These four characteristics mean that a given perfectly competitive firm is unable to exert any control whatsoever over the market. The large number of small firms, all producing identical products, means that a large (very, very large) number of perfect substitutes exists for the output produced by any given firm.
This makes the demand curve for a perfectly competitive firm's output perfectly elastic. Freedom of entry into and exit out of the industry means that capital and other resources are perfectly mobile and that it is not possible to erect barriers to entry. Perfect knowledge means that all firms operate on the same footing, that buyers know about all possible perfect substitutes for a given good and that firms actually do produce identical products.
Large Number of Small FirmsA perfectly competitive market or industry contains a large number of small firms, each of which is relatively small compared to the overall size of the market. This ensures that no single firm can exert market control over price or quantity. If one firm decides to double its output or stop producing entirely, the market is unaffected. The price does not change and there is no discernible change in the quantity exchanged.
How many firms are needed in a perfectly competitive industry, such that each is so small it has absolute no market control? There is no actual number that answers this question. This is due partly to the fact that perfect competition is an idealized market structure that does not exist in the real world. It is also partly due to the notion that the number of firms is not as important as the result... that no firm has market control.
Here are two extreme examples that will help illuminate this notion. Example 1 is Phil's home grown zucchinis. Phil is one among gadzillions (a really large number) of people who grow zucchinis in their backyard gardens. Phil has no control over the zucchini market because the total zucchini market contains gadzillions of zucchini producers, each producing only a handful of zucchinis. Should Phil decide to produce more zucchinis, fewer zucchinis, or none at all, the zucchini market and especially the zucchini price are unaffected. Zucchini buyers continue buying zucchinis from the remaining gadzillions of zucchini producers as if nothing changed. As far as the market is concerned, nothing has changed.
Example 2 is the innovative folks at Quadra DG Computer Works, which produces the Quadra 400 Data RAM Cartridges (a memory storage cartridge used in the Quadra 400 Data RAM Computer Storage System). In this hypothetical economic world, Quadra DG Computer Works is only one of threes companies that produce computer storage products. Because it holds a market share of 33 percent, Quadra DG has a substantial degree of market control. Should Quadra DG decide to produce more or fewer Quadra 400 Data RAM Cartridges, or stop producing them altogether, then the computer storage market takes notice. The price and quantity exchanged are likely to change.
Identical GoodsEach firm in a perfectly competitive market sells an identical product, which is also commonly termed "homogeneous goods." The essential feature of this characteristic is not so much that the goods themselves are exactly, perfectly the same, but that buyers are unable to discern any difference. In particular, buyers cannot tell which firm produces a given product. There are no brand names or distinguishing features that differentiate products by firm.
This characteristic means that every perfectly competitive firm produces a good that is a perfect substitute for the output of every other firm in the market. As such, no firm can charge a different price than that received by other firms. If they should try to charge a higher price, then buyers would immediately switch to other goods that are perfect substitutes.
Once again, Phil the zucchini grower offers an example. Phil's zucchinis are no different than Becky's zucchinis, which are no different than Dan's zucchinis, which are no different than Alicia's zucchinis, which are no different than any of the other zucchinis produced by any of the other gadzillions of zucchini growers. They look the same. They taste the same. And most important, they satisfy the same zucchini need.
In contrast, the Quadra 400 Data RAM Cartridges used in the Quadra 400 Data RAM Computer Storage System are unique. First of all, Quadra 400 Data RAM Cartridges only work in the Quadra 400 Data RAM Computer Storage System. Second of all, Quadra 400 Data RAM Computer Storage System only uses Quadra 400 Data RAM Cartridges. Third of all, the brand name of Quadra DG Computer Works is printed on each cartridge, signifying whatever quality notion (good or bad) that buyers have for this product. To most buyers, Quadra 400 Data RAM Cartridges are NOT identical to OmniRam computer storage cartridges or MegaMem computer storage cartridges. Each works with a different system, have different uses, and have different quality connotations.
Perfect Resource MobilityPerfectly competitive firms are free to enter and exit an industry. They are not restricted by government rules and regulations, start-up cost, or other barriers to entry. While some firms incur high start-up cost or need government permits to enter an industry, this is not the case for perfectly competitive firms. Likewise, a perfectly competitive firm is not prevented from leaving an industry as is the case for government-regulated public utilities.
Perfectly competitive firms can acquire whatever labor, capital, and other resources that they need without delay and without restrictions. There is no racial, ethnic, or sexual discrimination.
For example, if Phil wants to leave the zucchini industry and entry the kumquat industry, he can do that without restriction. Likewise if Becky is a kumquat producer who wants to entry the zucchini industry, she can do so without restraint. Phil and Becky are not faced with up-front investment cost nor brand-name recognition that might prevent them from entering a perfectly competitive industry. When they enter an industry they can instantly compete on equal ground with existing firms.
By comparison, when Quadra DG Computer Works entered the market it needed to build several expensive factories, spend millions of advertising dollars to achieve brand name recognition, and obtain several government patents to produce its Quadra 400 Data RAM Cartridges. Additionally, because Quadra 400 Data RAM Cartridges are used in top secret military projects, Quadra DG Computer Works is not allowed to STOP producing Quadra 400 Data RAM Cartridges without authorization from the Secretary of Defense and an act of Congress.
Perfect KnowledgeIn perfect competition, buyers are completely aware of sellers' prices, such that one firm cannot sell its good at a higher price than other firms. Each seller also has complete information about the prices charged by other sellers so they do not inadvertently charge less than the going market price. Perfect knowledge also extends to technology. All perfectly competitive firms have access to the same production techniques. No firm can produce its output faster, better, or cheaper because of special knowledge of information.
Phil, for example, has all of the information needed to grow zucchinis. This is the same information possessed by Becky, Dan, Alicia, and the other gadzillions of zucchini producers. Phil also knows that the going price of zucchinis is 50 cents. All of the zucchini buyers know that the going price is fifty cents.
In contrast, Quadra DG Computer Works has several patents on the production of Quadra 400 Data RAM Cartridges that are not available to its competition (OmniRam and MegaMem). Quadra DG also has a secret formula that it uses for production locked away in the company safe.
PERFECT COMPETITION, CHARACTERISTICS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: August 28, 2014].