Question

What are the four basic assumptions of perfect competition? Explain in words what they imply for a perfectly competitive firm.

Short answer

Perfect Competition, Assumptions : Large number of buyers and sellers, Identical Goods, perfect information, uniform prices, ease of entry & exit.

Step-by-step solution

Assumptions Concept 

Assumptions of Perfect Competition :

Large number of buyers and sellers in the market

Homogeneity of goods & services sold by all the sellers

Uniform price in the market taken by firm, no control of latter over price.

Perfect knowledge about all the aspects among buyers and sellers

Free entry and exit

Implications Explanation 

• Large number of buyers and sellers have insignificant share of market supply & market demand, they cannot influence market price by altering their individual supply or demand.
• Uniform price implies perfectly elastic horizontal demand curve, with infinite elasticity of demand & infinite selling capacity at constant price. No firm can sell at higher price.
• Homogeneity of goods and services leads to buyers being indifferent among sellers and their goods & services.
• Perfect Knowledge among buyers and sellers implies that all know about price, no seller is willing to sell at lower price & no buyer is willing to buy at higher price.
• Free entry and exit leads to firms earning only normal profits and normal losses in long run. As super normal profits and abnormal losses are ruled out by market supply & price adjustment.