Although this type of market does not have a real or physical existence, yet it is most importantly used for understanding the Basic Market models of Economics. Let us discuss this topic step by step:
Basic Assumptions of Perfectly Competitive Markets
The assumption that a perfectly competitive market is a price taker means that each firm does not have any influence over the prices of the Product and therefore, takes the market price as it is given. The reason behind this is that it is assumed that each firm has a very small or minor impact over the industry output so it does not have enough power to effect the product price.
Its is assumed that the commodity or the product of all the firms are Substitutes. Now by substitutes I mean perfect Substitutes without any product differentiation. And that its quality as well as its characteristics is similar to that of the product of the other firms.
You can take an example of agricultural products, oil, iron, lumber, copper, chicken, meat etc. Though they still aren’t the exact perfect substitutes yet we can take their examples.
On the other hand, heterogeneous products that are usually differentiated products using different brand names, qualities and characteristics can be charged higher prices because they cannot be perfectly substituted (monopolistic competition, More on that later)
Free Entry and Exit
How would you think of entering a business which requires licenses, branding and advertising etc etc ? And what about businesses that does not require any barrier to enter or exit ? So which one would you prefer. Obviously , when there are no special costs for a business so the supplier can easily start or leave the business as well as the buyers can easily shift from one supplier to another since the product is homogenous.
Every market model ahs its own assumptions. So These are the 3 assumptions which are considered to be the basis for a Perfectly Competitive Market.
So when is a Market considered Competitive ?
Many markets have low entry and exit costs and face a highly elastic demand curve like that of the household common products of toothpaste, shampoo, dishwasher, notebooks, journals, utensils etc etc. To conclude , there is no rule of thumb in finding out either a market is highly competitive or not. It depends on a lot of factors and on how they behave in different situations at different times.
(Up next Profit Maximization of Perfectly Competitive Markets)