Learning Economics: The Three Assumptions of Perfectly Competitive Markets

Perfectly competitive markets is a term used in economics to describe markets in which companies are price takers, meaning that they do not have any control over the price, but instead are only able to control the quantity of an item that they produce. The market establishes the price, and attempting to sell for a higher dollar amount will not work. A common example of a perfectly competitive market is agriculture. A farmer can only sell an ear of corn for a certain amount. Attempting to get more than the current market price will not work, and he or she has no reason to sell for less then the market price, so he or she becomes a price taker. There are three assumptions made about perfectly competitive markets: there are a lot of buyers and sellers, the businesses are offering identical products, and businesses are free to enter and exit the market whenever they so choose.

When there are many buyers and sellers in a perfectly competitive market and may become price takers. If there is only limited amount of buyers, and the supply would exceed the demand, and the price would go down. Respectively, if there were too few sellers, and the demand will exceed supply, and the price would go up. If either of these things occurred, and the market is no longer considered perfectly competitive.

Another assumption about perfectly competitive markets is that buyers and sellers are offering identical products. This means that there is a large number of sellers are all selling the same item. There is no difference between them, so buyers can choose to buy from whoever they would like to. This again leads to the market establishing a price, and the sellers becoming price takers.

The final assumption about perfectly competitive markets is that businesses are free to enter and exit the market as they see fit. Perfectly competitive markets, in the long run, will have an economic profit equal to zero. If at some point in time the economic profit becomes greater than zero, then more businesses will enter the market and supply will go up. Eventually supply will exceed demand, and the price will go back down. Additionally, if the current economic profit is less than zero, then businesses will leave the market, in turn decreasing the supply. This helps keep the market in balance, leading to a perfectly competitive market.

Source:

Jameson, George. Lecture: Economics. December 2, 2009