Perfect competition in the context of Productive efficiency

In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service by manipulating either the supply or demand of the product or service to increase economic profit. In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing revenue. This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output. The size of the gap, which encapsulates the firm's level of market dominance, is determined by the residual demand curve's form. A steeper reverse demand indicates higher earnings and more dominance in the market. Such propensities contradict perfectly competitive markets, where market participants have no market power, P = MC and firms earn zero economic profit. Market participants in perfectly competitive markets are consequently referred to as 'price takers', whereas market participants that exhibit market power are referred to as 'price makers' or 'price setters'.

The market power of any individual firm is controlled by multiple factors, including but not limited to, their size, the structure of the market they are involved in, and the barriers to entry for the particular market. A firm with market power has the ability to individually affect either the total quantity or price in the market. This said, market power has been seen to exert more upward pressure on prices due to effects relating to Nash equilibria and profitable deviations that can be made by raising prices. Price makers face a downward-sloping demand curve and as a result, price increases lead to a lower quantity demanded. The decrease in supply creates an economic deadweight loss (DWL) and a decline in consumer surplus. This is viewed as socially undesirable and has implications for welfare and resource allocation as larger firms with high markups negatively effect labour markets by providing lower wages. Perfectly competitive markets do not exhibit such issues as firms set prices that reflect costs, which is to the benefit of the customer. As a result, many countries have antitrust or other legislation intended to limit the ability of firms to accrue market power. Such legislation often regulates mergers and sometimes introduces a judicial power to compel divestiture.

A price signal is information conveyed to consumers and producers, via the prices offered or requested for, and the amount requested or offered of a product or service, which provides a signal to increase or decrease quantity supplied or quantity demanded. It also provides potential business opportunities. When a certain kind of product is in shortage supply and the price rises, people will pay more attention to and produce this kind of product. The information carried by prices is an essential function in the fundamental coordination of an economic system, coordinating things such as what has to be produced, how to produce it and what resources to use in its production.

In mainstream (neoclassical) economics, under perfect competition relative prices signal to producers and consumers what production or consumption decisions will contribute to allocative efficiency. According to Friedrich Hayek, in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan.

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, the unit price for a particular good or other traded item in a perfectly competitive market, will vary until it settles at the market-clearing price, where the quantity demanded equals the quantity supplied such that an economic equilibrium is achieved for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

In situations where a firm has market power, its decision on how much output to bring to market influences the market price, in violation of perfect competition. There, a more complicated model should be used; for example, an oligopoly or differentiated-product model. Likewise, where a buyer has market power, models such as monopsony will be more accurate.

In economics, profit maximization is the short run or long run process by which a firm may determine the price, input and output levels that will lead to the highest possible total profit (or just profit in short). In neoclassical economics, which is currently the mainstream approach to microeconomics, the firm is assumed to be a "rational agent" (whether operating in a perfectly competitive market or otherwise) which wants to maximize its total profit, which is the difference between its total revenue and its total cost.

Measuring the total cost and total revenue is often impractical, as the firms do not have the necessary reliable information to determine costs at all levels of production. Instead, they take more practical approach by examining how small changes in production influence revenues and costs. When a firm produces an extra unit of product, the additional revenue gained from selling it is called the marginal revenue (${\displaystyle {\text{MR}}}$), and the additional cost to produce that unit is called the marginal cost (${\displaystyle {\text{MC}}}$). When the level of output is such that the marginal revenue is equal to the marginal cost (${\displaystyle {\text{MR}}={\text{MC}}}$), then the firm's total profit is said to be maximized. If the marginal revenue is greater than the marginal cost (${\displaystyle {\text{MR}}>{\text{MC}}}$), then its total profit is not maximized, because the firm can produce additional units to earn additional profit. In other words, in this case, it is in the "rational" interest of the firm to increase its output level until its total profit is maximized. On the other hand, if the marginal revenue is less than the marginal cost (${\displaystyle {\text{MR}}<{\text{MC}}}$), then too its total profit is not maximized, because producing one unit less will reduce total cost more than total revenue gained, thus giving the firm more total profit. In this case, a "rational" firm has an incentive to reduce its output level until its total profit is maximized.

Perfect information is a concept in game theory and economics that describes a situation where all players in a game or all participants in a market have knowledge of all relevant information in the system. This is different than complete information, which implies common knowledge of each agent's utility functions, payoffs, strategies and "types". A system with perfect information may or may not have complete information.

In economics this is sometimes described as "no hidden information" and is a feature of perfect competition. In a market with perfect information all consumers and producers would have complete and instantaneous knowledge of all market prices, their own utility and cost functions.

The list price, also known as the manufacturer's suggested retail price (MSRP), or the recommended retail price (RRP), or the suggested retail price (SRP) of a product is the price at which its manufacturer notionally recommends that a retailer sell the product.

Suggested pricing methods may conflict with competition theory, as they allow prices to be set higher than would be established by supply and demand. Resale price maintenance—fixing prices—goes further than suggesting prices, and is illegal in many countries.

In economics, industrial organization is a field that extends the theory of the firm by analyzing the structure of firms and markets, as well as the boundaries between them. It introduces real-world features that depart from the perfectly competitive model, such as transaction costs, imperfect information, and barriers to entry faced by potential competitors.

The field studies how firms and markets are organized and how they behave across a spectrum ranging from competitive markets to monopoly, including cases shaped by government intervention and regulation.

