A Look into the Process of Perfect Competition

We have already looked into how perfectly competitive markets come about and how they benefit society. But, how does perfect competition really work? The following explains just that:

The market price of a product sold by each company in the industry is determined by the interaction of the total supply and demand curves of the industry.

Each one of the companies accept the market price as given and they produce the product amount that maximizes their own benefit or minimizes their own loss if the price is so low that it is not possible to get a benefit from it.

Given that the company has an identical production technology, each company will choose to produce the same amount and as a result, will have the same benefit or loss that each one of the other companies in the industry will have.

Depending on if the companies are obtaining benefits or losses, they will decide on if they enter or leave the industry until the market price adjusts itself to the level where all the companies that remain have economic benefit from zero.

The last point of this process – which is where a company goes in or goes out of an industry – is very important. In order to understand it clearly, it can be separated in two cases, one in which each company in the industry obtains a benefit because the price of the market is high and another where the company in the industry has a loss because the price of the market is low:

Attracting new companies when benefits are obtained. If all of the companies in an industry obtain benefits, it is pretty obvious new companies will be interested in the industry because they are interested in participating in this benefit. When they enter however, the total product of the industry increases so that the price of the market starts to decrease. As the price goes down, the benefits are reduced too, and this makes it less attractive for new companies to go into.

The entry of a new company in the industry continues until the price goes down so much that the benefits go down to nothing, to zero. When this happens, the incentive to enter into the industry goes away and no more companies get into it.

Beginner Money Investing Analysis of Deadweight Loss Causes and Consequences of Perfect Competition A Look into the Process of Perfect Competition Losing existing companies due to financial loss.