The Theory of the Firm under Perfect Competition
Perfect competition
Explain what happens to a firm that raises its price above the market price.
We assume a firm wants to maximise profit, and can sell all it produces.
Perfect competition is a market with four features:
- many buyers and many sellers, each too small to affect the price;
- a homogeneous product: every firm's product is identical;
- free entry and exit: firms can join or leave the industry easily, which keeps their number large;
- perfect information: all buyers and sellers know the market price.
The result is price-taking behaviour: each firm, and each buyer, simply accepts the market price. A firm is a price taker.
Why? If a firm charged even slightly more than the market price, it would sell nothing: buyers know the price, and they can buy the identical product from any other firm without any trouble. And a buyer who offered less than the market price would find no seller.
Practise this lesson
Questions that get harder as you improve, a Tutor that helps without giving the answer away, and progress you can see. Free for every learner.
No account, no email address. Opens the real product.