A market or industry is considered under perfect competition if it has a sizeable number of producers or sellers offering homogenous products to a large number of consumers or buyers. These are the fundamental characteristics of this market structure.
Some of the characteristics of this structure are also similar to monopolistic competition. These include low entry and exit barriers, as well as the prevalence of anti-competitive regulations. However, it has notable advantages, as well as disadvantages.
Pros: Advantages of Perfect Competition
Note that perfect competition is a situation in a market in which there is a sizeable number of well-informed sellers and buyers that leave no room for elements of oligopoly and monopoly. Furthermore, because of their number, the prices of the particular products in this market are free from the influence of individual sellers and buyers.
Below are the specific advantages of this market structure:
• Insignificant Entry and Exit Barriers: One of the notable advantages of perfect competition is that the barriers to both entry and exit are too low that they are considered insignificant. Firms can readily compete in the market or exist as they please. This benefits the entire market because it promotes healthy competition while also giving consumers more options to choose from.
• High-Quality Products with Low Price: Products in this market structure have high quality because of industry-wide standardization. These products also have low prices. There is no incentive for producers or sellers to increase their prices because doing so would drive away their customers and affect their market share.
• Availability of Market Information: Costs associated with searching product-related information are often low or negligible. Remember that products in this structure are perfect substitutes for one another because they are homogenous and standardized. Switching cost is also insignificant. Producers or sellers also do not need to spend much or invest in marketing and advertising.
• Efficient Utilization of Resources: Producers or sellers earn a small profit margin because they cannot increase their prices. Nevertheless, to maximize their earnings and profitability, they are compelled to develop and implement strategies aimed at ensuring that their operations are as cost-efficient as possible.
• Promotes the Welfare of Consumers: This structure is also consumer-oriented rather than profit-oriented. Misleading advertising is absent. There is also little room for monopoly because of the sizeable number of producers or sellers offering homogenous products. No single producer or seller can influence prices. The chance of exploitation is low because the bargaining powers of customers are high.
Cons: Disadvantages of Perfect Competition
This market structure sounds idealistic from its name alone. However, it is not “perfect” in the sense that it is not without faults or more specifically, drawbacks, issues, and limitations, especially when compared to other market structures such as monopolistic competition, as well as oligopolistic and monopolistic structures.
Below are the specific disadvantages of this market structure:
• Limited Profitability for Sellers: Remember that the profit margin of producers or sellers in this market structure is low because of the large number of competitors. This compels them to find strategies aimed at maximizing their earnings. Most of these strategies center on cost leadership through optimal utilization of resources, efficient production, and streamlined operational processes, among others.
• Absence of Consumer Options: Product differentiation is one of the major advantages of monopolistic competition. However, in perfect competition, because products are identical and are perfect substitutes, consumers have no other choices or options. This market structure does not cater to different preferences.
• Few Incentives to Innovate: Another disadvantage of perfect competition is that it does not entice producers or sellers to innovate. Their low profit margin means that there are little earnings for research and development. Investing in innovation to achieve competitive advantage can also be futile because of their limited profitability, limited market share, and the sheer number of market competitors.
• No Chance for Economies of Scale: It is also impossible for a single producer or seller to achieve and maximize the advantages of economies of scale. Both the large number of competitors and the limited market share of each mean that it is impossible for a particular producer or seller to reach economies of scale.
• Impossible to Exist in Reality: Note that this market structure remains theoretical. It is impossible to exist and persist in the real world, particularly in markets or industries operating in market economies. Firms or sellers are both incentivized and compelled to act on their traditional social responsibility of maximizing their profitability or meeting and expanding further their earning potentials.