There are several characteristics that mainly define the pure competition market structure and distinguish it from the three other imperfect markets. In microeconomics studies, the purely competitive market structure stands out to represent the ideal market competition in which efficient allocation of resources is consummated. There are typically five underlying assumptions that explain the workings of the perfectly competitive market, and these are:
- Firms sell a homogeneous product;
- There are a large number of small firms and no single firm is dominant;
- Firms are price takers;
- There are no barriers to entry and exit in the long-run; and
- Firms and consumers have perfect information or perfect knowledge or sufficient knowledge.
The notion of perfect, sufficient and symmetric knowledge is a critical element to the whole theory of perfectly competitive market structures. Without the assumption of perfect or sufficient knowledge, there can be no concept of a perfectly competitive market. Its marked absence as a structural characteristic in the theory of imperfect markets renders the behavior of the other competitive markets clear. In the latter case, asymmetric information plays the real nature of the state of knowledge in imperfect markets and paints the more typical competition interaction between participants in the market exchange.
Under perfect competition, consumers are assumed to have symmetric and perfect information about all relevant prices of resources and competitor prices. This state of perfect knowledge allows players in the market to move freely to where there is the most efficient exchange transaction. It is the assumption that players can freely move and choose their goods and prices rationally because of perfect knowledge that ultimately the general equilibrium under conditions of perfect competition is achieved, which is a flat horizontal market demand curve in the long-run, where price is equal to marginal revenue which is equal to marginal cost. This is efficiency illustrated at its full capacity or full resource utilization level.
On the other hand, asymmetric information is the more realistic state of knowledge that makes imperfect markets and their characteristic behavior – monopolist, monopolistic, oligopolistic – the norm in competition theory and policy. Well-informed decisions are built around the assumption that information is asymmetric or imperfect and rational behavior is bounded rather than unlimited or perfect so that people have to make decisions with a knowledge base that is incomplete. Because of asymmetric information, problems such as moral hazard and adverse selection surely arise because perfect or sufficient knowledge simply does not exist.
In the imperfect competitive market structures, be it monopoly, monopolistic competition or oligopoly, the profit-seeking behavior of market players dictate that producers scale their production to the level where there is always excess capacity meaning some resources are purposely left unutilized. Asymmetric information is the assumption behind the rational profit-seeking behavior of firms to produce at where marginal revenue is equal to marginal cost. Under all the imperfect markets, price is always greater than the point where marginal revenue equals marginal cost. At that level of production, the profit-seeking firm maximizes his profit, working the markets with bounded rationality because the information that he has about the market and its players is incomplete. In many cases, asymmetric information can lead to incomplete contracts with resulting inefficiencies.
Asymmetric information is a given in the real world because there is simply no perfect knowledge. People make rational decisions within the bounded rationality framework in which the best choice is selected from an array of alternatives built on knowledge that is insufficient or inadequate. Therefore, to make the best and most rational choice must require well-honed decision skills that can effectively select the best alternative.
The other challenge that asymmetric information presents is that the risks associated with having inadequate information are managed so that even with the lack of perfect knowledge they do not pose a heavy threat to the market outcomes. The idea of uncertainty becomes real in a world equipped with information that is far from complete and when people act on some bounded rationality hypothesis. Risk mitigating measures are undertaken to protect firms and people against adverse outcomes because decisions had to be made under imperfect conditions.
Be that as it may, precisely because perfect knowledge does not exist then asymmetric information becomes the rule. Therefore, competitive market structures and their behavior are governed by inadequate information and men and women must decide accordingly and hopefully effectively based on this imperfect body of knowledge.
Against the backdrop of financial crises in the U.S. and its underlying impact on world economies and global financial systems, the role of asymmetric information has never been pronounced. Companies around the world are now pressed to address this issue of information gaps and insufficient knowledge as far as investing relations go by adopting corporate governance codes and implementing corporate governance measures in organizations and industries. Organizations are increasingly pressed to make their business transactions and operations transparent, properly disclose financial and business information and ensure the accountability of management and officers to the stockholders for the performance of the organization. These measures are seen to temper the propensity of organizations especially corporations to exploit the problem of asymmetric information and even compounding the problem such inadequacy represents to market players.
References
Beaulier , Scott A. and Mounts, Jr., Wm. Stewart. “Asymmetric Information about Perfect Competition: The Treatment of Perfect Information in Introductory Economics Textbooks.” September 2008. Web. 2 May 2013.
Rosser, Jr.. J. Barkley. A Nobel Prize for Asymmetric Information: The Economic Contributions of George Akerlof, Michael Spence, and Joseph Stiglitz. N.d. Web. 2 May 2013.
The Organization for Economic Cooperation and Development. “Corporate Governance”. 2013. Web. 2 May 2013.
