Chapter 23: Problem 4

Explain why the demand curve facing the individual firm in a perfectly competitive industry is a horizontal line.

Short Answer

Expert verified

Answer: The demand curve facing an individual firm in a perfectly competitive industry is a horizontal line because the firm cannot influence the market price due to the large number of buyers and sellers and the homogeneous nature of the products being sold. As a result, the firm can only adjust its output level according to the established market price, making the demand curve perfectly elastic.

Step by step solution

Understanding Perfect Competition

Perfect competition is an idealized market structure, which assumes that there are a very large number of buyers and sellers, homogeneous products, perfect information, free entry and exit, and no externalities. In a perfectly competitive market, individual firms are price takers, meaning they cannot control the market price. They can only adjust their production level based on the market price.

Demand Curve for an Individual Firm

In a perfectly competitive market, an individual firm faces a completely elastic or horizontal demand curve. It means that the firm can sell any quantity of output at the market price without affecting the price. The horizontal line represents the market price that all buyers are willing to pay for the products.

Homogeneous Products

One key characteristic of a perfectly competitive market is that all firms sell homogeneous or identical products. This means that consumers have no preference among the competing producers. Consequently, if an individual firm were to increase the price of its product, consumers would immediately switch to purchasing the same product from another firm at the lower market price. This makes the demand curve for an individual firm perfectly elastic.

Large Number of Buyers and Sellers

In a perfectly competitive market, there is a large number of buyers and sellers such that no one firm can influence the market by changing its output or price. Since each firm represents a small portion of the total market, their output decisions have no noticeable impact on the market price. This is why the demand curve for an individual firm is horizontal at the market price.

Conclusion

In a perfectly competitive industry, the demand curve facing the individual firm is a horizontal line because the firm cannot influence the market price, all firms sell homogeneous products, and there are a large number of buyers and sellers. Therefore, individual firms in such a market must accept the market price and can only adjust their output level according to that price.