Page 146 - DECO405_MANAGERIAL_ECONOMICS

Unit 9: Market Structure – Perfect Competition

9.1 Assumptions of Perfect Competition Notes

In a perfectly competitive market structure there is a large number of buyers and sellers of the
product and each seller and buyer is too small in relation to the market to be able to affect the
price of the product by his or her own actions. This means that a change in the output of a single
firm will not perceptibly affect the market price of the product. Similarly, each buyer of the
product is too small to be able to extract from the seller such things as quantity discounts and
special terms.
The model of perfect competition is based on the following assumptions:

1. Large numbers of sellers and buyers: The industry in perfect competition includes a large
number of firms (and buyers). Each individual firm, however large, supplies only a small
part of the total quantity offered in the market. The buyers are also numerous so that no
monopolistic power can affect the working of the market. Under these conditions each
firm alone cannot affect the price in the market by changing its output.

2. Product homogeneity: The technical characteristics of the product as well as the services
associated with its sale and delivery is identical. There is no way in which a buyer could
differentiate among the products of different firms. If the products were differentiated the
firm would have some discretion in setting its price. This is ruled out in perfect competition.
The assumption of large number of sellers and of product homogeneity implies that the
individual firm in pure competition is a price-taker: its demand curve is infinitely elastic,
indicating that the firm can sell any amount of output at the prevailing market price.
3. Free entry and exit of firms: There is no barrier to entry or exit from the industry. Entry or
exit may take time but firms have freedom of movement in and out of the industry. If
barriers exist, the number of firms in the industry may be reduced so that each one of them
may acquire power to affect the price in the market.
4. Profit maximisation: The goal of all firms is profit maximisation. No other goals are
pursued.

5. No government regulation: There is no government intervention in the market (tariffs,
subsidies, rationing of production or demand and so on are ruled out).
Figure 9.1

The above assumptions are sufficient for the firm to be a price-taker and have an infinitely
elastic demand curve. The market structure in which the above assumptions are fulfilled
is called pure competition. It is different from perfect competition, which requires the
fulfilment of the following additional assumptions.

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