Certain conditions are necessary for the functioning of an efficient market: a large number of buyers and sellers each acting independently according to their own self-interest, perfect information about what is being traded, and freedom of entry and exit to and from the market. Add to this list that firms deal in identical products and that they are “price takers,” and you now have perfect competition.
Identical products mean that there are no real differences in the output of firms. They are all making and selling the same stuff. Think of things like wheat, corn, rice, barley, and whatever else goes into making breakfast cereal. Wheat grown by one farmer is not significantly different from wheat grown by another farmer.
Why are perfectly competitive markets preferable to other types of market?
Perfectly competitive markets are what economists call allocatively efficient. Consumers get the most benefit at the lowest price without creating any loss for producers. Perfect competition is also productively efficient because in the long run, firms produce at the lowest total cost per unit.
Economists refer to firms as “pricetakers” when a firm does not set the price of its output but instead sells its output at the market price. Remember, one outcome when markets have many different small buyers and sellers is that none are able to influence the price of the product.