What is perfect competition?

In microeconomics, perfect competition is an ideal market situation in which there are  many sellers and many buyers  . This scenario would favor a natural equilibrium in prices due to the relationship between supply and demand.

Also called  competition  pure  , perfect competition is a concept that is not in the real world  , since it is a theoretical model rather than practical. The horticulture sector is often mentioned as the closest example of this model.

In a perfectly competitive market, the tendency is that, in the long run, the income of the companies corresponds to its total cost.

This total cost includes the opportunity cost, which is the entrepreneur’s remuneration, also called normal profit. The normal profit would be an average return on the market, corresponding to how much the entrepreneur would earn if he had chosen to invest his money in another activity. Therefore, the pure competition market avoids the so-called extra profit or extraordinary profit, which is the disparity between income and costs  .

Perfect competition market structure

In a perfectly competitive situation,  the number of sellers and consumers should be large enough that no  player  in the market can influence only its equilibrium  .

Therefore, if a seller deliberately lowered or raised its price, this movement would have no influence on the dynamics of the market as a whole. The reduction of the price to values ​​lower than those practiced would end with the end of the stocks of this seller, while the increase would cause the consumer to immediately migrate to other brands.

Furthermore,  to have perfect competition, the products offered must be similar  . There could be no differentiation in quality, packaging or associated services, such as after sales, for example. This means that consumers would always find similar options to replace their purchase.

The market should also be permeable  , that is, totally open to the entry of new competitors. Finally, there must be a  free flow of information  , including about earnings and prices. In this system, the fact that a company makes very high profits would soon attract new competitors to the market, forcing that company to reduce its profits.

Perfect competition in the factor market.

The perfect competition structure does not apply only to the market for goods and services. It can also be designed for the market for production factors, which are the set of essential elements for a production process, such as labor and natural resources.

In a market for factors of production with perfect competition, there would, for example, be an abundant supply of labor and suppliers, making the prices of these factors constant for firms.

Market types

The perfectly competitive market is opposed to other types of markets more common in the real world, such as  monopoly  and  oligopoly  . Monopoly corresponds to a situation in which there is only one seller who, due to his exclusivity, has the power to dictate his prices. In the oligopoly, which is a market structure concentrated in a few companies, there is a risk that sellers may agree on prices.

Another more common situation is the so-called  monopolistic competition  , an intermediate structure between pure competition and monopoly. It is characterized by having a relatively large number of vendors, but they sell differentiated products. Each has a particular niche, with some room for pricing. However, this margin is not infinite, because the consumer can choose substitute products.

Imbalances in market structures can also be seen from the point of view of consumers. In  monopsony  , there is only one buyer for many sellers of inputs or services. In a similar logic,  oligopsony  corresponds to a market with few buyers. In both cases, these buyers have the power to negotiate more advantageous prices, to the detriment of the sellers’ interests and needs.