Answer to Question #246883 in Economics for Another you

Question

Answer the following:

1. What are the advantages and disadvantages of perfect competition in the market?

2. Is perfect competition realistic? Justify your answer.

3. What do you think is the importance of the market structure?

Answer 1

1. The advantages are:

Because there is perfect knowledge, there is no information failure and knowledge is shared evenly between all participants.

There are no barriers to entry, so existing firms cannot derive any monopoly power.

There is maximum allocative and productive efficiency.

The disadvantages are:

Only normal profits made, so producers just cover their opportunity cost.

In addition, selling unbranded goods makes it hard to construct an effective advertising campaign.

2. Very few markets or industries in the real world are perfectly competitive. For example, how homogeneous is the output of real firms, given that even the smallest of firms working in manufacturing or services try to differentiate their product. The assumption that producers and consumers act rationally is questioned by behavioural economists, who have become increasingly influential over the last decade. Numerous experiments have demonstrated that decision making often falls well short of what could be described as perfectly rational. Decision making can be biased and subject to rule of thumb ‘guidance’ when consumers and producers are faced with complex situations.

3. Although unrealistic, it is still a useful model in two respects. Firstly, many primary and commodity markets, such as coffee and tea, exhibit many of the characteristics of perfect competition, such as the number of individual producers that exist, and their inability to influence market price. Secondly, for other markets in manufacturing and services, the model is a useful yardstick by which economists and regulators can evaluate levels of competition that exist in real markets.