The Economics Book

127

See also: Monopolies 92–97 ■ Supply and demand 108–13 ■ Economic liberalism 172–77 ■ Price discrimination 180–81 ■
Markets and social outcomes 210–13

In fact, Marshall himself preferred
the terms “free competition” and
“perfect markets.”
The model is based on a set
of assumptions, derived from the
ideas of the classical economists,
about conditions in the market and
the behavior of firms.
The first assumption is that
there is such a large number of
firms selling the product to such
a large number of customers that
each of the firms and customers
individually represents a negligible
part of the market.
The second assumption is
that every firm is trying to sell an
identical product. Third, the model
assumes that all the firms are free
to enter or leave the industry at
will, and they are able to move or

acquire the factors of production

they need to produce goods with

perfect ease.

Competition in action

The market for foreign currency

meets the conditions of perfect

competition, and it is a useful

example for exploring its operations.

Globally, there are so many firms

selling foreign currency that they

each make up a tiny fraction of the

market for euros, for example. They

sell to millions of buyers who all

need to buy currency, and each

buyer (a single tourist, for example)

also makes up an insignificant part

of the market.

Second, the euro or dollar that

the tourist buys from each company

is exactly the same, so the buyers

INDUSTRIAL AND ECONOMIC REVOLUTIONS

Companies are

price takers

not price makers.

In competitive industries small

firms make identical products, and sellers

and buyers alike know the

market price.

Any firm that attempts

to sell at a price higher

than the market price

will sell nothing.

are indifferent about which firms

they buy from. Third, anyone can

start buying and selling foreign

currency without any legal, social,

or technological barriers being

placed in their way—entry to the

market is easy.

In a perfect market there is

perfect information—all the

participants know exactly what the

“going price” is. Those buying and

selling foreign exchange know how

much is being paid for a currency

at all times. In addition each firm

knows everything about the other

firm’s costs of production. This

transparency implies that no

consumer can be fooled into paying

a higher price, and that firms know

the best and cheapest way to

supply the product. Finally, self-

interested firms aim to maximize

profits. Workers will look for the

highest-paid work, and capitalist

investors will look for markets with

the highest profits. ❯❯

The industry price

is determined by the

actions of all consumers

and all producers.

Firms must accept

the market price.

A perfect market is a

district... in which there are

many buyers and many sellers

all so keenly on the alert and

so well acquainted with one

another’s affairs that the price

of a commodity is always

practically the same for the

whole of the district.

Alfred Marshall