Does Perfect Competition Exist in the Real World?

In neoclassical economics, perfect competition is a theoretical market structure in which five economic factors must be met. Neoclassical economists claim that perfect competition would produce the best possible economic outcomes for both consumers and society.

However, perfect competition is theoretical: it doesn't exist in the real world. Outside of the realm of theory, there are many significant obstacles that prevent perfect competition from existing in any real industry.

Key Takeaways

  • Neoclassical economists claim that perfect competition—a theoretical market structure—would produce the best possible economic outcomes for both consumers and society.
  • All real markets exist outside of the perfect competition model because it is an abstract, theoretical model.
  • Significant obstacles prevent perfect competition from actually emerging in the real economy.
  • Some critics of perfect competition claim that it is too theoretical to be a useful tool; others state that perfect competition is not even a desirable outcome.

Criteria for Perfect Competition

There are five criteria that must be met in order for a market to be considered perfectly competitive.

  1. All firms sell an identical product.
  2. All firms are price-takers.
  3. All firms have a relatively small market share.
  4. Buyers know the nature of the product being sold and the prices charged by each firm.
  5. The industry is characterized by freedom of entry and exit.

All real markets exist outside of the perfect competition model because it is an abstract, theoretical model. In the real world, it is impossible for all five criteria to be met exactly.

Barriers to Perfect Competition

There are many barriers that prevent perfect competition from existing. For example, one of the criteria for a market to experience perfect competition is that all firms must sell an identical product.

Theoretically, this should be easy to achieve. But in reality, most products have some degree of differentiation. Even with a product as seemingly simple as bottled water, producers will vary in their given method of purification, product size, and brand identity.

Commodities—such as raw agricultural products—come closest in terms of firms offering identical products, although products can still differ in terms of their quality. In a market where products are close to identical, such as the commodities market, the industry tends to become concentrated into a small number of large firms, a type of market structure called an oligopoly.

Another characteristic of an industry that experiences perfect competition is the freedom of entry and exit. In the real world, however, many industries have significant barriers to entry. High startup costs or strict government regulations may limit the ability of firms to enter and exit industries.

High startup costs, for example, are a characteristic of the automobile manufacturing industry. In the utility industry, there are strict government regulations that prevent new utilities from operating.

Another criterion of perfect competition is full consumer awareness of all products and their prices. This is virtually impossible to achieve in a global economy. While consumer awareness has increased as more people seek out and research information online, there are still few industries where the buyer remains aware of all available products and prices.

An online search for something as simple as a sofa, for example, produces thousands of options from manufacturers and sellers all over the world. It is impossible for any one consumer to be informed about all these products and prices.

Perfect Competition and Neoclassical Economics

Neoclassical economists believe that perfect competition creates a perfect market structure, with the best possible economic outcomes for both consumers and society. In general, though, they do not claim that this model is representative of the real world.

This has led to debates about whether or not perfect competition should be used as a theoretical benchmark for real economic markets. Neoclassical economists argue that perfect competition can be useful as a tool for analyzing and comparing the behavior of real markets to theoretical ones. Most of their analysis stems from its principles.

Many other smaller schools of economic thought disagree that perfect competition is a useful model and question whether or not–if it could be executed in real economic markets–it would provide positive economic outcomes for consumers and businesses.

Critiques of Perfect Competition

Some economists are highly critical of the neoclassical school's reliance on perfect competition. Critics of perfect competition can be broadly separated into two groups. The first group believes the assumptions built into the model are so unrealistic that the model cannot produce any meaningful insights. The second group argues that perfect competition is not even a desirable theoretical outcome.

For example, the Austrian economist and winner of the Nobel Prize for Economics in 1974, Friedrich Hayek, argued that perfect competition had no claim to be called "competition." In his critique of perfect competition, Hayek claimed that the model removes all competitive activities and reduces all buyers and sellers to mindless price-takers. Hayek's contributions to the field of economics were informed by the Austrian school of economics.

The economist Joseph Schumpeter, also part of the Austrian school of economics, noted that research, development, and innovation are undertaken by firms that experience economic profits, rendering perfect competition less efficient than imperfect competition in the long run.

Is Any Industry Close to Reaching Perfect Competition?

At times, the agricultural industry exhibits characteristics of a perfectly competitive market. In it, there are many small producers with virtually no ability to alter the selling price of their products. The commercial buyers of agricultural commodities are generally very well-informed. Finally, although agricultural production involves some barriers to entry, it is not particularly difficult to enter the marketplace as a producer.

What Is Neoclassical Economics?

Neoclassical economics is a school of economic thought that focuses on supply and demand as the primary drivers of market behavior. It theorizes that utility to customers, and not the cost of production, is what creates the value of a good or service. Neoclassical economics was developed in the late 19th and early 20th centuries.

What Is the Main Criticism of Perfect Competition?

Critics of perfect competition as a theoretical model have two main objections. They argue both that it is not a desirable outcome and that is too unrealistic. As a result, critics say it is an unhelpful benchmark against which to measure real industries. In general, many critics of neoclassical economics state that its theories cannot accurately describe real economies or real consumer behavior.

The Bottom Line

Perfect competition is a theoretical market structure in which five criteria are met: all firms sell an identical product, are price-takers, and have small market share; buyers are informed about all products and prices; and there are no barriers to entering or exiting an industry.

Neoclassical economists claim that perfect competition would produce the best possible economic outcomes for both consumers and society. However, perfect competition doesn't exist in the real world. It is impossible for any real market to meet its criteria. Critics of the theory of perfect competition claim that this makes it unhelpful as a tool for gaining insight into real economies.

Article Sources
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  1. The Nobel Prize. "Friedrich von Hayek Facts."

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