Conditions for Perfect Competition

Four characteristics or conditions must be present for a perfectly competitive market structure to exist. First, there must be many firms in the market, none of which is large in terms of its sales. Second, firms should be able to enter and exit the market easily. Third, each firm in the market produces and sells a nondifferentiated or homogeneous product. Fourth, all firms and consumers in the market have complete information about prices, product quality, and production techniques.

Price-taking behavior. A firm that is operating in a perfectly competitive market will be aprice-taker. A price-taker cannot control the price of the good it sells; it simply takes the market price as given. The conditions that cause a market to be perfectly competitive also cause the firms in that market to be price-takers. When there are many firms, all producing and selling the same product using the same inputs and technology, competition forces each firm to charge the same market price for its good. Because each firm in the market sells the same, homogeneous product, no single firm can increase the price that it charges above the price charged by the other firms in the market without losing business. It is also impossible for a single firm to affect the market price by changing the quantity of output it supplies because, by assumption, there are many firms and each firm is small in size.