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Perfect and Imperfect Competition

Economic theory often describes an industry as either experiencing perfect competition or one of several forms of imperfect competition.  Production agriculture is frequently used as an example of an industry with perfect competition; that is, "your wheat can substitute for my wheat."   Although this may be accurate for many segments of production agriculture, a question is whether this is changing.  Will production agriculture transform into an industry of less-than-perfect competition?  This page presents a brief overview of perfect competition.  With this background, we can consider whether the perfectly competitive nature of production agriculture may be changing.

Characteristics of Perfect Competition

The following list summarizes the characteristics of a perfectly competitive market:

• homogenous product (one seller's product can easily be substituted with or replaced by the another seller's product),
• many buyers and sellers (buyers can easily find replacement sellers and sellers can generally find replacement buyers),
• full (readily available) information (about market opportunities and production technology),
• easy entrance and exit (i.e., easy to start or discontinue a business in the industry), and
• mobile resources (easy to move resources from this industry to an alternative use).

As a result of perfect competition, sellers have limited opportunity to earn an economic profit.

• Conversely, an industry that lacks one or more characteristics of perfect competition is considered to be facing imperfect competition and an opportunity to earn more than a minimal return.
• Does this imply that a business person should intentionally try to "eliminate" one or more characteristics of perfect competition so the business now has an opportunity to increase its earnings?

If production agriculture lacks one of these characteristics, which one is it and why?

As a result of perfect competition, no one person or business can control price; there is no nonprice competition (e.g., advertising your product does not make a difference; the primary factor influencing who the purchaser is willing to buy from is the price the seller is requesting); and there is limited opportunity for economic profit.

• However, some sectors of the food industry lack one or more characteristics of perfect competition (i.e., they are experiencing imperfect competition) and this offers those businesses an opportunity to earn economic profits.
• Production agriculture generally lacks mobile resources; that is, it can be difficult to find an alternative use for farmland or for a tractor that is no longer needed to produce ag commodities.
  • One would assume, as mentioned above, that lacking a characteristic of perfect competition opens an opportunity for the firms to act as if they are facing imperfect competition, which generally means opportunity to earn more than normal profit. However, in the case of production ag, lack of alternative uses for farmland, for example, can have the opposite affect. That is, lacking an alternative use, farmers will continue to use the land to produce ag commodities even if there is already excess production and declining market price for the commodities produced on the land. Therefore in the case of production ag, lack of alternative use can lead to a situation of continued downward pressue on commodity prices and business profit.
  • What is the impact when individuals are willing to farm either though the business is generating less than a minimal level of income? Is that an example of an immobile "labor" resource? How might that "immobility" impact the overall production ag sector?

Factors that influence the level of competition:

• information technology is increasing the availability of information; e.g., market information for sellers and buyers, and information about production techniques.
• access to new production technology, whether the firm is raising livestock, baking bread, or transporting oranges; is new technology available to all businesses, or is the technology controlled and accessible to only some of the businesses?
• advancing transportation technology allows businesses to move products around the world thereby increasing the number of buyers and sellers in their market.

An implication of increasing competition is "reduced opportunities for profit from traditional sources" (this restates the thought that "firms in perfect competition have limited opportunity to earn an economic profit").

Competition among suppliers never hurts consumers.

Intentionally Eliminate One of the Characteristics of Perfect Competition?

In response, businesses try to identify and shift to markets that offer opportunities to earn additional profit.  These markets are generally less than perfectly competitive -- these markets lack one or more of the characteristics of perfect competition listed above.  For example, businesses try to differentiate their product ("Angus beef"), or reduce the ease of entry (must have a contract before you can sell), or develop and maintain trade/business secrets (biotechnology).

Businesses try to move to less-than-perfect competition by being innovative (using information before it is general knowledge), collectively marketing to reduce the number of sellers, urging social policies that subsidize or protect market prices, differentiating their product or service by accepting added risk in exchange for a premium, or differentiating their product or service so they are not selling a "commodity."

How do these thoughts about perfect competition relate to the readings discussed as part of the changing agriculture?

Bottom line -- what basic strategy might ag producers want to consider if they find their business is facing perfect competition?

Last Updated September 11, 2007

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

E-Mail:sswandal@ndsuext.nodak.edu
Published by Agricusiness and Applied Economics
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