Marginal revenue (or marginal benefit) is a central concept in microeconomics that describes the additional total revenue generated by increasing product sales by 1 unit. Marginal revenue is the increase in revenue from the sale of one additional unit of product, i.e., the revenue from the sale of the last unit of product. It can be positive or negative. Marginal revenue is an important concept in vendor analysis. To derive the value of marginal revenue, it is required to examine the difference between the aggregate benefits a firm received from the quantity of a good and service produced last period and the current period with one extra unit increase in the rate of production. Marginal revenue is a fundamental tool for economic decision-making within a firm's setting, together with marginal cost to be considered.

In a perfectly competitive market, the incremental revenue generated by selling an additional unit of a good is equal to the price the firm is able to charge the buyer of the good. This is because a firm in a competitive market will always get the same price for every unit it sells regardless of the number of units the firm sells since the firm's sales can never impact the industry's price. Therefore, in a perfectly competitive market, firms set the price level equal to their marginal revenue ${\displaystyle (MR=P)}$.

In neoclassical economics, a market distortion is any event in which a market reaches a market clearing price for an item that is substantially different from the price that a market would achieve while operating under conditions of perfect competition and state enforcement of legal contracts and the ownership of private property. In other words, a distortion is "any departure from the ideal of perfect competition that therefore interferes with economic agents maximizing social welfare when they maximize their own". A proportional wage-income tax, for instance, is distortionary, whereas a lump-sum tax is not. In a competitive equilibrium, a proportional wage income tax discourages work.

In perfect competition with no externalities, there is zero distortion at market equilibrium of supply and demand where price equals marginal cost for each firm and product. More generally, a measure of distortion is the deviation between the market price of a good and its marginal social cost, that is, the difference between the marginal rate of substitution in consumption and the marginal rate of transformation in production. Such a deviation may result from government regulation, monopoly tariffs and import quotas, which in theory may give rise to rent seeking. Other sources of distortions are uncorrected externalities, different tax rates on goods or income, inflation, and incomplete information. Each of these may lead to a net loss in social surplus. Market distortions are events, decisions, or interventions taken by governments, companies, or other agents, often in order to influence the market. They are often the response on market failures, i.e., circumstances that prevent perfect competition and achieving an optimal equilibrium in the market.

The Lange model (or Lange–Lerner theorem) is a neoclassical economic model for a hypothetical socialist economy based on public ownership of the means of production and a trial-and-error approach to determining output targets and achieving economic equilibrium and Pareto efficiency. In this model, the state owns non-labor factors of production, and market simulations are used by the planning organs to allocate final goods and consumer goods. The Lange model states that if all production is performed by a public body such as a democratic state, and there is a functioning price mechanism, this economy will be Pareto-efficient, like a hypothetical market economy under perfect competition. Unlike models of capitalism, the Lange model is based on direct allocation, by directing enterprise managers to set price equal to marginal cost in order to achieve Pareto efficiency. By contrast, in a capitalist economy, private owners seek to maximize profits, while competitive pressures are relied on to indirectly lower the price; this discourages production with high marginal cost and encourages economies of scale.

This model was first proposed by Oskar R. Lange in 1936 during the socialist calculation debate, and was expanded by economists like H. D. Dickinson and Abba P. Lerner. Although Lange and Lerner called it "market socialism", the Lange model is a form of centrally planned economy where a central planning board allocates investment and capital goods, while markets allocate labor and consumer goods. The planning board simulates a market in capital goods by a trial-and-error process first elaborated by Vilfredo Pareto and Léon Walras. The Lange Model is in practice a type of centrally planned economy and not a type of market socialism.

In mathematical economics, the Arrow–Debreu model is a theoretical general equilibrium model. It posits that under certain economic assumptions (convex preferences, perfect competition, and demand independence), there must be a set of prices such that aggregate supplies will equal aggregate demands for every commodity in the economy.

The model is central to the theory of general (economic) equilibrium, and it is used as a general reference for other microeconomic models. It was proposed by Kenneth Arrow, Gérard Debreu in 1954, and Lionel W. McKenzie independently in 1954, with later improvements in 1959.

Porter's Five Forces Framework is a method of analysing the competitive environment of a business. It is rooted in industrial organization economics and identifies five forces that determine the competitive intensity and, consequently, the attractiveness or unattractiveness of an industry with respect to its profitability. An "unattractive" industry is one in which these forces collectively limit the potential for above-normal profits. The most unattractive industry structure would approach that of pure competition, in which available profits for all firms are reduced to normal profit levels.The five-forces perspective is associated with its originator, Michael E. Porter of Harvard Business School. This framework was first published in Harvard Business Review in 1979.

Porter refers to these forces as the microenvironment, to contrast it with the more general term macroenvironment. They consist of those forces close to a company that affects its ability to serve its customers and make a profit. A change in any of the forces normally requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Firms are able to apply their core competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airline industry. As an industry, profitability is low because the industry's underlying structure of high fixed costs and low variable costs afford enormous latitude in the price of airline travel. Airlines tend to compete on cost, and that drives down the profitability of individual carriers as well as the industry itself because it simplifies the decision by a customer to buy or not buy a ticket. This underscores the need for businesses to continuously evaluate their competitive landscape and adapt strategies in response to changes in industry dynamics, exemplified by the airline industry's struggle with profitability despite varying approaches to differentiation. A few carriers – such as Richard Branson's Virgin Atlantic – have tried, with limited success, to use sources of differentiation in order to increase profitability.