Next video:
Loading the player...

Perfect competition is a theoretical market structure in which competition is at its greatest possible level. Some markets, such as stock exchanges and commodity markets, approximate perfect competition. But a true state of perfect competition in a market is not attainable in real life. In theory, if perfect competition existed, resources would be allocated in the most efficient way possible. As a concept, though, perfect competition is useful because it functions as a standard to measure the efficiency and effectiveness of real world markets.

A perfectly competitive market contains these 5 elements:

1) All firms sell an identical product; 2) All firms are price takers - they cannot control the market price of their product because price is determined by supply and demand; 3) All firms have a relatively small market share; there are no monopolies; 4) Buyers have complete information about the product being sold and the prices charged by each firm; and 5) The industry is characterized by low barriers or no barriers to enter and exit an industry.  

As an example of a perfectly competitive market, imagine a group of fishermen who all sell the same type of rainbow trout at a local market.

Each stand at the market sells each rainbow trout at $1.00. This is just enough for each fisherman to pay for his costs and have enough money to live on. Now assume all the fishermen get together and agree to raise the price of each fish to $1.50 so they can make more money. This strategy only works for a short period of time due to the very low to non-existent barriers of entry to the fishing business. (The up-front investment in becoming a fisherman is relatively low). New fishermen know that they can make money selling each fish for $1.00. These new fishermen can easily set up their own stands at the local market and start selling rainbow trout for less than the $1.50 collusion price. Very shortly, because of perfect competition, fish prices at every stand return to $1.00, as their product won’t sell at the inflated price. 

Related Articles
  1. Small Business

    Understanding Competitive Pricing

    Competitive pricing is the practice of setting prices for products or services based on what the competition charges.
  2. Insights

    Competitive Advantage Counts

    What's the best indicator of a company's future success? Its ability to succeed when others fail.
  3. Investing

    Alphabet, Inc. Helps Crack Down On Illegal Fishing

    Google has partnered with non-profits to use a big data approach to solve the illegal fishing problem.
  4. Investing

    Perfect Stocks Based on Book Value (HDNG, CLMS)

    Searching for perfection can improve long-term returns.
  5. Investing

    Capital Intensive Companies: What Are The Pros & Cons for Investors?

    Learn about the pros and cons of investing in capital-intensive industries. Find out how barriers to entry and mature industries impact investment outlook.
  6. Financial Advisor

    Think You Can Stomach the Perfect Investment?

    When it comes to investing, great long-term track records are not immune from pullbacks, but try telling that to any investor.
  7. Investing

    Avoid These Overvalued Blue Chips with Poor Financials (APA, CBS)

    When you are looking for bargains in the stock market, limit your buying to stocks with a verified strong fiancial condition.
Hot Definitions
  1. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  2. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  3. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  4. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
  5. Dilution

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
  6. Agency Problem

    A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The problem ...
Trading Center