If all the rules we set above were applied, how would you set the price of the good you're selling? If you try and sell at a higher price than your competitors, you will be out of the market in no time. On the other hand, you can't afford to set it at a lower price. Hence, you choose to take the price as the market sets it. More specifically, the price that the perfectly competitive market sets it.
Read on to find a definition of a perfectly competitive market, and find out whether it exists or not in the real world.
Perfectly Competitive Market Definition
The definition of a perfectly competitive market is a market that consists of many buyers and sellers, and none of them are capable of influencing the price. A market is where buyers and sellers meet and exchange goods and services. The number of sellers and goods exchanged in the market, and the price, depends on the type of market.
A perfectly competitive market is a type of market in which all available goods and services are identical, there are no restrictions on who can enter the market, and there are a substantial number of buyers and sellers, none of whom can influence the market price.
A perfectly competitive market is the opposite of a monopolistic market, in which a single company offers a particular good or service. The company in a monopolistic market is capable of influencing the price. That's because consumers in a monopolistic market do not have other options to choose from, and new firms have entry barriers.
We have covered the Monopolistic Market in detail. Feel free to check it out!
A perfectly competitive market structure would allow any firm to enter the market without an entry barrier. This then prevents any firm from influencing the price of the good.
For example, think about an agricultural company that sells apples; there are many apples out there. If the company decided to set a high price, another company would enter the market and offer apples for a lower price. How do you think consumers would react in such a scenario? Consumers will choose to buy from the company that provides apples at a lower price as it is the same product. Hence, firms can't influence the price in a perfectly competitive market.
There are some critical characteristics of a perfectly competitive market:
- Buyers and sellers are price-takers
- All companies sell the same product
- Free entry and exit
- Buyers have all available information.
- Perfectly competitive markets do not really exist in the real world, as it is hard to find markets that meet all these characteristics. Some markets may have some of the traits of a perfectly competitive market but violate some other features. You could discover free entry and exit markets, but those markets don't provide all the available information to buyers.
Although the theory behind a perfectly competitive market is not applicable in reality, it is a helpful framework for explaining market behaviors in the real world.
Characteristics of a Perfectly Competitive Market
A perfectly competitive market has four essential characteristics as seen in Figure 1: price taking, product hom*ogeneity, free entry and exit, and available information.
Whenever a market meets all four characteristics simultaneously, it is said to be a perfectly competitive market. However, if it violates only one of the characteristics, the market is not in perfect competition.
Characteristics of a Perfectly Competitive Market: Price-Taking.
Companies in a perfectly competitive market have many competitors who offer the same or similar products. As many companies provide the same product, a company cannot set a price higher than the market price. Additionally, the same company can't afford to set the price lower due to the cost of producing the product. In such a case, the company is said to be a price-taker.
Price takers are firms in perfect competition that can't influence the price. As a result, they take the price as given by the market.
For example, a farmer that produces wheat faces high local and international competition from other farmers who grow wheat. As a result, the farmer has little space for negotiating the price with his customers. His customers will buy from elsewhere if the farmer's pricing is not competitive with other farmers.
Characteristics of a Perfectly Competitive Market: Product hom*ogeneity.
Product hom*ogeneity is another crucial characteristic of a perfectly competitive market. Firms are price-takers in a market structure where several other firms produce the same product.
If companies were to have differentiated products from competitors, it would give them the ability to charge different prices from competitors.
For example, two companies that produce cars offer cars. However, the different features that come with the vehicles allow these two companies to charge different prices.
Having companies that offer identical goods or services is an essential characteristic of a perfectly competitive market.
Most agricultural goods are identical. In addition, several types of raw commodities, including copper, iron, timber, cotton, and sheet steel, are relatively similar.
Characteristics of a Perfectly Competitive Market: Free entry and exit.
Free entry and exit is another critical characteristic of a perfectly competitive market.
Free entry and exit refers to the ability of firms to enter a market without having to face costs associated with entering the market or leaving it.
If new firms face a high cost of entering or exiting a market, it will give the firms who already are in the market the ability to set prices different from the market price, which means that firms are no longer-price takers.
The pharmaceutical industry is an example of a market that is not in perfect competition as it violates the free entry and exit characteristic of a perfectly competitive market. New companies can't enter the market easily as substantial pharmaceutical companies already hold patents and the rights to distribute certain medications.
New companies would have to spend significant money on R&D to develop their drug and sell it in the market. The cost associated with R&D provides the main entry barrier.
Characteristics of a Perfectly Competitive Market: Available Information
Another important characteristic of a perfectly competitive market is that buyers must be provided with complete and transparent information about the product.
