The assumption of the Perfect competition theory in the economic theory is one among other markets that then to show that no association under the theory is large enough to hold the market power that sets the prices of comparable products. Such markets are rare or not found at all because of their harsh conditions. Competition in economics generally tends to suggest that the desire of firms and individuals striving for an additional or greater share of a market to sell or purchase goods and services.
Some of the assumptions that are used by the theory include: many buyers in the market, many buyers, free entry and free exit, no advertisement cost; there is the clear knowledge about the market; products sold in the market are similar or homogeneous, there is no transport cost because buyers and sellers stay at one location, and there is no government involvement in making any decision in the market. All these assumptions tend to give us a different meaning of the theory, also; the assumptions are not of a competitive market, thus, they give questions on the credibility of the theory using competition while it does not go as per the true meaning (Walter, 2005).
Friedrich von Hayek went ahead and said that the perfect competition was just a framework that provided judgment on the effectiveness of competition in real life that made it perfectly from an actual model, thus displaying an entirely different meaning. The perfect competition depends mainly on assumptions, for example, competition used was not basically based on those assumptions. This model depends on a number of assumptions, which are characterized by the following listed below. –
Many Sellers in the Market
Sellers in the business design the market supply. Sellers may be in the form of a firm, business, or simply individually. In the model of perfect competition, a price of commodity is usually decided by market forces that are being the demand and supply. For instance, in the perfect competitive market, no particular seller is in a position of changing prices by controlling the supply. This is because the single seller and the single supply are forming just a small percentage of the total supply. If a supplier needs to increase the price of his product he will be in the losing side because nobody will tend to spend the extra dollar when he obviously knows that other suppliers are providing at a cheaper price. Therefore, a seller should follow the given market price, thus, becoming a price taker and not a price maker.
Many Buyers in the Market
Many buyers in the market are also an important assumption that the theory depends upon. This is directly controlling the market demand. For instance, the market should depend on many buyers because an individual consumer cannot check the price by changing or controlling the market; the individual market is so small and makes just a fraction of the total market demand. It is also assumed that every customer is forced to accept the market price that is decided by market forces of demands and supplies, thus, making them price takers not price makers. This is the same as that of suppliers. This ultimately ensures only one price market survival. This also differs with the competitiveness of the principle that should be freely decided by even a single buyer in the market. The state buyers are forced to use prices as the market price is not so competitive in class and then to check the principle for a possibility to know how it differs from other markets being the monopoly or monopolistic market.
A buyer usually wants to spend less for his greater effectiveness in terms of utility and enjoyment but they will be forced to use the prices; though the market is characterized by many suppliers, but due to the market forces the competitiveness control of the market is rendered useless.
Free to Enter and Free to Exit
When some abnormal benefits are realized more, new firms need to participate in the market and, thus, they enter the market that will lead to an excessive competition among suppliers. When the firms participate in large number, they will flood the market and the prices will go down; this will lead to less of profits at the end. This will eventually fix abnormal earnings being just normal earnings.
When profits are lower, many firms or suppliers need to move out; and due to this entitlement to the exits of many firms, they will exit since their motives were to make profits. This exit will lead to the reduced number of suppliers in the market that eventually will trigger the monopoly in the market. These remaining firms will increase their prices and ultimately will enjoy extraordinary befits again. The free entry is being an open door category to give unfairness to the market that should be reasonably competitive by nature and, thus, should limit the model from its name. Firms should be prepared to compete with other firms, even though profits are lower or higher. Suppliers will be entering the market only to enjoy their profits and not to dispense under market forces. These will be the unfair grounds for such theory like the perfect competitive market.
Homogenous Products
These are perfectly identical products, which are being same in their size, shape, taste, color, ingredients, quality, and trademarks. This eventually ensures the existence of a single price in the market. Homogeneity in products is a hard thing when people want to compete for their own customers in the market; that is why I stated above that in order to obtain a perfect competitive market in the current time is hard. Many suppliers tend to modify their products in order to get some favors from their customers.
Producers will try as much as possible to win the customers by providing some new brandings to their products; also some of them tend to advertise their products as much as possible in order for the buyers to choose their firms over the other ones. This is a kind of competition that the perfect competition lacks because of its formulation that heavily relies on the assumption being outdated at the current economic era. Homogeneity also forces a consumer to choose a product with or without looking at its utility factor.
