This is “Assumptions of the Perfect Competition Model”, section 6.1 from the book Managerial Economics Principles (v. 1.0).
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6.1 Assumptions of the Perfect Competition Model
The perfect competition model is built on five assumptions:An idealized market in which there are many buyers and sellers who are price takers, sellers are free to either enter or exit the market, the good or service being sold is the same for all sellers, and all buyers and sellers have perfect information.
- The market consists of many buyers. Any single buyer represents a very small fraction of all the purchases in a market. Due to its insignificant impact on the market, the buyer acts as a price takerA buyer who presumes his or her purchase decision has no impact on the price charged for the good; a seller who presumes its production decisions have no impact on the price charged for the good by other sellers., meaning the buyer presumes her purchase decision has no impact on the price charged for the good. The buyer takes the price as given and decides the amount to purchase that best serves the utility of her household.
- The market consists of many sellers. Any single seller represents a very small fraction of all the purchases in a market. Due to its insignificant impact on the market, the seller acts as a price taker, meaning the seller presumes its production decisions have no impact on the price charged for the good by other sellers. The seller takes the price as given and decides the amount to produce that will generate the greatest profit.
- Firms that sell in the market are free to either enter or exit the market. Firms that are not currently sellers in the market may enter as sellers if they find the market attractive. Firms currently selling in the market may discontinue participation as sellers if they find the market unattractive. Existing firms may also continue to participate at different production levels as conditions change.
- The good sold by all sellers in the market is assumed to be homogeneousThe characteristic that every seller sells the same good, and the buyer does not care which seller he or she uses if all sellers charge the same price.. This means every seller sells the same good, or stated another way, the buyer does not care which seller he uses if all sellers charge the same price.
- Buyers and sellers in the market are assumed to have perfect informationProducers understand the production capabilities known to other producers and have immediate access to any resources used by other producers; both buyers and sellers know all the prices being charged by other sellers.. Producers understand the production capabilities known to other producers in the market and have immediate access to any resources used by other sellers in producing a good. Both buyers and sellers know all the prices being charged by other sellers.