Perfect competition is a market structure that has specific characteristics. In reality, perfect competition rarely exists. A market with perfect competition has the following characteristics:
- All firms sell an identical product
- There is an absence of barrier for firms to enter and exit the market
- Buyers have all the information about the product
- Every firm has a small share of the total market
- There is no monopoly
- Firms are price takers.
Let us discuss these characteristics in detail.
1. All firms sell identical products
In a perfectly competitive market, there are several firms that sell the same type of product in the market. This means there is no competition prevailing in the market as the consumers get the same type of product from all sellers. If firms were selling smartphones in a perfectly competitive market, every firm would sell the same colored smartphone with the same features and capacities.
2. There is an absence of barrier for firms to enter and exit the market
Barriers to entering the market is a factor that makes it difficult for a new business to enter the market. There are some common barriers including Patents, Government regulations, and costs which affect most organizations. In certain markets like utilities, the government regulates how many firms can enter the market. Further, when firms hold a patent, they prevent other firms from entering the market. Lastly, many industries have high capital expenditure or start-up costs and it acts as a barrier to entry. Due to high costs, only a limited number of companies will be able to enter the market. In perfect competition, no such barrier exists.
3. Buyers have all the information about the product
In a market where perfect competition exists, the buyers have detailed information about the products that the firms sell. Consumers understand all the features of the product being sold and the amount the competitors charge for it. No firm can make false claims about the product in the market because the consumer will know that they are lying.
4. Every firm has a small share of the total market
Since there are many firms in the market selling identical products, every firm will have a very small share of the total market. This means the firms will not be able to set a price they sell their product for. The price of their product will be determined by the demand and supply and it will be identical.
5. Firms are price takers
In a perfectly competitive market, firms do not get to set the price on their products. They are price takes and not price setters. The price of a product is determined by the demand and supply in the market.
6. There is no monopoly
Perfect competition is the exact opposite of a monopoly. In a monopoly market, a large part of the total market share is owned and controlled by an organization or a group of organizations. As far as a perfectly competitive market is concerned, there are firms selling identical products and they are price takers, hence, there is an absence of monopoly.
In reality, a perfectly competitive market does not exist. There are always several buyers and sellers in the market, this means one seller or buyer cannot influence the price. No consumers are aware of all the details about the product.
Drawbacks of perfect competition
In the current situation, there are several barriers to entry in the market, and not all firms can enter and exit the market. It is hard to imagine a market in perfect competition or a complete monopoly. It is unrealistic and cannot exist. If all firms sold similar products, consumers would have no choice. The market would lack innovation. With an aim to achieve a high market share, firms innovate and introduce new products in the market. This leads to a wider choice for consumers.
Another drawback of the system is that the profit margin will be fixed by the demand and supply. No firm can set itself apart by offering a unique product or setting a premium price on their product. It would be impossible for a company like Apple to exist in a perfectly competitive market because its phones are priced higher than most other phones available in the market today.
Real-world markets differ from the economic market theory of perfect competition. Different firms are manufacture different products and sell them at varying rates. There is differentiation in production, marketing, and selling. It is competition and availability of different products that make the market interesting and allow an economy to grow. Perfect competition cannot prevail in today’s economy.