The textbook case of perfect competition is an ideal model of a competitive market. Perfect competition rarely (if ever) occurs in practice. It is more an ideal than a market reality, and so is not useful as a standard for analyzing the performance of real world markets.
Perfect competition requires a number of conditions:
- The product concerned must be “homogeneous”. That is, the product must have identical attributes and quality regardless of who buys or sells it;
- There must be a large number of buyers and sellers for that product;
- Buyers must be homogeneous and perfectly informed;
- No single consumer or firm must buy or sell anything more than an insignificant proportion of the available market volume of that product;
- All buyers and sellers must enjoy the freedom to enter or exit the market at will and without incurring additional costs;
- There must be no economies of scale. Economies of scale arise where the average cost of production falls as the volume of production increases. Where economies of scale exist it is more efficient for a single firm to produce a given volume than for two or more firms that between them produce the same total volume, as the larger firm;
- There must be no economies of scope. Economies of scope arise when different products have significant shared fixed costs, so that a single firm can produce them using a common facility. Where economies of scope exist it is cheaper (and more efficient) to produce different products out of a common plant or facility than to produce them separately;
- There must be no externalities. An externality is an unintended side effect (either beneficial or adverse) of an ordinary economic activity that arises outside the market or price system so that its impact is not reflected in market prices and costs;
- There must be no regulation of the market or franchise obligations; and
- There must be no restrictions on capital.