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.
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Thus, no individual seller (or buyer) has any economic or market power to influence the market price in his favour through his own individual behaviour or action.
The number of sellers and buyers are so numerous that variations in output by one seller or change in purchase by a single buyer can hardly make any difference to the total quantity of output offered in the market. The possibility of any illusion or agreement among the sellers or buyers to influence the price is ruled out.
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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.
There should also be no imagined differences in the minds of different buyers for the products made available by various sellers. As the products of different firms are perfect substitutes to each other, it makes no difference to the buyer to purchase the product from one or the other seller. It should merely be a matter of chance from which seller a particular buyer makes his purchases. Here, the elasticity of substitution between different units of the product is infinity.
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Given the assumption of large number of sellers and buyers along with the assumption of product homogeneity ensure that each individual firm takes the price of the product as a given datum and adjusts its output to earn maximum profits. In other words, the firm is a price taker and output adjuster.
No individual seller would change its price from the prevailing level. If he attempts to raise the price above this level, he loses all his buyers, who will shift to products supplied by some other seller.
Similarly, no seller would like to lower his price below the prevailing level, as he can sell any quantity at the prevailing price. Any such attempt will also mean losses to the firm. Since the price of the commodity remains constant at its prevailing level, so all the units of the commodity must be sold at the same price.
Thus, under perfect competition, each additional unit of the commodity sold at the margin leads to the equal increase in the total revenue as the price of the commodity. That is why, just like the price or average revenue, the marginal revenue of a seller also remains constant at all levels of output under perfect competition and is equal to the former.
3. Free Entry and Exit:
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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. If restrictions on entry or exit exist, the number of firms in the industry may be reduced.
As a result, each or some of them may acquire economic power to affect the market price. Free entry and exit by strengthening the competitive process ensures that in the long run economic profit cannot deviate from zero (that is, normal profit).
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.
They tend to move, where they derive greatest advantage (i.e., highest remuneration). This implies that new skills can be acquired easily. Trade unionism is assumed away. Further, there is unimpeded flow of raw materials and other resources (or factors) between alternative uses in response to price differentials.
This mobility of resources also enables the firms to adjust their supply in response to the changing market demand and achieve equilibrium positions. Finally, it is assumed that raw materials and other resources are not monopolised. In short, there is perfect competition in the factor market. Firms have equal access to all the inputs, which are available on similar terms.
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 cost 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. An expense on sales promotion and advertisement is ruled out under perfect competition on account of perfect knowledge on the part of sellers, buyers and input suppliers.