CA Foundation · Business Economics · Price Determination in Different Markets
In a perfectly competitive market, a firm's demand curve is horizontal at the prevailing market price. Which of the following best explains why the firm cannot charge a price higher than this market price?
A perfectly competitive firm cannot charge above the market price because it is a price taker facing perfectly elastic demand. Since its product is identical to competitors' products, any price increase causes customers to switch entirely to other sellers offering the market price.
- AThe firm's average cost of production is fixed at the market price
- BThe firm is a price taker and faces perfectly elastic demand; customers will purchase from competitors at the lower market priceCorrect
- CThe government sets price ceilings in competitive markets
- DConsumers have a preference for homogeneous products over differentiated ones
Explanation
In perfect competition, individual firms are price takers because they sell homogeneous products and face many competitors. If a firm tries to charge above the market price, all demand shifts to competitors offering the same product at the market rate. This creates perfectly elastic demand for the individual firm. The other options misrepresent the nature of competitive markets.
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