Perfect Competition Defined
Imagine yourself as a street food vendor, selling tacos topped with fried onions, ground meat, cheese, fresh tomatoes and dollops of guacamole and spicy sauce in the main plaza of a town close to the border of Mexico. There are three other taco vendors on the other corners of the plaza selling the exact same thing of the same quality. None of the other vendors (nor you) can change the price, because everyone knows that the deal is 3 tacos for $5. Anyone else who wants to sell tacos on the street can do so, and if you want to quit and sell something else one day (or sell your tacos at one of the many other public spaces in your town), no one is stopping you. A business expert might describe this as perfect competition (or a perfect market or pure competition), which means an equal level for all firms involved in the industry. But what does that really mean?
Characteristics of Perfect Competition
In order to attain perfect competition, several factors need to be met. The following list outlines some of the main factors:
- Knowledge is available to all buyers and sellers, and no individual has control over the prices.
- Buyers and sellers have no barriers to enter or leave the market.
- Buyers and sellers want to maximize profit.
- There are too many sellers and buyers to take control of the market.
- All goods are homogeneous.
- The government does not get involved.
- There are no costs associated with transportation.
Benefits of Perfect Competition
Now that the factors have been introduced, you might be asking, what are the benefits to a perfect market? Let's look at some of the benefits in more detail:
- All of the knowledge, such as price and information pertaining to the goods, is equally dispersed among all buyers and sellers. In other words, there are no secrets, and communication about the products is shared evenly, preventing corruption.
- Since there are no barriers to enter the market, this makes it impossible for a monopoly to occur.
- Advertisement is not needed in a perfect competition because all goods are the same, and customers have all the knowledge pertaining to those goods.
Examples of Perfect Competition
This leads to the next question: Is perfect competition in a market realistic in the real world? The answer is no, not really. There aren't any 100% perfect markets, but there are some industries that come close. Like we mentioned earlier, street food vending (more common in developing countries) has many of the factors required of a perfect market. Agricultural markets are examples of nearly perfect competition as well. Imagine shopping at your local farmers' market: there are numerous farmers, selling the same fruits, vegetables and herbs. You can easily find out the prices for the goods, but they are usually all about the same.
Another example is the currency market. First of all, the goods that are involved in the currency market are homogeneous. No matter where a dollar is traded, it is still a dollar. Not one buyer or seller can individually determine the price, and, with all of the technology available today, each buyer and seller has access to any current knowledge, or in this case, the current market value.
Most industries fall on the other end of the spectrum and are not even close to perfect competitions. Think about the cell phone industry. It seems like not a day goes by without a new commercial making its debut for the newest phone available. Bigger screens, higher quality cameras and new apps are just a few of the ways each firm is working to gain competition over other firms in the industry.
Let's review. Perfect competition provides an equal level for all firms involved in the industry. Each firm has all of the knowledge pertaining to the goods, which prevents a monopoly, and each firm is free to enter and leave without any barriers. Lastly, in a perfect competition, profit can be maximized, and the goods are homogeneous. Like mentioned before, when all of these factors are met, a 'perfect' market occurs.
Notes on Perfect Competition
- Perfect competition means all sellers in the industry are on the same level
- In perfect competition, knowledge is equally shared among buyers and sellers so advertisement is not needed
- Perfect competition has no barriers and prevents monopolies
Working through this lesson should help you do these tasks:
- Describe perfect competition
- List some of the qualities of perfect competition
- State the benefits of perfect competition
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Examples of Perfectly-Competitive Markets
For each of the following examples, answer the following questions.
- Is the market perfectly competitive?
- If the market is not perfectly competitive, explain which characteristic (or characteristics) of a perfectly-competitive market does (do) not apply.
- The market for all types of sugar (including white and brown sugar).
- The market for onlybrown sugar.
- The pizza industry, where all firms using slightly different ingredients and cooking methods.
- The market for wheat.
- The market for wheat after one firm purchased all wheat firms in the world.
Determine if each of the statements about perfect competition are true or false.
- In perfectly-competitive markets, the price is set by the market and all firms sell their output at the market price.
- If a firm in a market holds a patent on the product being produced, then the market can't be perfectly competitive.
- A firm in a perfectly-competitive market has the ability to determine the price at it sells its product.
- Firms in perfect competition can increase their profits by spending more money on advertising.
- A government-imposed price ceiling or price floor can help an industry become perfectly competitive.
- The internet has allowed markets to become more competitive because information is now more readily available to consumers compared to the time before the internet.
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