Perfect Competition

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What is 'Perfect Competition'

Perfect competition is a market structure in which the following five criteria are met: 1) All firms sell an identical product; 2) All firms are price takers - they cannot control the market price of their product; 3) All firms have a relatively small market share; 4) Buyers have complete information about the product being sold and the prices charged by each firm; and 5) The industry is characterized by freedom of entry and exit. Perfect competition is sometimes referred to as "pure competition".

BREAKING DOWN 'Perfect Competition'

Perfect competition is a theoretical market structure. It is primarily used as a benchmark against which other, real-life market structures are compared. The industry that most closely resembles perfect competition in real life is agriculture.

Perfect competition is the opposite of a monopoly, in which only a single firm supplies a particular good or service, and that firm can charge whatever price it wants because consumers have no alternatives and it is difficult for would-be competitors to enter the marketplace. Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Also, consumers have many substitutes if the good or service they wish to buy becomes too expensive or its quality begins to fall short. New firms can easily enter the market, generating additional competition. Companies earn just enough profit to stay in business and no more, because if they were to earn excess profits, other companies would enter the market and drive profits back down to the bare minimum.

Real-world competition differs from the textbook model of perfect competition in many ways. Real companies try to make their products different from those of their competitors. They advertise to try to gain market share. They cut prices to try to take customers away from other firms. They raise prices in the hope of increasing profits. And some firms are large enough to affect market prices. But the perfect competition model is not an ideal that we should try to achieve in the real world.

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