Perfect Competition

An idealized market structure with the following assumptions: (a) buyers and sellers have perfect knowledge of what is going on in the market place, (b) there are many buyers and sellers, (c) there is unrestricted entry into and out of the market, (d) the good in question is homogeneous (of the same quality), and (e) the seller of the product has limited or no control over the price (price taker) in the marketplace because of competition. The perfect competitor, therefore, faces an infinitely elastic demand curve, which is equal to his or her marginal revenue and average revenue.

The idealism of perfect competition serves the useful theoretical purpose of explaining why competition in the marketplace leads to an efficient outcome in the long run when all inputs are variable. Profit maximization, which is attractive in the short run because of the lack of restrictions to entry and the potential to earn economic profit, will allow other firms to enter the market. As firms enter the market, the available profit will be competed away, and some firms will exit the market. In the long run, the price that will prevail in the market will be equivalent to the least per unit cost (productive efficiency) and the cost of the scarce resources used to produce a good in alternative markets (allocative efficiency). For more information, see McConnell and Brue (2008), Salvatore (2002), and Schiller (2006).