The customer has the opportunity to see any and all information regarding the product's history as well as its current state when there is total transparency.
Publicly traded companies are required by law to disclose all of their financial information. Investors in the stock market can see all of the corporate information and the stock price fluctuations.
However, not all information is accessed by all stock buyers, and companies often do not disclose everything about their financial health; hence, the stock market is not considered a perfectly competitive market.
Perfectly Competitive Market Examples
As perfect competition does not exist in the real world, there are no perfectly competitive market examples. However, there are examples of markets and industries that are quite close to perfect competition.
Supermarkets are an example of markets that are close to perfect competition. When two competing supermarkets have the same group of suppliers and the products being sold in these supermarkets are not distinct from one another, they are close to satisfying the characteristics of a perfectly competitive market.
The foreign exchange market is another example of a real-life market close to perfect competition. Participants of this market exchange currency with one another. The product is consistent throughout since there is just one United States dollar, one British pound, and one euro.
In addition, there are a large number of buyers and sellers participating in the market. However, buyers in the foreign exchange market do not have complete information on the currencies. Additionally, there is the possibility that traders might not have "precise knowledge." Compared to experienced traders who do this for a livelihood, average buyers and sellers may be at a competitive disadvantage.
Perfectly Competitive Labor Market
A perfectly competitive labor market shares the same characteristics as a perfectly competitive market; however, instead of goods, it is labor that is being exchanged.
A perfectly competitive labor market is a type of labor market that has many employers and employees, none of whom are capable of influencing the wage.
A perfectly competitive labor market is characterized by many employees offering the same type of labor. As many employees are offering the same type of labor, they can't negotiate their wages with companies; instead, they are wage takers, meaning they take the wage set by the market.
Additionally, companies that demand labor in a perfectly competitive labor market can't influence the wage as many other companies are demanding the same labor. If a company were to offer a lower wage than other companies already offer in the market, employees might choose to go and work for other companies.
In the long term, both employers and workers would have unrestricted access to the labor market; nevertheless, an individual employer or company would be unable to influence the market wage by the activities they take on their own.
In a perfectly competitive labor market, employers and employees would have complete information about the market. In the real world, however, that is far from true.
Perfectly Competitive Labor Market Graph
In figure 2 below, we have included the perfectly competitive labor market graph.
Fig 2. Perfectly Competitive Labor Market graph
To understand the perfectly competitive labor market graph in Figure 2, you need to know how a firm sets wages in a perfectly competitive market.
The labor supply in a perfectly competitive market is perfectly elastic, meaning that there are infinitely many individuals willing to offer their services at We, which is shown in the firm graph. As labor supply is perfectly elastic, marginal cost equals the average cost.
A firm's demand in a perfectly competitive market is equal to the marginal revenue product of labor (MRP). A firm that wants to maximize its profit in a perfectly competitive labor market will set the wage such that the marginal cost of labor equals the marginal revenue product of labor (point E) in the graph.
The equilibrium in the firm (1) then translates to the industry (2), which is the market wage all employers and employees agree on.
To understand the perfectly competitive labor market graph in detail, check out our explanation!
Perfectly Competitive Market - Key takeaways
- A perfectly competitive market is a type of market in which all available goods and services are identical, there are no restrictions on who can enter the market, and there are a substantial number of buyers and sellers. None of them can influence the market price.
- A perfectly competitive market has four essential characteristics: price taking, product hom*ogeneity, free entry and exit, and available information.
- Price takers are firms in perfect competition that can't influence the price. As a result, they take the price as given by the market.
- A perfectly competitive labor market is a type of labor market that has many employers and employees, none of whom are capable of influencing the wage.
Frequently Asked Questions about Perfectly Competitive Market
What is a perfect competitive market?
A perfectly competitive market is a type of market in which all available goods and services are identical, there are no restrictions on who can enter the market, and there are a substantial number of buyers and sellers. None of them can influence the market price.
What are some examples of perfectly competitive markets?
Agriculture is a close example of a perfectly competitive market.
What are the characteristics of perfect competitive market?
There are some critical characteristics of aperfectly competitive market:
- Buyers and sellers are price-takers
- All companies sell the same product
- Free entry and exit
- Buyers have all available information.
What is the advantage and disadvantage of perfect competition?
The main advantage is free entry and exit for firms. The biggest disadvantage is that it is an ideal market structure that does not exist in the real-world.
What are the main assumption of perfectly competitive market?
- Buyers and sellers are price-takers
- All companies sell the same product
- Free entry and exit
- Buyers have all available information.
