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A perfectly competitive market is a market where businesses sell identical products, and there are no barriers to entry and exit. Perfectly competitive markets are advantageous to new market entrants who are trying to minimize the risk of the business. The new market entrant will reduce the risk of failing because the business deal in identical products that already exist in the market. Theoretical models have found that a significant equilibrium will be reached in a market with a perfect competition where the quantity demanded at the current price is equal to the quantity supplied for every product (Kononenko & Kugai, 2019). Perfect markets create a state of the economy where the production of goods and services is tailored to the consumers’ preferences. Also, perfect markets lead creates productive efficiency where an economic system that operates within constraints of industrial technology cannot increase the production of goods and services without sacrificing the production of other goods and services.
In a perfect market, no single supplier has more influence over the market price. The prices in a perfect market are determined by the demand and supply forces. Notably, in a perfect market, many businesses are under operations; this is due to the absence of barriers to entry and exit, which allow many firms to compete. A person can enter the market, and when it turns out to be unfavourable, they can easily exit (Kononenko & Kugai, 2019). This is one of the advantages of operating in a perfectly competitive market. Some examples of products that form a perfectly competitive market are agricultural products such as soybeans, corn, and wheat.
Features of Perfect Market
There are many buyers and sellers in the market; in a perfectly competitive market, the number of consumers willing and able to purchase certain products and services at a certain price is quite many. Also, many sellers and suppliers in the market are willing to sell and supply the products and services at a certain price (Komleh, n.d). And as such, no party, either sellers, suppliers or consumers, can influence the pricing of the products and services.
Homogenous products are available in the market can be used interchangeably because they are substitutes for one another. Consumers can choose to substitute one product with another. For instance, the market might sell butter and margarine, and the two products are substitute products. When the price of one substitute increases by a certain margin, consumers shift their consumption to other available substitute products.
There are no barriers to entry and exit; in a perfect market, firms can enter and exit at their convenience. Barriers to entry, such as fixed costs required to enter the market, are not present. Therefore firms find it easy to enter because they are not required to incur costs when entering the market. In a perfect market, a firm can exit at any time because there are no obstacles to be followed during exit.
All market participants have perfect information; consumers and producers in a perfect market have perfect information about the prices of goods and services. When consumers know all the information regarding the products and pricing, producers cannot exploit them. This prevents businesses from obtaining information that they will use to manipulate the prices of products in the market.
Zero transaction cost; buyers and sellers in a perfectly competitive market have the advantage of zero transaction cost. Buyers and sellers do not incur costs in conducting business transactions. This is based on the assumption that buyers and sellers come from the same locations; thus, transaction costs are unnecessary since they can meet and carry out the transactions (FajrinManik & Wahyudi, 2020).
Profit maximization of sellers; in a perfectly competitive market, sellers tend to maximize profits by selling products that are in high demand. The sellers also ensure that the marginal revenue covers the marginal costs incurred. Therefore, all sellers are wealth maxima oriented in the perfectly competitive market.
Firms in a perfect market do not incur transportation costs due to the perfect mobility factor. In the market, the factors of production are considered mobile and, therefore, free movement of works from one firm to another. It also enables the firms to make adjustments when changes in market conditions arise.
Efficiency in Perfectly Competitive Markets
During profit maximization, perfectly competitive firms combine with the maxima-utility consumers, which results in allocation efficiency and productive efficiency. Productive efficiency refers to producing products without waste; therefore, the choice will fall in the production possibility frontier. Due to the limited entry and exit barriers in the perfect markets, the prices will always be equal to the minimum long-run average cost (Gowdy, 2020). This means that goods are produced and sold to consumers and retailers at the lowest cheaper cost.
On the other hand, allocative efficiency is achieved in perfectly competitive markets that distribute goods and services optimally. The points along the possibility frontier curve are considered to be preferred socially. In perfect markets, the prices of goods and services are equal to the marginal cost of production. The price of a product is considered a measure of social benefit derived. The marginal cost incurred by a business firm is considered to measure the social cost of producing the product (Gowdy, 2020). Since the firms in perfectly competitive markets maximize profits by carrying out production at the quantity where the price will be equal to the marginal cost of production, the firms, therefore, ensure that social benefits received from the production of goods and services are in line with the social costs of production.
Market structures such as monopoly, oligopoly, and monopolistic competition are observed more in the real world than in perfect markets. This market structure does not produce the product at a minimum average cost, and their prices are usually not equal to the marginal costs. The fact that the marginal cost of production is not equal to the marginal price of the product makes the market structures to be considered inefficient because they will not produce allocation efficiency and productive efficiency (Komleh, n.d). This makes perfect markets to be more superior compared to other market structures.
