Advantages and Disadvantages of Perfect Competition

Quick little Re- cap on Perfect Competition:

  • This is the market which has many small firms and they themselves don’t have enough market power to affect the price
  • Homogeneous products
  • Perfect Knowledge/Information
  • No barriers to entry and exit
  • Factor of production perfectly mobile

Advantages of Perfect Competition

  1. They allocate resources in the most efficient way- both productively (P=MC)  and allocatively efficient (P> MC) in the long run. 
  2. There is no information failure as all knowledge is spread out evenly 
  3. Only normal profits made just cover their opportunity cost
  4. Maximum consumer surplus and economic welfare

The disadvantages:

  1. No Scope for economies of scale because of the high number of firms in there
  2. Undifferentiated products- all homogeneous. Important in industries like clothes and cars
  3. Lack of supernormal profits may mean the investment of Research and Development(R&D)  is unlikely. Important for industries like pharmaceuticals.
  4. With perfect knowledge there is no incentive to develop new technology because of the ability to share information.- FREE RIDERS of info.

HOW REALISTIC IS THE PERFECT COMPETITIVE MODEL?

In reality it is more about theory rather than pratical. This the extreme spectrum of market structure.

However it is said that being perfectly competition is the position that firms should be or similarly in due to the efficiencies it can bring to the economy. Scarce resources would be allocated well.

It is said it doesn’t have to be perfectly competition but in real life competition should have similar characteristics like:

  • Many firms in the market
  • Few barriers of entry and exit
  • Incentives to cut costs
  • profits will be lower compared in markets than monopoly power
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