What is "perfect competition"

In economics and general equilibrium theory, a perfect market is defined by several conditions, collectively called perfect competition. These conditions are:

• A large number of buyers and sellers – A large number of consumers with the willingness and ability to buy the product at a certain price, and a large number of producers with the willingness and ability to supply the product at a certain price.
• Perfect information – All consumers and producers know all prices of products and utilities each person would get from owning each product.
• Homogeneous products – The products are perfect substitutes for each other, (i.e., the qualities and characteristics of a market good or service do not vary between different suppliers).
• Well defined Property rights – These determine what may be sold, as well as what rights are conferred on the buyer.
• No barriers to entry or exit
• Every participant is a price taker – No participant with market power to set prices
• Perfect factor mobility – In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions.
• Profit maximization of sellers – Firms sell where the most profit is generated, where marginal costs meet marginal revenue.
• Rational buyers: Buyers make all trades that increase their economic utility and make no trades that do not increase their utility.
• No externalities – Costs or benefits of an activity do not affect third parties. This criteria also excludes any government intervention.
• Zero transaction costs – Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market.
• Non-increasing returns to scale and no network effects – The lack of economies of scale or network effects ensures that there will always be a sufficient number of firms in the industry.

When conditions of perfect competition hold, it has been proven that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium will be a Pareto optimum, meaning that nobody can be made better off by exchange without making someone else worse off.

Such markets are allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue (MC = MR). But perfectly competitive markets are not necessarily productively efficient as output will not always occur where marginal cost is equal to average cost (MC = AC).

In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P = MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a monopoly does not have a supply curve". The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition.

Real markets are never perfect, but range from close-to-perfect to very imperfect. Share and foreign exchange markets are commonly said to be the most similar to the perfect market. The real estate market is an example of a very imperfect market.