THE THEORY OF THE FIRM UNDER PERFECT COMPETITION
Q) What does price-taking entail from the viewpoint of a firm?
Answer: A price-taking firm believes that if it sets a price above the market price, it will be unable to sell any quantity of the good that it produces.
Q) What does price-taking entail from the viewpoint of a buyer?
Answer: A buyer would obviously like to buy the good at the lowest possible price. However, a price-taking buyer believes that if she asks for a price below the market price, no firm will be willing to sell to her.
Q) Why is price-taking often thought to be a reasonable assumption when the market has many firms and buyers have perfect information about the price prevailing in the market?
Answer: Because in such a market, each individual firm is too small to have any influence on the market price.
Q) What happens if a firm in a perfectly competitive market sets a price above the market price?
Answer: The firm will lose all its customers to other firms that are charging the market price.
Q) What happens if a firm in a perfectly competitive market sets a price below the market price?
Answer: The firm will be able to sell as many units of the good as it wants, but it will not be making any profit.
Q) Why would a firm in a perfectly competitive market not set a price below the market price?
Answer: Because there is no reason to do so; the firm can sell as many units of the good as it wants by setting a price equal to the market price.
Q) What is the difference between a price-taking firm and a price-setting firm?
Answer: A price-taking firm has no influence on the market price, while a price-setting firm can set its own price.
Q) What are some examples of perfectly competitive markets?
Answer: Agricultural markets, financial markets, and some retail markets.
Q) What are some of the limitations of the price-taking model?
Answer: The price-taking model assumes that firms have perfect information about the market price, which is not always the case. The model also assumes that firms are identical, which is not always the case.
Q) What are some of the implications of price-taking for economic efficiency?
Answer: Price-taking can lead to economic efficiency because it forces firms to produce at the minimum efficient scale.
