BASIC CONCEPTS OF
PERFECT COMPETITION/COMPETITIVE MARKETS
OR
"THE COMPETITIVE IDEAL"

We use the "competitive ideal" because it is an excellent benchmark against which to compare actual results in actual markets. The processes which characterize virtually all markets are first understood best by thinking about them in the framework of a competitive market. Of course, the "competitive market" is part of American ideology and Americans are first and foremost in advocating and advancing "free markets" to the rest of the world (often in its private property guise of "capitalism"). So on many levels it behooves us to study the process of competition.

At first we need to think of competition in its strict form, called "perfect competition." Economists have a careful definition of what they mean when they say "perfect competition." There are several characteristics of perfect competition:

  1. Many buyers and many sellers, none of which has sufficient market power to have any perceptible influence on the market price by their own actions, no matter how much they buy or sell.
  2. A homogeneous (identical) product: no matter who produces the product. Consequently, buyers don’t care from whom they purchase the product–there is no difference from one source to another. And there is nothing that producers can do to differentiate their product from that of their competitors. (Consequently, one doesn’t see advertising in such markets.)
  3. Freedom of entry and freedom of exit (including the freedom to go bankrupt!) in the "long run." New firms can enter profitable markets and there are no significant barriers to their doing so in the "long run" (long enough to get a business established–up and running). Existing firms will be seen leaving unprofitable markets–there is no government subsidy or other external means of propping them up such as import tariffs.
  4. Perfect information: Alternatives are widely known and available: (1) to consumers, who know all the sources from which they can buy a good or service, the quality of each source, and the price from each source; (2) to producers, who know all the sources of inputs–labor and materials–which they use, the quality of each, and the price from each.
  5. Technology is widely known and available to all. This means that knowledge diffuses quickly through the industry and keeps cost structures the same for competitive firms in this competitive market. Thus, firms look basically alike.

Keep constantly in mind throughout the chapter this comparison: What is happening in the "broader market"? And what is happening at the level of the "typical competitive firm"?

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