Essay on Perfect Competition

Perfect, free or pure competition is the economic model, presenting itself the idealized state of the market, where individual buyers and sellers cannot affect the price, but form it through their contribution to supply and demand (Russell & Cohn, 2012). In other words, this is a type of market structure, where the market behavior of buyers and sellers consists in adapting to the equilibrium state of the market conditions. Generally, the signs of perfect competition include (Russell & Cohn, 2012; Machovec, (1995):

• presence of infinite variety of equal buyers and sellers;
• homogeneity and divisibility of products sold;
• absence of barriers for entry or exit from the market;
• high mobility of factors of production and unrestricted freedom of movement of capital;
• equal and full access of all the participants to information (prices of goods);
• in the case, where at least one feature is missing, the competition is called imperfect.

Thus, perfect competition exists in the spheres, where a large number of small sellers and buyers of identical products are functioning, and therefore, none of them is able to influence the price of products. The existence of a large number of buyers and sellers also means that neither one of them has more information about the market than the others. Entering the market, a seller faces an already existing level of prices and has no powers to change it, because it is the market itself that dictates the price at any given moment of time. This situation allows new sellers to start manufacturing products on equal terms (price, technology, legal terms) with the existing vendors (Dietsch, 2010). On the other hand, sellers may also freely leave the market, which implies an opportunity of the untrammeled exit from the market. The freedom of market movement creates the conditions for the ongoing change in the number of producers operating in the market. At the same time, the remaining vendors will still lack the opportunity to control the market, as they represent small production, and there is still a large number of them.

In economic reality, the market of perfect competition, in its strict theoretical value described above, does not practically occur (Machovec, 1995; Dietsch, 2010). It factually represents itself a so-called “ideal” structure, meaning that free competition exists rather as an abstract idea that actually existing markets can only be more or less aimed at. However, in the economic practice, there are still markets for some commodities which fall under the criteria of this market structure most, e.g., the stock market or the market for agricultural products (Cukrowski & Aksen, 2003). Here, the number of buyers and sellers is so large and they are so small that, with few exceptions, no person or group is able to control the market for certain types of securities or agricultural products. Moreover, the products in these markets are identical in all manufacturers and the latter possess full information about the changes in the market. This confirms the need for using special “exchange” mode of operation for this particular market (agricultural commodity exchange or stock exchange).

Further, as the production of companies functioning in the perfect competition market is homogeneous, consumers do not factually care from which specific manufacturer they buy it. All products of the industry are perfect substitutes, and the cross-price elasticity of demand for each pair of companies tends to infinity (Russell & Cohn, 2012):

This means that any small price increase over the market level by one manufacturer leads to the reduction of demand for its products to zero. Thus, the difference in price can be the only reason for choosing one or another company. In this case, there is no non-price competition.

The mechanism of functioning of such a market can be illustrated by the following example. If the price of wheat increases as a result of increasing demand, the farmer’s reaction to this is to extend the field for the next year. For the same reason, other farmers will also plant large areas, as well as those who had never done this before. As a result the supply of wheat in the market will increase, which can lead to a drop in the market price. If this happens, all producers including even those who did not expand the wheat fields will have problems with selling it at a lower price.