Benefits Derived from Perfect Markets
Perfect markets offer participants many benefits; the first benefit is that a firm can easily enter and exit the market. A trader can start a business venture without any restrictions in a perfectly competitive market. A firm can also exit the market after achieving a target objective. Secondly, consumers enjoy lower prices because, in a perfect market structure, the prices are determined by demand and supply mechanisms. If a firm charges high prices for its products and services, the customers shift to other firms that offer lower prices. Thirdly, consumers are not exploited by sellers in the market, due to the stiff competition, no single seller has control over the market prices. Therefore sellers cannot influence the market by changing the prices (Guthmann, 2021). A perfectly competitive market is reducing the exploitation of consumers. Fourthly, sellers in a perfect market incur less promotional costs because the market deals with homogeneous products.
Furthermore, the prices are determined by demand and supply mechanisms. Therefore a firm does not require to spend a lot on product advertisement, product promotions and publicity. Lastly is the optimum utilization of resources because the profit margins are usually low due to low prices of products producers in a perfect market will strive to reduce wastage by utilizing the available resources.
Demerits of Perfectly Competitive Markets
Despite the advantages of perfectly competitive markets, there are drawbacks as well. The first disadvantage of engaging in a perfect market is the low profits because of the competition that exists in the market. Small and medium enterprises will not survive the market due to the limited profit size and lack of incentives. Secondly, due to limited barriers to entry and exit, many firms enter the market leading to stiff competition, thus limited market share and reduced profits. Thirdly, there is limited freedom of choice; perfect markets deal with inhomogeneous products and services; this limits the choice of customers because they cannot access a variety of products (Wijaya, 2020). The last disadvantage is that firms do not enjoy economies of scale because there are no economies of scale in a perfectly competitive market.
Equilibrium in Perfect Markets
Equilibrium in a perfect market is the point where the demands in the market equal the market supply. The prices of a firm are determined at the point where supply and demand are equal. The firm operating in a perfect market will achieve equilibrium when marginal cost equalizes with the price. The demand for products affects the equilibrium level in the short run, while in the long run, the equilibrium is affected by both demand and supply of products (Arora, 2021). At equilibrium, a business receives normal profits in the long run. In perfect markets, some factors are deemed to be fixed, and therefore, as the prices of other factors are provided, the cost per unit of quantity is expected to rise after a certain point.
Criticisms of Perfect Competitive Markets
Economists and researchers have criticized assumptions of the perfectly competitive markets. Economists criticize the price take assumption; it is assumed that in a perfect market, bother sellers and buyers are price takers. This makes the economic agents look passive; the concern is who sets the prices of buyers, and sellers are price takers. Therefore, the perfect market assumption is not appropriate because it does not provide the price maker in the market (Gordon, 2020). Economists, therefore, link the perfect market model to communists and capitalists.
The price theory of perfect markets has been criticized for representing passive agents as it limits active attempts by firms to maximize profits and wealth. The perfect markets are based on the assumption that no seller can set their prices because every participant is a price taker. It has been criticized that the market limits wealth maximization and individual welfare by limiting price undercutting processes, designing products, branding, and innovation. The criticism points out the lack of realism that the products are homogeneous and cannot be differentiated. Another common criticism of perfect markets is that a change in demand and supply does not necessarily cause a change in prices (Gordon, 2020). It is not true that the differences in demand and supply will cause an increase or decrease in the process in the short run.
In conclusion, perfectly competitive markets are an efficient market structure compared to oligopoly, monopolistic and monopoly market structures. The prices of products in the perfect market are determined by the demand and supply forces, and therefore sellers are not limited from overcharging. A perfect market leads to allocative and productive efficiency, an important aspect of the economy. Perfect markets protect the consumers from exploitation, save firms the cost of promotion, and enter the market and exit at their convenience, among other benefits. It is worth mentioning that perfectly competitive markets are the best forms of market structure.
Arora, C. (2021). Block-3 Equilibrium under Perfect Competition.
FajrinManik, L., & Wahyudi, D. R. (2020, February). Perfect Competition Market In Islamic Economic Perspective. In Proceeding International Seminar of Islamic Studies (Vol. 1, No. 1, pp. 822-827).
Gordon, D. (2020). Book Review: “Economics in Two Lessons: Why Markets Work So Well, and Why They Can Fail So Badly.” Quarterly Journal of Austrian Economics, 22(4), 655-659.
Gowdy, J. M. (2020). 4 Introducing Prices: Perfect Competition and Pareto Efficiency. In Microeconomic Theory Old and New (pp. 57-78). Stanford University Press.
Guthmann, R. (2021). The Illusion of Perfect Competition: The Law of One Price under Trading Frictions. The Illusion of Perfect Competition: The Law of One Price under Trading Frictions (September 13, 2021).
Kamlesh, R. A. A. (n.d). Comparison between conditions of perfect competition market and pure monopoly in supply, demand and equilibrium.
Kononenko, A. I., & Kugai, K. (2019). Competitive market types development and market concept for competitive position formation. Conceptual aspects management of competitiveness the economic entities.
Wijaya, T. (2020). Pasar Persaingan Sempurna Dan Pasar Persaingan Tidak Sempurna Dalam Perspektif Islam. Profit: Jurnal Kajian Ekonomi Dan Perbankan Syariah, 4(2), 1-16.
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