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What is Perfect Competition in Economics? Who determines price in perfect competition? Explain

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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 a labor are perfectly mobile; and firms can enter or exit the market without cost.”

In order to meet these criteria, there have to be a very large number of firms, all have the same cost of production, and nobody should be able to differentiate their product. Because there have to be a large number of firms in any industry, economies of scale are not allowed.

This limits competition to simply price competition, with all of these numerous firms competing to see which can shave their profit margin the thinnest, selling their product for the smallest increment above the cost of production possible.

The big problem with this is that it puts a limit on how low an industry can reduce prices to the consumer. Reducing the cost of production is not allowed.

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perfect competition market

Under real world competition, there may be barriers to entry involving high initial capital costs, imperfect information, and even a very small number of firms. There might even be only one, if that proves to be efficient, without it actually being a monopoly. Advocates of this kind of competition define monopoly in terms of what kinds of barriers there are, if they are based on government coercion or not.

In this messy, imperfect form of competition, you may get high profit margins, but the price to the consumer can fall much lower, because firms can find ways to lower the cost of production using new technology, economies of scale, new production techniques, and the reduction of waste to increase productive efficiency.

Under so-called perfect competition, the limit of price reduction enjoyed by the consumer is the cost of production. The price can fall so far, and no farther.

Under real-world competition, with economies of scale, unlimited capital investment, and new technology, the cost of production can fall, and the only limit is zero. Everything has some cost of production, so the cost can approach zero, though not reach it.

The supposed benefits of perfect competition are small compared to those of actual, real world, free market, and entrepreneurial competition. Under real-world competition, with economies of scale, unlimited capital investment, and new technology, the cost of production can fall, and the only limit is zero. Everything has some cost of production, so the cost can approach zero, though not reach it.

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