What is perfect competition? Pros and cons

One of the theoretical concepts in economics is the model of perfect competition. It allows you to describe ideal market conditions in a given sector and compare them with the actual competitive position of a company. What are the characteristics of perfect competition and do such economic entities exist in the economy? Find out in this article!

What is perfect competition?

The perfect competition model serves as a benchmark against which we can compare our business. Although it is not a common structure, understanding it provides valuable information about the impact of supply and demand on the market.

The opposite of this model is a monopoly, which is a company that dominates a particular market and dictates the price of goods or services. It attracts all customers who have no other alternatives in this situation. It is usually very difficult for new entrants to enter such a market, so a monopoly company does not have to worry about its competitive advantage.

Features of perfect competition

The attributes that distinguish perfect competition are as follows:

• Low barriers to entry and exit

Entry barriers refer to, among other things, regulatory requirements that must be met for a firm to enter an industry (permits, licenses, concessions, etc.), start-up costs, and technological requirements. Exit barriers, on the other hand, refer to factors that reduce the profitability of leaving an industry while increasing the costs associated with such an activity. If we’re talking about low barriers to entry and exit, it means that we can set up a business easily and quit without much loss.

• Information availability

Producers, sellers, and customers have access to information about prevailing market conditions – pricing strategies, demand and supply of goods, and their quality. Consumers realize that the goods and services offered are homogenous. They make rational purchasing decisions.

• A homogenous and extensive market

It means there are a lot of companies in the market selling similar products. Since the products have similar features, customers mainly rely on price. Demand and supply are equal, and all companies that fit this model have relatively small shares.

• Firms are price-takers

Therefore, companies must accept the prices that prevail in the market. They also have no control over their formation – they cannot lower or raise them.

Pros and cons of perfect competition

Pros:

• Low barriers to entry and exit,
• Customer focus (they have strong bargaining power),
• Companies compete by lowering prices and to be profitable, they must strive to optimize costs and reduce waste.

Cons:

• It usually exists only in theory and does not accurately define economic realities,
• Lack of innovation – companies’ offerings are almost identical, so there is no room for improvement and development,
• The break-even point of businesses is less than 0 (there are too many competitors in the market), which means lower profits,
• It’s impossible to scale the business, i.e., to maximize the benefits of the company,
• High competition – customers have many choices.

Examples of perfect competition

Several industries in the market are close to the described model of perfect competition. Take a look at the following examples.

• Agricultural market

In some countries, agricultural products are similar, e.g., wheat, rye, barley, and soybeans. Starting such a business is quite easy – it requires buying land and starting to grow crops (assuming you know how to do it). The prices of the products are comparable to each other and are mainly influenced by factors beyond the farmers’ control – weather conditions, imports and exports, yields, and demand.

• Currency markets

The value of any currency depends on external factors. Access to information about the stock market is widespread, and transactions are uniform. Barriers to entry are also low – if you want to start investing, all you need to do is set up a brokerage account. You don’t need much money to get started.

• E-commerce industry

Another example is e-commerce, which is growing rapidly. The barriers to entry and exit for sellers are low – with little investment, virtually anyone can start or quit this type of business. The availability of different offers, the best prices, and the necessary information about products and services is very wide. In addition, there are several people engaged in this business and consumers who choose this form of shopping.

Summary

You should remember that the model of perfect competition is a construct that represents an idealized market situation. The reality is quite different, and not all of its features are observed in various companies, which shows the imperfection of the modern economy. Nevertheless, it can be an interesting way to analyze your market environment.

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