Perfect Competition

Overview

Description

Perfect competition is an economic model that describes a market wherein all participants are free actors with perfect knowledge of market conditions, there is no barrier for firms to enter or exit from any market sector, the goods produced are identical, and profit and loss tend toward zero over time. Although perfect competition can never be completely attained, it is still a concept economists find useful in delineating conditions under which a market may approach perfect efficiency. In perfect competition, the price of goods or services approaches equality with the marginal cost of producing those goods or services and overall output changes to perfectly align with demand.

At A Glance

  • Perfect competition is a theoretical market state wherein there are many buyers and sellers, there are no barriers to entry, goods are identical, and economic profits tend toward zero in the long run.
  • In a state of perfect competition, demand is essentially unlimited for any particular firm's products at the prevailing market price.
  • Marginal revenue is the amount of additional revenue that a company earns from selling one additional unit of its product.
  • Companies in perfect competition maximize profit by increasing their output until marginal revenue equals marginal cost.
  • In a situation of perfect competition, whether a company earns profits or suffers losses depends on whether a price is greater or less than the average cost of production.
  • Experiencing a loss does not necessarily mean a company should shut down production. Whether to shut down depends on whether revenue is great enough to cover the average variable cost of production.
  • In a situation of perfect competition, the supply curve for an individual firm is equal to the marginal cost curve, above a minimum point on the average variable cost curve.
  • Under perfect competition, in the long run the cost of production will approach the lowest possible cost per unit, profits and losses will tend toward zero, and prices will fall to the point of generating maximum efficiency in the market.
  • Because there are no barriers to entry or exit from markets under perfect competition, firms tend to move to the markets in which they can maximize profit. The eventual effect of this freedom of movement is to move toward an equilibrium state where neither profit nor loss is earned by production and sales of goods or services.
  • The theoretical situation of perfect competition is called perfect because it leads to maximum efficiency in the marketplace.