perfect competition

• Perfect competition is a theoretical extreme, not a realistic market structure, but it is very important to assess the efficiency of real-world market structures as a benchmark
• Characteristics of a perfectly competitive market structure


  • Many buyers and sellers (infinite)
  • Firms sell homogeneous goods/services
  • Firms are price takers
  • No barriers to entry and exit
  • Perfect information of market conditions
• Profit maximisation


  Firms produce where MC = MR
• Long-run equilibrium in perfect competition


  Normal profit is being made
• Supernormal profit in the short run


  1. Attracts new firms to enter

  2. Supply shifts right

  3. Price falls

  4. Until normal profit remains
• Subnormal profit in the short run


  1. Firms incentivised to leave the market

  2. Supply shifts left

  3. Price rises

  4. Until normal profit remains
• Allocative efficiency in perfect competition

  Price = Marginal cost
• Efficiencies in perfect competition


  • Allocative efficiency
  • Productive efficiency
  • X-efficiency
• Perfect competition is statically efficient but not dynamically efficient due to lack of supernormal profit to reinvest in innovation