Perfect Competition

What is perfect competition?

A perfectly competitive market is a hypothetical market where competition is at its greatest possible level. It is argued that this type of market gives the best results for consumers and for society overall.

What are the assumptions of this model?

1. The market consists of many firms which are relatively small as compared to the overall market size. 
2. All products which all the firms in an industry produce are considered to be homogenous. 
3. There is Perfect Knowledge for all stakeholders in the market.
4. There are no Barriers to Entry or Exit.
5. Firms are Profit maximizing.
6. Firms are Price Takers due to the Perfect Knowledge available. 

Explanation:

The single firm takes its price from the industry and is referred to as a price taker. The industry is made up of all firms in the industry and the market price is where demand is equal to supply. Each single firm must charge this price. Any other price will lead to consequences which will have a negative impact on the business.

Under perfect competition, firms can make abnormal profits or losses.

However, in the long run firms are attracted into the industry if businesses are making abnormal profits. This is due to the availability perfect knowledge and the lack of barriers to entry. The effect of this entry into the industry is to shift the supply curve to the right, which decreases price until there are no abnormal profits anymore. If firms are making losses, they will leave the market as there are no exit barriers, and this will shift the supply curve to the left, which increases price and enables those left in the market with just normal profits.

Advantages:

1. No monopoly power
2. no information failure
3. allocatively and productively efficient
4. more choice
5. lower prices (as compared to other market structures)

Disadvantages:

1. No abnormal profits possible - no dynamic efficiency.
2. less choice to consumers - due to less product differentiation.
3. benefits of economies of scale are lost.
4. no profits for research and development.

Examples:

 - Agricultural markets.

In some cases, there are several farmers selling identical products to the market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect competition.

 - Financial markets

eg. Currency markets.

Sources: http://www.economicsonline.co.uk/