Perfect competition

The model of perfect competition is built up on four assumptions:

1. Firms are price takers. There are so many firms in the industry that each one produces an insignificant small portion of total industry supply, and therefore has no part whatsoever to affect the price of the product.
2. Firms face a horizontal demand ‘curve’ at the market price: the price determined by the interaction of demand and supply in the whole market for stock
3. There is complete freedom of entry of new firms into the industry. Existing firms are unable to stop new firms setting up in business. Setting up in business takes time, however. Freedom of the entry, therefore, it applies in the long run. Extension of this assumption is that there is complete factor of mobility in the long run. If profits are higher than elsewhere, capital will be free the attracted into that industry. Likewise if wages are higher than for equivalent work elsewhere, workers will for any move into that industry and will make no barriers. All firms produce an identical product. The product is homogenous. There is therefore no branding or advertising.
4. Producers and consumers have perfect knowledge of the market. That is, and producers are fully aware of prices, cost and market opportunities. Consumers are fully aware of the price, quality and availability of the product.

These assumptions are very strict. Few if any industry’s in the real world meet these conditions. Certain markets approximate to perfectly competitive markets. The market for fresh vegetables is an example.

Nevertheless, despite the lack of real world cases, the model of perfect competition played a very important role in economic analysis and policy. Its major relevance is as an ideal type. Many on the political Right argue that perfect competition brings a number of important advantages. The model can thus be used as a standard against which to judge the shortcomings of real world industry.