What Is a Perfect Market?

John Markley

A perfect market is a concept in economics, primarily neoclassical economics, that refers to a market with what is known as perfect competition, a set of conditions in which no market participant has the power to affect the price of whatever commodities it buys or sells. In such a market, the forces of supply and demand will produce an equilibrium in which supply and demand for every commodity are precisely matched at the existing price. True perfect competition can exist only under a set of conditions that are not possible in the real world, and so no real perfect markets exist. The concept is used in economics, not to describe any state of affairs in the real world, but as a construct to simplify thought experiments about how economies work and provide a benchmark to which real world markets can be compared.

The concepts of the perfect market and perfect competition are widely used in modern neoclassical economics, the dominant school of modern economic thought.
The concepts of the perfect market and perfect competition are widely used in modern neoclassical economics, the dominant school of modern economic thought.

It is important to note that perfect market and perfect competition are not moral judgments. Whether or not the market is efficient is a separate question from the justice or desirability of that market's processes or outcome. In this context, calling something perfect means that it is an ideal concept used to simplify thought experiments or calculations. It is similar to concepts in physics such as a perfectly rigid body, meaning an object that is completely unaffected by applying forces and never undergoes deformation under any circumstances or a perfect black body, which refers to an object that completely absorbs all incoming electromagnetic radiation. No real material has these attributes, but they can be used as mental constructs for thinking about a scientific field.

There are a number of necessary conditions for a perfect market. The number of buyers and sellers is extremely large or infinite, making it impossible for any market participant to have any effect on market prices. All goods sold in each market are also completely homogeneous from one supplier to the next, and firms can enter and exit the market freely. All producers make normal profits, meaning that their revenue is equal to their opportunity costs. All market participants additionally possess perfect information about the economic factors relevant to their decisions and are assumed to be rationally acting to maximize their own utility. Finally, all exchanges can be carried out with no transaction costs, and all factors of production — labor, capital, and natural resources — are perfectly mobile and can be shifted to new uses in response to market conditions at no cost.

A perfect market produces a situation called Pareto efficiency or Pareto optimality, named for the economist Vilfredo Pareto. This means that it is impossible to change the distribution of goods to make one person better off without simultaneously making anyone worse off. This is because, in the equilibrium created by perfect competition, all possible mutually beneficial exchanges have been made. No actual market is like this, obviously, but many economists use the idea as a way to explain economic concepts or because examining how and why a real market differs from a perfect market can help to explain its workings.

The concepts of the perfect market and perfect competition are widely used in modern neoclassical economics, the dominant school of modern economic thought, but their role and importance are disputed among economists. Many economists see these concepts as a way to identify areas where market processes can be improved upon through government intervention or other changes. Others regard them as a useful thought experiment that helps to explain economic principles but dispute its value as a guide to judging the effectiveness of real-world markets or improving them through government policy, as many real markets function well despite their deviation from the model of perfect competition. Some economists and schools of economic thought reject the perfect market model altogether, usually arguing that the assumptions of the model leave out factors that are too essential to be dispensed with, such as imperfect information and how market processes work over time.

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The perfect market might not be possible, but it's a great baseline -- a way to study how markets deviate from "perfection" and what factors influence departure from and ideal norm. A perfect market might not be achievable, but it is precisely what we're shooting for when discussing consumer behavior, legislation that impacts markets, etc.

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