How does buying and selling of stock fit the model for perfect competition?
The buying and selling of stocks only fits the model of perfect competition if we are thinking about the buying and selling of a single company’s stock by a number of different buyers and sellers. It does not fit the model if we are thinking about the decisions investors make about which stocks to buy.
Perfect competition exists when there are many sellers who are all selling an identical product. The product has to be absolutely identical. There can be nothing about one seller’s products that make them in any way preferable to another seller’s products.
Looking at this definition, we can see that the stock market as a whole does not fit. All stocks are not completely identical. Some companies are weak and their stocks are not as attractive while other companies are on the rise and have stocks that are a superior product.
However, when we look at the buying and selling of one company’s stock, we are looking at perfect competition. A company has a huge number of shares of stock, which means that there can be many people who own stock and are looking to sell. All of the company’s stock is identical. There is no benefit to buying a stock from Seller A or Seller B. Because of this, the market for a single company’s stock is an example of perfect competition. Once equilibrium is reached, no buyer would rationally choose to buy a share of the stock for a price higher than equilibrium because there is nothing about that particular share that could possibly make it more valuable than another share.