Perfect competition in economic theory refers to a market that does not have sufficient participants to have market power for setting prices of homogenous products. For a market to have a perfect competition, there are criteria that must be met.
In a market with perfect competition, an identical product must be sold by all firms. All companies have to be price takers. This implies that the companies cannot control price of the product in the market.
Each firm must have a market share that is relatively small. Complete information of the product that is being sold as well as the prices that each firm is charging must be available to buyers. Freedom of exit and entry into the industry must also exist for a market to have perfect competition.
Some people call perfect competition pure competition. Basically, perfect competition refers to a market structure model that is used as the benchmark for comparing market structures in real-life. In real life, the only industry that resembles a perfect competition closely is agriculture.
Nevertheless, monopoly is the opposite of perfect competition. In monopoly, a particular service or good is supplied by one firm. The firm supplying the service or good has the freedom to change the price when it wants since there are no alternatives for consumers. Entering marketplace is also not easy for the would-be competitors.
Perfect competition envisions a situation where several sellers and buyers as well as prices are a reflection of demand and supply. Additionally, there are many substitutes for consumers in case the service or good that they would like to purchase is sold at a price that is too high or quality not pleasant. Entry to the market is easy for new firms which generates more competition.
In perfect competition, firms make profit that is just enough to enable them to remain in business. Companies are not able to make excess profits because if they do, other firms would venture into the market driving profits down to minimum levels.
In real world, competition is extremely different from the perfect competition model in different ways. In the real world, companies attempt to make products that are different from the ones produced by competitors. In an attempt to obtain a larger share in the market, firms advertise their products. To win customers from their competitors, firms cut prices and raise prices hoping to make more profits. There are also forms that are sufficiently large making them capable of affecting prices in the market.
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