Perfect competition is considered an idealized model of a market economy. This is a market structure where sellers and buyers adapt to existing market conditions and cannot influence the price, but form it with their total contribution to market demand and supply.
With this model, competition between sellers reaches its peak. Since market participants have virtually no influence on the terms of sale, the economy becomes resistant to the emergence of inflation, unemployment and other negative processes.
Perfect competition market conditions
We have listed the main features of a perfectly competitive market. These are necessary and sufficient conditions for their emergence and functioning. What should you pay attention to here?
[1]. “SPONTANEOUS” , chaotic formation of prices for products. Any expansion on the part of larger producers may result in an unjustifiably sharp rise or fall in prices, which is contrary to the conditions under which pure competition can exist.
The share of each (even the largest) participant in a perfectly competitive market should be INsignificant and ideally be reduced to an arithmetic error.
None of the participants should physically influence the formation of prices for certain products. Demand for products must be perfectly elastic. Graphically, this demand corresponds to a horizontal line (parallel to the x-axis).
[2]. MOBILITY of market participants. Each of them should be able to freely enter and just as freely exit the market. And at any time and under any circumstances.
[3]. HOMOGENEOUSNESS and standardization of a particular type of product or service: many companies produce the same microcircuits, baseball bats or ballpoint pens. However, the cost of production will not always be the same.
The price of these goods will largely depend on labor productivity at specific manufacturing enterprises, the level of wages and other costs, and the cost of production (that is, solely on economic, not administrative factors).
[4]. AWARENESS of perfect competition market participants about prices for goods and services is the next condition for its existence.
All buyers and sellers, without exception, must have equal access to relevant information and make decisions about the purchase or sale of goods (including investment decisions) in conditions of absolute clarity and certainty.
[5]. EQUALITY of opportunities and powers for each of its participants and FAIRNESS of competition.
No one should take advantage of unjustified advantages or benefits, or enter into illegal collusion with other market participants in order to “unsettle” the prices of goods and services in one direction or another.
The features noted above are the cornerstone conditions for the emergence, functioning and maintenance of any perfect competition market in a working state, so to speak.
Three types of competition
Direct competitors
This type of competition occurs whenever there are other businesses within the same market sector that offer the same products and services as your company. You are directly competing with each other in terms of location, target audience reach and your products. In case of direct competition, your customer relationship management plays an important role in gaining market share. If a customer receives excellent service from a company, they are unlikely to switch to a competitor.
Indirect competitors
This type of competition occurs when someone from another company takes a customer away from you by offering products or services that are not in your range. For example, for cinemas, the Internet and cable television become an indirect competitor. A certain part of the target audience is given the opportunity to watch movies in good quality exclusively at home. Thus, this type of competition forces the establishment of barriers to luring customers.
In the case of indirect competition, your marketing strategy should include a more extensive commercial offer, and you should conduct active promotions so that the client cannot ignore you.
Competitors are phantoms
This phenomenon occurs when, instead of buying your service or your product, the client is going to buy something completely different. This type of competition involves offerings from companies that do not exist in the typical customer mindset. For example, in the above example, instead of going to the cinema, the client, coming to the shopping center, can easily change his plans. He may get carried away with shopping or, meeting friends, spend time with them in a cafe having a friendly conversation. At this point, the client changed his plans and did not spend his money with your company.
Screening such competitors is very difficult to do because it is entirely in the minds of the customers. Marketers are aware of direct and indirect competitors, but if a product has too many phantom competitors and your offer ends up being ignored by the potential customer, then the product or service will have a very short life cycle. Against phantom competitors, more engaging promotional activities are needed.
In-Depth Characteristics of Perfect Competition
The perfect competition model is based on three assumptions: (1) the pricing nature of all market participants, (2) undifferentiated/standardized products, and (3) no barriers to entry or exit.
#1. Taking prices for granted
With perfect competition, all market participants (both producers and consumers) influence price formation. Each of them takes the market price as given.
If a manufacturer tries to sell a product at a price higher than the market price, he will not be able to sell anything. In conditions of perfect competition, no firm is able to independently determine the market price.
This does not mean that the market price cannot change. It can only change as a result of the collective movement of the market as a whole, and not as a result of the actions of any one producer or consumer.
Even though the market demand curve is downward sloping, the demand curve faced by each individual firm is horizontal.
