Perfect Competition

Abstract

In order to construct a model of how firms behave under perfectly competitive conditions we need to begin by making the following set of assumptions:

• (a) the typical unit of production is a small firm which is both owned and managed by an entrepreneur, and no single firm supplies more than a very small share of total demand for a product;

• (b) the products of all firms supplying the market are regarded by potential customers as very close substitutes for each other;¹

• (c) an individual firm is able to alter its output level without this having any effect upon the price of the product which it sells. The firm is a passive price-taker;

• (d) the industry displays freedom of entry and exit in the sense that there are no impediments upon the ability either of new firms to enter the industry or of existing firms to leave the industry;

• (e) the sole objective of a firm is to maximise its profits;

• (f) in order to attain its profit-maximising output a firm equates its marginal cost with its marginal revenue; and

• (g) both firms and potential customers make decisions in full knowledge of all information which is relevant to those decisions.