Answer to Question #80654 in Microeconomics for john

Question

3 Explain SEVEN (7) conditions necessary for a perfectly competitive market to exist.

Answer 1

The following features serve as a necessary set of assumptions or conditions underlying the model of perfect competition:
1) Large Number of Sellers and Buyers: In perfectly competitive market, there are a large number of sellers and buyers in the indus­try. On account of innumerable transactors, each seller produces a very small portion of the total quantity offered in the market and each buyer has an inappreciable portion of the total demand of the market.
2) Homogeneous Product. The products produced by all the firms in the industry are homogeneous. The technical charac­teristics of the product (including its physical qualities) as well as the services associated with its sale as well as delivery are identical.
3) Free Entry and Exit. Under perfect competition, the firms are free to enter or leave the industry. There are no barriers or impediment (natural, artificial or legal) on their free movements, in and out of the industry. This assumption is actually supplementary to the assumption of large numbers.
4) Absence of Government Regulation. Under perfect competition, each buyer/seller acts independently. There is no restraint upon their independence by custom, contract, collusion. Further, any type of Government intervention into the free interplay of market forces is assumed to be absent. Thus, the intervention of the Government through tariffs, taxes, subsidies, duties, licensing rationing of production or demand is ruled out. The Government intervention restricts the competition.
5) Perfect Mobility of Factors of Production. The factors of production are assumed to move freely from one firm to another throughout the economy. Here, mobility means geographical and occupational freedom. It is assumed that workers can move between different occupations.
6) Perfect Knowledge. All the sellers, buyers and input suppliers are supposed to have perfect knowledge about the present as well as future conditions in the market. Under these conditions, uncertainty about future developments in the market is ruled out.

The information regarding the availability, cost, price, quan­tity, nature of the factor or product, etc. is assumed to be available free of cost. Knowledge transmis­sion is also quick and costs less. Perfect knowledge coupled with product homogeneity ensures that no two prices can prevail in the perfect competitive market.
Perfect knowledge means perfect foresight and certainty. Under perfect competition, uncer­tainty of any kind does not exist. Further, perfect knowledge leads to optimal allocation of the re­sources.
7) Absence of Transportation and Selling Costs. Under perfect competition, there is no transportation cost for either the movement of factors or products between different parts of the market. This condition is also necessary for uniform price to prevail in the market. If cost of transportation is considered, then prices will differ in different seg­ments of the market. Expenses on sales promotion and advertisement are ruled out under perfect com­petition on account of perfect knowledge on the part of sellers, buyers and input suppliers.