For each firm, the contribution margin (the additional income received from selling one additional unit) is equal to the current market price.
#2. Product uniformity
The second most important determinant of perfect competition is the nature of the product.
Perfect competition occurs only when the product traded in the market is homogeneous, that is, standardized in such a way that the buyer cannot tell the difference between the products of firm A and firm B.
Because of the standardized nature of the product, the units produced by Firm A and Firm B are perfect substitutes.
If there is a difference in quality, or even the perception of a difference, consumers may be willing to pay a premium to the firm whose quality they perceive to be higher.
If a perfectly competitive market introduces differentiated products, then it is more like monopolistic competition.
#3. No barriers to entry or exit
Under perfect competition, incumbent firms cannot prevent new firms from entering the market or existing firms from leaving the market.
There are no patents, copyrights, or other legal or economic barriers such as economies of scale, increasing returns to scale, and so on, for new entrants to enter the market.
No firm will earn positive economic profits in the long run. If the market is profitable in the short term, new firms will enter the market and this will return the market to zero economic profit.
If existing firms suffer losses, some of them will exit the market and the remaining firms will begin to earn zero economic profit.
Market model of economic relations
Definition 2
Economic relations are connections established between economic entities in the process of social reproduction.
The development of economic relations between people is directly related to the formation of the human community. For a long time there was a traditional method of farming, which was based on subsistence communal ownership of property. State authorities determined distribution and sales channels. The standard of living of the population was quite low. At the same time, the main income was generated through agriculture, as well as folk arts and crafts. This model of relations was typical for most states that adhered to monarchical power. Nowadays, the traditional form of economic management has been preserved in underdeveloped countries dependent on foreign investment. The main sources of income for such countries are agriculture and handicrafts. They are not competitive in the global market.
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Another model of economic relations can be called a planned-command model. It was typical for countries that sought to introduce the ideology of communism. In the planned model, the leading role in the economy is also assigned to the state, and it controls all areas of economic activity, including consumption. The basis of a command economy is collective property, that is, all existing property belongs to the people. However, the legal entity capable of managing property and carrying out activities related to its use is the state.
The command-planning model is characterized by centralization of resources, direct administrative intervention in the creation, distribution, marketing and consumption of finished goods. Cash flows are also first concentrated in the hands of the state, and then distributed depending on the goals and objectives implemented by the state authorities. Less significant sectors of the national economy are financed on a residual basis.
The emergence of capitalist relations contributed to the development of market relations. The market business model has the following features:
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- Variety of forms of ownership.
- Private interest and freedom of choice.
- Free pricing.
- Private property.
Note 1
The freedom of economic entities in a market economy gives rise to competition. Competition is the struggle between economic agents for more favorable living conditions and maximizing profits.
Most modern countries of the world adhere to a mixed model of relations, that is, national economic systems include elements of all of the above forms.
An example of perfect competition in agriculture
The Burenka enterprise is one of 250 exactly the same enterprises in the agricultural sector that grow wheat.
There are about 50 companies that buy wheat from the market, including bakers, flour mills, wholesalers, retailers and so on.
When determining whether a market is perfectly competitive, the following three questions need to be asked:
- Is the number of buyers and sellers so large that one (or even more) of them cannot influence the market price?
- Are there any new firms that are prohibited from entering or exiting the market?
- Do consumers give preference to wheat produced by the Burenka enterprise over any other wheat, say, produced by the Muravushka enterprise?
What happens if Burenka tries to sell wheat for $200 a ton while all other farms are selling it for $180? Nobody will buy from Burenka while they can buy at a price of $180.
Thus, Burenka cannot influence the market price. Our first condition for perfect competition is satisfied.
Since there are no restrictions on the type of crop in the agricultural sector, farmers can switch from other crops to wheat or from wheat to other crops. This circumstance satisfies the second requirement of the perfect competition model.
Since wheat is wheat, the consumer cannot reasonably choose the wheat from farm A over the wheat from farm B. This means that the third condition is also satisfied.
We can conclude that the market described above represents perfect competition.
An example from the sugar processing industry
Now let's look at companies specializing in sugarcane production. Let there be only one sugar factory for 100 such companies in the district. However, the cost of transporting sugarcane to any other area is too high.
Since there is only one buyer, the market does not satisfy the first condition of perfect competition. This is effectively a monopsony, a market structure in which there is only one buyer and a few producers.
