Perfect competition and Pareto efficiency are separate theoretical economic constructs. Specifically, perfect competition provides the framework for a Pareto-optimal event to arise. A market achieves Pareto efficiency when it becomes impossible to improve one party without making one party worse off.

Hypothetically, if resources were used to their maximum efficient capacity, or perfect competition, then everyone would be at their highest standard of living, or Pareto efficiency. Neoclassical microeconomics uses both of these concepts as benchmarks to judge the efficiency of real markets. Neither outcome is experienced outside of economic theory.

Perfect Competition

Perfect competition models place incredibly rigid parameters onto markets. For perfect competition to exist, there must be enough buyers and sellers of equal power so no one actor has any control over prices. It must be costless to enter or exit any market. All parties have perfect information and clear foresight. There are no long-run economic profits in a perfectly competitive market.

The most paradoxical parameter in perfect competition is that all goods must be homogeneous and have no clear substitutes. In other words, there is no reason to select one good over another. Competition is said to be "perfect" when all of the potential causes for competition are assumed away.

Pareto Efficiency

Italian economist Vilfredo Pareto believed an efficient economic outcome arises when one party is made better off and no other party is made worse off. These events came to be known as "Pareto improvements."

Pareto further stipulated that the most efficient market would lead to a situation where no one party could be made better off without harming another party. This concept is also related to productive efficiency; a Pareto-optimal production level rests on the outermost portion of the production possibility frontier. Pareto improvements refer to standards of living and should not be confused with benefits from trade under the subjective theory of value.

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  2. Are perfect competition models in economics useful?

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  3. What factors influence competition in microeconomics?

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  4. Why are there no profits in a perfectly competitive market?

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  5. What is the difference between perfect and imperfect competition?

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  6. How does marginal utility relate to indifference curves in microeconomics?

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