NCPA - National Center for Policy Analysis

The Flawed Idea of "Perfect Competition"

June 16, 1999

Anyone who has ever taken an economics course probably has heard the term "perfect competition." As my college economics textbook (Samuelson, 7th ed.) put it, "The virtues claimed for free enterprise are fully realized only when the complete checks and balances of 'perfect competition' are present."

In his book, "Risk, Uncertainty, and Profit," the great economist Frank Knight listed 11 different conditions that had to be met for perfect competition. Among them: no buyer or seller is large enough to affect prices by themselves, there must be no barriers of entry into any market, all participants have perfect knowledge, and there must be no transactions costs, among other things.

Clearly, it would be impossible to satisfy all these conditions. Therefore, critics of capitalism have always justified government regulation on the grounds that perfect competition does not exist.

Over the years, a few economists have argued that perfect competition is unnecessary and irrelevant. Indeed, in a sense, the primary motivation in the economy is a desire to achieve some degree of monopoly. That is why firms spend so much money on research and development, and are constantly striving to innovate.

Trademarks, copyrights and patents can put up barriers to copycats, but in the long run a company can only stay on top through continuous innovation that constantly keeps its competitors off balance.

Computers and the internet are in fact bringing us closer to perfect competition. The internet makes it possible to have nearly perfect knowledge about products. One can almost instantly compare prices, product quality and availability everywhere at once. And continuously improving delivery services mean that distance is less of a barrier all the time.

Although the idea of perfect competition is flawed, it turns out that we are getting closer to it all the time anyway.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, June 16, 1999.


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