Microeconomics: core concepts and principles

Microeconomics

Perfect competition is a theoretical concept, representing ideal market conditions. It is typically used as a template against which existing markets are evaluated. There are six conditions that characterize perfect competition. An analysis of these will reveal that very few, if any, markets in the world today meet these conditions.

The first characteristic of perfect competition is that all firms sell an identical product. Product differentiation is one of the main ways in firms compete in modern economies. This differentiation has been facilitated by technological advancements that allow even basic products to be produced in slightly different ways. Even within agriculture, for example, bioengineering has allowed for differentiation within vegetables and meat, products traditionally viewed as commodities. It is important to remember that in perfect competition, not only must the products be homogenous, but the consumer must view them as such. If firms establish a premium position for an otherwise homogenous product - for example bottled water or "sea" salt (all salt derives from the ocean originally) - perfect competition is lost.

The second characteristic of perfect competition is that all firms have a relatively small market share. When one or more firms establish a dominant market position, they are able to leverage this to drive factor costs down, giving them a competitive advantage. Should they become so large as to constitute an oligopoly or monopoly, they can drive costs to the consumers up, again eliminating perfect competition. The rise of the modern capital markets has allowed for firms to grow sufficiently large as to gain these advantages. Only industries that have not experienced this have the potential for perfect competition.

The third characteristic of perfect competition is that the buyers have perfect information. If they do not, the sellers can leverage this to extract higher prices. Perfect competition implies that buyers and sellers have the same degree of bargaining power. This requires them to have the same information. The marketplace of the 21st century is of almost infinite complexity, which presents a strong barrier with respect to consumers' ability to gather information.

The fourth characteristic of perfect competition is that there are no entry or exit barriers. Firm are able to come and go from the market with ease.

Entry barriers inhibit competition by restricting the number of competitors. Moreover, they imply some form of competitive advantage, something which cannot exist in perfect competition.

Exit barriers provide incentive for firms to engage in competitive behavior that they would otherwise not engage in. The deviation from the expected is an imperfection, so exit barriers represent a deviation from perfect competition.

The fifth characteristic of perfect competition is that all firms have equal access to resources. Unequal access would provide a competitive advantage for one firm over another, a situation which by definition cannot exist in perfect competition. In the modern world access to resources is affected by, for example, credit ratings (access to capital), unequal access to higher education (access to knowledge), legal considerations (unequal access to legal services) and unequal access to many other key inputs. This is in part caused by increases in complexity of both the inputs themselves and of the systems by which we derive access to those inputs.

The sixth characteristic of perfect competition is the lack of externalities in production or consumption. Any externality can upset the competitive balance. Perfect competition represents a situation where buyers and sellers bargain directly; externalities are influencers on this process and therefore by definition interfere with the condition of perfect competition. Changes in communication, education, transportation and political structures have resulted in significant influence of externalities in most market situations in the world today.