Assumptions about firm behaviour
•A firm, we maintain, is a ruthless profit maximiser.
•The amount that a firm produces and sells in the market is that which maximises its profit.
•The firm sells whatever it produces so that ‘output’ and quantity sold are used interchangeably.
Features of a perfectly competitive market
1. The market consists of a large number of buyers and sellers
2. Each firm produces and sells a homogenous product. i.e., the product of one firm cannot be differentiated from the product of any other firm.
3. Entry into the market as well as exit from the market are free for firms.
4. Information is perfect.
1. Existence of a large number of buyers and sellers
•The existence of a large number of buyers and sellers means that each individual buyer and seller is very small compared to the size of the market.
•This means that no individual buyer or seller can influence the market by their size.
2. Homogenous products
•Homogenous products mean that the product of each firm is identical.
•So a buyer can choose to buy from any firm in the market, and she gets the same product.
3. Free entry and exit
•Free entry and exit mean that it is easy for firms to enter the market, as well as to leave it.
•This condition is essential for the large numbers of firms to exist.
•If entry was difficult, or restricted, then the number of firms in the market could be small.
4. Perfect information
•Perfect information means that all buyers and all sellers are completely informed about
•Other relevant details about the product and the market.
Price taking behaviour
•The satisfaction of all these features result in the single most distinguishing characteristic of perfect competition: price taking behaviour.
Price-taking behaviour of a firm
•A price-taking firm believes that
•If it sets a price above the market price, it will be unable to sell any quantity of the good that it produces.
•If it sets price be less than or equal to the market price, the firm can sell as many units of the good as it wants to sell.
Price-taking behaviour of a buyer
•A price-taking buyer believes that
•If she asks for a price below the market price, no firm will be willing to sell to her.
•If the price asked be greater than or equal to the market price, the buyer can obtain as many units of the good as she desires to buy.
Prove of perfect market taking behavior
•Assume a situation where each firm in the market charges the same (market) price.
•Suppose, now, that a certain firm raises its price above the market price.
•In such a situation, the firm loses all its buyers.
•No “adjustment” problems arise because there are so many other firms in the market.
•Hence, an individual firm’s can’t sell any amount of the good at a price exceeding the market price in a perfect market.