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Disadvantages of Perfect Competition

What Are the Disadvantages of Perfect Competition?

Perfect competition establishes an ideal framework for establishing a market. But that market is flawed and has a couple of disadvantages. The first one is the absence of innovation. The prospect of greater market share and setting themselves apart from competition is an incentive for firms to innovate and make better products. But no firm possesses a dominant market share in perfect competition. Profit margins are also fixed by demand and supply. Hence firms cannot set themselves apart by charging a premium for their product and services. For example, it would be impossible for a company like Apple Inc. (AAPL) to exist in a perfectly competitive market because its phones are pricier as compared to competitors. The second disadvantage of perfect competition is the absence of economies of scale. Limited to zero profit margins means that companies will have less cash to invest for expanding their production capabilities. An expansion of production capabilities could potentially bring down costs for consumers and increase profit margins for the firm.

But the presence of several small firms cannibalizing the market for the same product prevents such an occurrence and ensures that the average firm size engaged in the market remains small.  

Does Perfect Competition Exist In The Real World? 

Real-world competition differs from this ideal primarily because of differentiation in production, marketing and selling. For example, in agriculture, the owner of a small organic products shop can talk extensively about the grain fed to the cows that made the manure that fertilized the non-GMO soybeans – that’s differentiation. Through marketing, companies seek to establish “brand value” around their differentiation and advertise to gain pricing power and market share. Thus, the first two criteria – homogeneous products and price takers – are far from realistic. Yet, for the second two criteria – information and mobility – the global tech and trade transformation is improving information and resource flexibility. While reality is far from this theoretical model, the model is still helpful because of its ability to explain many real-life behaviors.