What is ‘Perfect Competition’
Pure or perfect competition is a theoretical market structure in which the following criteria are met: all firms sell an identical product (the product is a “commodity” or “homogeneous”); all firms are price takers (they cannot influence the market price of their product); market share has no influence on price; buyers have complete or “perfect” information – in the past, present and future – about the product being sold and the prices charged by each firm; resources such as labor are perfectly mobile; and firms can enter or exit the market without cost.
BREAKING DOWN ‘Perfect Competition’
Perfect competition is a benchmark to which real-life market structures can be compared.
Perfect competition is the opposite of a monopoly, in which only a single firm supplies a good or service and that firm can charge whatever price it wants, since consumers have no alternatives and it is difficult for would-be competitors to enter the marketplace. Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down.
Real-world competition differs from this ideal primarily because of differentiation in production, marketing and selling. For example, in agriculture, the owner of a small organic products shop can talk extensively about the grain fed to the cows that made the manure that fertilized the non-GMO soybeans – that’s differentiation. Through marketing, companies seek to establish “brand value” around their differentiation and advertise to gain pricing power and market share. Thus, the first two criteria – homogeneous products and price takers – are far from realistic. Yet, for the second two criteria – information and mobility – the global tech and trade transformation is improving information and resource flexibility.
While reality is far from this theoretical model, the model is still helpful because of its ability to explain many real-life behaviors.