What is a Perfect Competition
When no manufacturer may affect the market price, perfect competition exists. In a perfect market, there are numerous tiny firms that all produce the same product and are all too small to influence the market price. Complete or perfect competition refers to a market condition in which a significant number of market participants have no price control, i.e. the price is fixed and new businesses can easily enter the market.
Assumptions of Perfect Competition
1. Price taking
2. Product homogeneity
3. Free entry and exit
Because there are so many companies competing in the market, each product has a number of direct competitors. Because individual company sales account for such a small portion of the market, their actions have no bearing on market prices. As a result, each company defaults to market prices. Individual enterprises are thus price-takers in a perfectly competitive market.
In markets where companies provide identical or nearly identical items, price takeovers are most common. When all of the products on the market are perfectly interchangeable, or homogeneous, no company can raise its product's price above the competition without seeing a major drop in sales. Most agricultural goods (corn, wheat, barley, etc.) are homogeneous, as are oil, gasoline, and raw materials such as copper, iron, wood, cotton, and so on. Such homogeneous things are referred to be commodities by economists. All of these items have the same characteristics, and if some businesses decide to raise their prices, their sales will decrease.
Free Entry and Exit
A situation in which there are no constraints in the form of specific charges that would make it difficult for companies to enter (leave) a branch is defined as free entry and exit. Customers can simply switch suppliers, and suppliers can enter and exit the market without difficulty. A new company entering the market does not have to invest a big sum of money, making it simple to quit if it begins to lose money.
Profit of a Completely Competitive Business
The product of the selling price and the amount sold equals the company's total income. When we divide the total income by the number of products sold, we get the average income, which shows us how much money the company makes from the average unit of product sold. When perfect competition exists, the average income is equal to the cost of a good.
AVERAGE INCOME = TOTAL INCOME / QUANTITY
AVERAGE INCOME = (PRICE x QUANTITY) / QUANTITY
AVERAGE INCOME = PRICE
The difference in overall revenue generated by the sale of an additional unit of goods is referred to as marginal revenue. The marginal revenue of competing enterprises is equal to the price of a product. A competitive company's goal is to maximize profits.
In general, and across all market arrangements, it is true that in order to maximize profits, companies:
1. A preference for maximizing the difference between total revenue and total cost
2. Profit will increase as long as the increased revenue from the production/sale of the new unit of output (marginal revenue) exceeds the additional cost of the additional unit of output (marginal cost), and vice versa.
To put it another way, profit is the greatest when the gap between total revenue and the total cost is the greatest, i.e. when marginal revenue equals marginal cost.
In perfect competition, resources are allocated efficiently, according to neoclassical theory. In such circumstances, the consumer's utility has reached its maximum, and it can be demonstrated that the marginal utility of consumption of a commodity (the utility that an individual derives from consuming an additional unit of a thing) is equal to the price of that good. The marginal cost of production of a good (the cost of an additional unit of production) is equal to its price if the enterprise's theory behavior implies that profit is maximized. In a perfect market, marginal cost and marginal benefit will be equal to the price of some good in equilibrium. The Pareto resources are therefore efficiently distributed, meaning that redistribution between enterprises or consumers will not boost the production/usefulness of one good while diminishing the production/usefulness of another. However, there are times when the market is not Pareto efficient, which are referred to as market failures. The state then intervenes to try to fix market failings, which is considered justifiable. Monopolies, public goods, externalities, and information inadequacies are the most common types of market failures. Inefficiency develops when competition is limited. To make more money, the producer cuts production and raises the price. Prices are rising above marginal cost, capacity is underutilized, and production is falling short of expectations. Prices no longer reflect a relative scarcity of resources and, as a result, can no longer be used to drive effective resource allocation. The government must therefore protect consumers and regulate monopolistic behavior, i.e. set the price at which the monopoly can operate.
The Efficiency and Fairness of a Perfect Competition Market
A market economy is effective if it achieves allocative or Pareto Efficiency, which is defined as the inability to better one's position without harming another. In that circumstance, the economy has reached its output capacity limit.
If three conditions are met, economics achieves allocative efficiency:
1. When a consumer's price equals their marginal utility, they obtain maximum satisfaction.
2. That producers optimize their earnings by setting the price at the same level as their marginal costs.
3. That the last spent unit's social marginal utility is equal to its social one marginal cost of production.
Conditions for the Best Result
1. There must be incomplete competition or monopoly;
2. There must be no negative externalities, in which individual enterprises shift costs to a profit-making company without paying a charge;
3. There must be full information about all market participants.
Economic surplus is achieved through achieving allocative efficiency (profit from the exchange). The consumer's surplus (surplus utility over the price paid by the consumer) is equal to the producer's surplus (surplus producer income over costs). A fully competitive market can attain efficiency, but not equal sharing in accordance with society's ethical principles. As a result, the conclusion arises in a manner of a decision that has to be made: What is it going to be EFFICIENCY OR JUSTICE? Due to the nature of the problem the issue is not only economic but political and ethical as well, thereafter economics alone is not able to solve it. Because a market guided by an invisible hand does not provide ideal outcomes, the state's visible hand is required to intervene to address the market's deficiencies. The government can intervene directly or indirectly. The state's direct participation consists of price-fixing. Indirect intervention, which comprises taxes and transfer payments, allows the market to function successfully without restricting price movements. Numerous examples indicate that indirect state involvement is more effective than direct state intervention.
What would be your choice? We are sure that there are different standpoints that could potentially offer a more suitable modern economic perspective? Feel free to leave your opinion below in the comment section.
WEB: An Introduction to Business (v. 1.0) - Creative Commons Karen Collins,
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