The Perfectly Competitive Economy, Equilibrium, and the Pareto Efficient

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Perfectly Competitive Economy
The perfectly competitive economy is a theoretical model that attempts to explain how an ideally perfect market would look like. According to the theoretical construct, this kind of economy would serve as the ultimate benchmark for achieving economic efficiency (Gilbert, 21). This model assumes no external factors affecting the market. In a perfectly competitive economy, many small businesses have the right and ability to enter and exit the market at will. Further, these small firms deal with products that are entirely identical. In addition, the market participants have completed knowledge or what is otherwise known as perfect information about the market. This kind of economy is used to measure the efficiency of various policies relating to economics. This paper will focus on explaining a perfectly competitive economy. Some of the issues that will be discussed in the paper include the assumptions of the perfect economy, how the perfect economy attains equilibrium, the concept of Pareto efficiency, and an evaluation of the perfectly competitive model.
The Assumptions Behind Perfect Competition
The first assumption of the perfect competition model is that there are numerous buyers and sellers in the market. In this kind of market, no one business or entity has the ability to influence the price of commodities. Therefore, the businesses are price-takers. The second assumption of the perfect economy is that businesses deal in homogenous products. This factor relates to all properties, including the packaging. Consequently, the customer would have no reason to prefer the product of one business over another. Due to this situation, the firms can only compete on price.
The other key assumption of the perfect economy is that the buyers and sellers have absolute knowledge about the market (Komlos, 72). Therefore, it is assumed that every buyer and seller has perfect information concerning price, the quality of the commodities, and all other relevant factors. The fourth assumption relates to entry and exit. Any business can easily enter the market. Entry to the market is free and can happen anytime without barriers. Additionally, exiting the market is equally easy and has no costs involved. In addition, the model assumes that firms are aware of all production technologies. Therefore, it is not possible for one firm to have a competitive advantage over the other. While making these assumptions, the model assumes that there are not external factors affecting the market.
How the Market Reaches Equilibrium
In a perfect economy, the price of commodities is purely determined by demand and supply. The demand depends on both the willingness and ability of consumers to buy products at different prices. Since there are numerous buyers and sellers in the markets, the price is constantly shifting to attain the best possible price point. The sellers and buyers determine the supply and the demand (Komlos, 70). The sellers determine the supply through their willingness and ability to sell at various prices. These forces purely determine the price, and once the price has been determined, the businesses have no option but to accept the price. Therefore, a shortage of supply leads to an increase in cost, whereas a decrease in demand leads to a decrease in cost. The best possible price for buyers and sellers is attained at equilibrium. Now the equilibrium is the point at which the total demand in the market equals the total supply. In this perfect combination of factors, there are no excess commodities. There are just enough commodities and enough buyers of those particular commodities. Therefore, when the amount of products demanded is equal to the amount of products supplied, the market achieves an equilibrium point and an accompanying equilibrium price.
In a perfect economy, things work together to achieve this equilibrium price. If a firm attempts to sell at a price that is higher than equilibrium price, there will be excess supply of homogenous products. Consequently, the sellers will reduce the price with the intention of clearing the surplus. On the other hand, if the selling price is below the equilibrium price, it is an indication that there is a shortage of commodities. Consequently, the sellers will increase the price and maximize the profits.
Pareto Efficiency (What It Means and What it does not)
Suppose we reach a market situation where for someone to become better (economically speaking), another person has to be worse off. It is somewhat like we must take from someone if we have to add to another. In a perfect economy, Pareto efficiency describes the situation where the price is at equilibrium. In an economy that is Pareto efficient, the resources are distributed optimally (Anand and François., 4199). Consequently, a person can only become better than they are by making another person(s) worse off. Ideally, a Pareto efficient economy is one where the social welfare of all members is optimally catered for.
It would be best to have a simple example to illustrate the concept of Pareto efficiency. Suppose we have two people, Ken and Pauline. Let us further suppose that Ken has five bananas and Pauline has five o...