Competetive Firms
To discover what happens in a market in which perfect competition prevails, we must deal separately with the behaviour of the individual firms and the behaviour of the industry that is constituted by those firms. One basic difference between the firm and the industry under competition relates to pricing. We say that:
Under perfect competition, the firm is a price taker. It has no choice but to accept the price that has been determined in the market.
The fact that a firm in a perfectly competitive market has no control over the price it charges follows from the definition of perfect competition. The presence of a vast number of competitors, each offering identical products, forces each firm to meet but not exceed the price charged by the others. Like a stockholder with 100 shares of General Electric, the firm simply finds out the prevailing price on the market and either accepts that price or refuses to sell. But while the individual firm has no influence over price under perfect competition, the industry does. This influenc. is not conscious or planned-it happens spontaneously through the impersonal forces of supply and demand, as we observed in Chapter 4.
With two important exceptions, the analysis of the behavior of the firm under perfect competition is exactly the same as that pertaining to any other firm. The two exceptions are the special shape of the competitive firm’s demand curve and the effects of freedom of entry and exit on the firm’s profits. We will consider them in turn, beginning with the demand curve.
Assumed that the firm’s demand curve sloped downward; if a firm wished to sell more (without increasing its advertising or changing its product specifications), it had to-reduce the price of its product. The competitive firm is an exception to this general principle.
A perfectly competitive firm has a horizontal demand curve. This means it can double or triple its sales without any reduction in the price of its product.
How is this possible? The answer is that the competitive firm is so insignificant relative to the market as a whole that it has absolutely no influence over price. The farmer who sells his corn through an exchange in Chicago must accept the current quotation his broker reports to him. Because there are thousands of farmers, the Chicago price per bushel will not budge because Farmer Jones decides he doesn’t like the price and holds back a truckload for storage.
