: Regulations that eliminate anti-competitive actions are assumed.
Seller profit maximization: Sellers sell in areas where they are likely to make the most money and in efficient ways.
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Advantages of perfect competition model
There are several advantages to perfect competition, in theory. The perfect competition model creates an ideal scenario where buyer and seller needs are met, and this kind of economy has a number of benefits that make it a useful tool to compare against. These are:
Perfect knowledge: Because perfect knowledge exists, it can be presumed that market knowledge is shared evenly across buyers and sellers.
No monopolies: Without barriers that prevent smaller businesses from competing, there is never any concern of monopolization in the market.
Profit: Profits are normal and reliable, sellers make just enough to cover basic costs and have some leftover.
Branding and marketing are irrelevant: This is a benefit because businesses do not have to spend money to advertise or brand in a perfect market where all products are equal.
Maximums: In an ideal market, there is maximum performance and efficiency and maximum consumer choice.
Peak efficiency: In a perfect competition model business operate a peak efficiency, a metric not easily achievable in a regular market.
Useful: The model is useful for drawing comparisons to markets like coffee and tea where they operate more closely to a perfect market. It also provides an important for raising the competition in markets that are dissimilar.
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Disadvantages of perfect competition model
There are some disadvantages to the perfect competition model. Interestingly, the disadvantages of the model stem from the qualities the requirements at the core of perfect competition. These are:
Unrealistic: Most of the advantages listed in the previous section are based on the idea that perfect market conditions can exist, which is not a realistic premise.
Bias in decision making: Business decision making is rarely perfect, and this model doesn't account for biases that exist when businesses make decisions about how to approach the market.
Scope: There is no scope for economies of scale, as an inherent trait of perfect competition due to the high number of firms that must compete for it to exist.
No product differentiation: In a homogenous market all products are basically the same, or an equivalent to one another. That doesn't leave room for innovation to make products that are special to consumers.
Research impact: Without businesses having superfluous money to spend they are less likely to invest in research and development that advances medicine and science. This will likely have lasting societal impact.
No incentive to innovate: Between a lack of product differentiation and the concept that all buyers and sellers have all the knowledge they need to buy, there's no room for innovation growth.
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