Question

In a perfectly competitive market, how do firms set their price?

a) Take the market price b) Sell for less than market price to undercut competitors c) Set MR = MC and solve d) Sell for more than market price to make more profit

Answer 1

In perfect competition, there are large number of buyers and sellers in the market. All firms produce homogenous or identical goods. All firms are price takers as any single firm is too small to influence the market price. Market share has no influence on prices. Similarly, any buyer also cannot influence the market price as there are large number of buyers. There exists perfect knowledge of market to both buyers and sellers. There is free entry and exit of firms and there exixts no price discrimination.

The equilibrium in a perfectly competitive market occurs where P=MC and all sellers produce and sell at the market price. In the short run they can earn super-normal profits, normal profits or incurr losses but in the long run they can only earn normal profits.

Thus the correct option is (a) Take the market price.