Perfect competition

From Academic Kids

Perfect competition is a model in economic theory. It describes a hypothetical market form in which no producer or consumer has the market power to influence prices in the market. This would lead to an outcome which is efficient, according to the standard definition in economics (Pareto efficiency). The analysis of perfectly competitive markets provides the foundation of the theory of supply and demand.

Perfect competition would require:

  1. Atomicity, there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others, firms are price takers.
  2. Goods and services are perfect substitutes -- they are homogeneous.
  3. Perfect and complete information: all firms and consumers know the prices set by all firms.
  4. Equal access, all firms have access to production technologies, and resources (including information) are perfectly mobile.
  5. Free entry, any firm may enter or exit the market as it wishes.
  6. Transaction costs are zero.
  7. The price is determined at the level that equates supply and demand.

In such a market, the price would move instantaneously to equilibrium.

This model is in most cases only a distant approximation of real markets, with the possible exception of certain large street markets. In general, none of the conditions listed above will apply in real markets. For example, larger producers are generally (up to a point) more efficient than smaller producers, limiting the number of firms so that each has a degree of market power (in the extreme there is natural monopoly, with only one firm). Transaction costs and information costs can never be zero, although in some cases the marginal cost can be close to zero; and so on.

Some say that agriculture, whith a large amount of suppliers, relatively inelastic demand, and almost perfectly substitutable product is an approximation to the perfect competition model. This may be/have been true in some places and times, but in modern economies it is not. For example, in the global agriculture market, agricultural subsidies are provided to US and European (via the CAP) farmers whose products are exported (dumped) at prices below the cost of production.

See also


  • Luis M. B. Cabral: Introduction to Industrial Organisation, Massachusetts Institute of Technology Press, 2000, page Markt

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