Perfect competition is a market structure dominated by many firms. There is freedom of entry and exit, and is characterised by perfect information and homogenous products.
Diagram of Perfect Competition
1. Allocative Efficient. This is because P = MC
2. Productive Efficient. This is because firms produce at the lowest point on the AC
3. X Efficient. Competition between firms will act as a spur to increase efficiency
4. Resources will not be wasted through advertising because products are homogenous
5. Normal profit means consumers are getting the lowest price.
This also leads to greater equality in society
Disadvantages of Perfect Competition
- No scope for economies of Scale, this is because there are many small firms producing relatively small amounts. Industries with high fixed costs would be particularly unsuitable to perfect competition. This is one reason why p.c. is unlikely in the real world
- Undifferentiated products is boring giving little choice to consumers. Differentiated products are very important in industries such as clothing and cars
- Lack of supernormal profit may make investment in R&D unlikely this would be important in an industry such as pharmaceuticals which require significant investment
- With perfect knowledge there is no incentive to develop new technology because it would be shared with other companied
- If there are externalities in production or consumption there is likely to be market failure without govt intervention
In the real world perfect competition is very rare and the model is more theoretical than practical.
However in general economists often talk about competitive markets which do not require the strict criteria of perfect competition.
A competitive market is one where no one firm has a dominant position but the consumer has plenty of choice when buying goods or services. Therefore in competitive markets we would expect
- Firms to have a small share of the market
- Few barriers to entry
- Low prices for consumers
- Allocative efficiency
- Incentives for firms to cut costs and develop new products
- Profits will be lower than in markets with Monopoly power
This is linked closely to the idea of Contestable markets which is concerned with low barriers to entry and freedom of entry.