Advertisement Cost Is Zero
In the perfect competitive market, it is also assumed that there is no cost for advertisement, since there is no advertisement. It is believed that goods and services produced in the market are homogenous; thus, there is no need for the advertisement since buyers are aware of what is being in the market at the moment. Buyers may not be aware of prices for those products from different firms, thus they may be exploited. The need for advertisement should be imposed but upon its introduction this may change the operations of the perfect competitive market and this may not qualify to be the one. Friedrich von Hayek was right judging the credibility of competiveness as used by an economist that formulated this theory. So eventually as it should follow the assumptions, the advertisement cost is zero.
There Is the Knowledge about the Market
The perfect competition also assumes that there is some knowledge about the market. No buyers are charged more than for prices in the market. This knowledge will force the sellers not to raise their product prices; also, though it is clear for buyers and sellers, sellers will not sell at a lower price than the market price exists. The knowledge about the market will never allow a greater competition among suppliers as they will know that everything they are doing is watched closely by a buyer who may quit with another firm if they make any changes in their pricing ways.
These have been the rules of the market controlled by market forces. Here, the needs of consumers are well solved by suppliers with producing more to meet their needs. This reliance of the market on suppliers while supplying some extra amount of products is not what the market needs to rely on during the competition. Suppliers usually supply generally basing on market demands but also they introduce other marketing mechanisms in order to win their consumers, which are not being a part of the perfect competitive market. Buyers should not wait for the suppliers to go for what they are demanding but should get their suppliers; thus, suppliers should be predicting what their customers need and produce these products not making the buyers waiting. This will create a shortage in the market, thus, making the price of commodity rise that will be an extra cost to consumers (Roberts, 1987).
No Government Control
It is also believed that there is no government control over the market. Since it is known that market forces control the market, the need of the government to control the market is not applicable here. The government involvement to control the market in its perfect competition is not obligatory at all, thus, the government intervention like taxes, subsidies, and licensing policy also control the supply of raw materials. Due to the limitation to control the market under the perfect competitive market, the market will be more capitalistic rather than socialistic. Capitalistic is in its capacity belief in the competition; thus, an act of the perfect completion failure to compete adequately compared with other present market.
Profit Maximization
This is an assumption that tends to explain the intention for the perfect competition to maximize profits. This is not while seeking the consumers’ favor but tending to maximize profits by using an advantage of free exit. When firms exit, the remaining ones maximize their profits by raising prices for the product. This is due to market forces acting due to higher demands, and the remaining firms benefit from this process. Indeed, this is usually being the self-interest of producers or suppliers whose intentions make and ensure the market working efficiently. The profits’ maximization is done by any market, for example, the monopolistic market, monopoly, and even duopoly. The way that the perfect competition market gets its profits depends on the assumptions that firms exit, thus, the remaining firms raise their prices and get profits there. Many firms use the competitive nature to get profits, which the perfect competition never used to do. This contributes to the high critics that arises in order to criticize the competitive nature of the perfect competition model
The perfect competition model has also faced its criticism; it seems mostly that the model is merely a theoretical idea having many assumptions that have been discussed above, which are rarely working in the real world. It could be argued that the model does hold for some agricultural markets. A research has been provided in the U.S.A.; it has estimated that the elasticity of demand for sweet corn was 31,353, a value being very close to the perfect elasticity. However, it is seen to be unrealistic because it misses some very important points. For example, it should be analyzed how the idea of the market would look like in terms of its resource allocation. The theory provides a measure with which the alternative market structures can be compared. The rejection of perfect competition does not generally mean that the rejection of free exit also makes some profits. Indeed, it is seen that the competition among markets is getting stronger nowadays than in this old capitalistic regime.
The perfect completion issue is different with other factor markets. We may accept or deny the perfect competition in the labor markets, the difference of which is not big enough to the view of working over the market economies. We should be able to distinguish neoclassical from non-neoclassical economists. If eventually it is left free to operate, this would cause many problems like the decrease of wages for people as labor force; as well as there is the unemployment in the economy. Labor unemployment is caused by the absence of perfect competition in labor markets. Non-neoclassical economists deny that a full flexibility of wages, which ensures the full employment of labor, also finds the stickiness of wages as an indispensable component of the market economy. The failure of perfect competition to provide satisfaction in the labor market has led to being looked down as the unreliable policy in the economic world (Hayek, 1996).
Perfect competition in the economic theory tends to describe markets in such a way that participation is not sufficient enough to gain the market power. This market power usually sets market prices of some homogenous products because of the conditions and assumptions of the perfect competition that provides a strict condition for the perfectly competitive markets.
Conclusion
Perfect competition, as explained by neoclassical researchers, does not comply with their way the competition is applied because all the assumptions do not comply with it while being competitive. Therefore, Friedrich von Hayek’s tendency of criticizing the use of competition in the model is justified because of the failure of this theory providing an essential need of competition, like other markets in the economy do.