Perfect Competition
"PURE COMPETITION"
Perfect competition is characterized by many buyers and sellers, many products that are similar in nature and, as a result, many substitutes. Perfect competition means there are few, if any, barriers to entry for new companies, and prices are determined by supply and demand. Thus, producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. For example, in a perfectly competitive market, should a single firm decide to increase its selling price of a good, the consumers can just turn to the nearest competitor for a better price, causing any firm that increases its prices to lose market share and profits. The real-life markets which are closest to this theory are food markets. However, this is a very useful tool for gauging various real-world economies.
THE CRITERIA:
1) All firms sell an identical product
2) All firms are price takers - they cannot control the market price of their product
3) All firms have a relatively small market share
4) Buyers have complete information about the product being sold and the prices charged by each firm
5) The industry is characterized by freedom of entry and exit
THE BENEFITS:
-Because there is perfect knowledge, there is no information failure and knowledge is shared evenly between all participants.
-There are no barriers to entry, so existing firms cannot derive any monopoly power.
-Only normal profits made, so producers just cover their opportunity cost.
-There is no need to spend money on advertising, because there is perfect knowledge and firms can sell all they can produce. In addition, selling unbranded goods makes it hard to construct an effective advertising campaign
-There is maximum possible:
-Consumer surplus
-Economic welfare
-There is maximum allocative and productive efficiency:
-Equilibrium will occur, hence allocative efficiency.
-In the long run equilibrium will occur at output, which is productive efficiency.
-There is also maximum choice for consumers.
Laa
HOW DO WE GAUGE REAL-LIFE ECONS?
iMagazine / October, 2014 3