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12.2 An Individual Price Taker’s Demand Curve

Perfectly competitive firms are price takers; that is, they must sell at the market-determined price. An individual seller cannot sell at any figure higher than the current market price, and he certainly would not knowingly charge a lower price, because he could sell all he wants at the market price.

In a perfectly competitive market, individual sellers can change their outputs and it will not alter the market price. Each producer provides such a small fraction of the total supply that a change in the amount he offers does not have a noticeable effect on market price. In a perfectly competitive market, then, an individual firm can sell as much as it wishes to place on the market at the prevailing price. The demand, as seen by the seller, is perfectly elastic at the market price.

Since a perfectly competitive seller won’t charge more than the market price because no one will buy at higher prices, and she won’t charge less because she can sell all he wants at the market price, her demand curve is horizontal at the market price over the entire range of output that she could possibly produce.

Exhibit 1: Market and Individual Firm Demand Curves in a Perfectly Competitive Market

While perfectly competitive firms are price takers, the position of each firm’s demand curve varies with every change in the market price. In effect, sellers are provided with current information about market demand and supply conditions as a result of price changes. The perfectly competitive model does not assume any knowledge on the part of individual buyers and sellers about market demand and supply--they only have to know the price of the good they sell.

Exhibit 2: Market Prices and the Position of a Firm’s Demand Curve


12.3 Profit Maximization

The objective of the firm is to maximize profits. It wants to produce the amount that maximizes the difference between its total revenue and total cost.