Perfect competition is a market model in which there are many buyers and many sellers, and none of them affect the price, demand and supply. The participants of such market meet horizontal demand curve -no matter how much the firm sells, it acquires exactly the prices set by the market. On the one hand, if the company is trying to raise the price above the market, it will not sell anything because the buyer desert to one of the many competing companies, whose product is just as good but cheaper.
On the other hand, the company can sell any quantity at the market price, so the pricing below the market price does not make sense. A distinctive feature of the company operating in perfect competition, is above mentioned horizontal demand curve.
For the demand curve to took precisely this form, 4 conditions must be met:
- In the industry there must be many businesses, for their share of total industry production was negligible;
- The companies have to produce as homogeneous product as possible (e.g. wheat or potatoes) - this rule does not work anymore in the case of highly processed goods like a car or computer,
- buyers have complete or almost complete information about products or services sold in the competitive market and assume that they are identical
- there must be freedom of entry/exit in particular competitive industry, i.e.: at a time when the collusion arises for lifting prices, new producers flock to the marked (because to freedom to entry), and inevitably the price returns to the market level, and at the same time companies in the competitive industry lose money and some of them may even be liquidated (freedom of exit).
Perfect competition model was created by economists purely for analytical reasons and is based on extreme assumptions, detached from reality. However, there are many markets close to meet the assumptions of perfect competition model, because this model is a kind of reference point, unrivalled ideal, so that you can examine and compare any deviations and differences.
- Wilson, R. (1977). A bidding model of perfect competition. The Review of Economic Studies, 44(3), 511-518.