Characteristics of Perfectly Competitive Markets

Perfect competition exists when individual producers have no influence on market prices; they are price takers as opposed to price makers. This lack of influence on price typically requires

• Large numbers of buyers and sellers. Each firm produces a small portion of industry output, and each customer buys only a small part of the total.

• Product homogeneity. The output of each firm is essentially the same as the output of any other firm in the industry.

• Free entry and exit. Firms are not restricted from entering or leaving the industry.

• Perfect dissemination of information. Cost, price, and product quality information is known by all buyers and all sellers.

These basic conditions are too restrictive for perfect competition to be commonplace. Although the stock market approaches the perfectly competitive ideal, imperfections occur even there. For example, the acquisition or sale of large blocks of securities by institutional investors clearly affects prices, at least in the short run. Nevertheless, because up to 1,000 shares of any stock can be bought or sold at the current market price, the stock market approaches the ideal of a perfectly competitive market. Similarly, many industrial firms must make output decisions without any control over price, and examination of a perfectly competitive market structure provides insights into these operating decisions. A clear understanding of perfect competition also provides a reference point from which to analyze monopolistic competition and oligopoly, as described in Chapter 11.

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