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Difficulty: MediumPerfect Competition: Characteristics and Assumptions

In a market for standardized grain featuring numerous small buyers and sellers, a single producer decides to set their selling price 5%5\% above the prevailing market equilibrium price. Which of the following best describes the immediate economic outcome for this producer?

  1. The producer will experience a complete loss of sales as buyers switch entirely to identical alternatives offered at the market price.Answer
  2. B
    The producer's total revenue will rise slightly because agricultural commodities generally exhibit price-inelastic demand.
  3. C
    The producer will gain supernormal profit in the short run until competitor entry forces prices back down.
  4. D
    The prevailing equilibrium market price will adjust upward across the entire industry to match the producer's new price.

Answer

The producer will experience a complete loss of sales as buyers switch entirely to identical alternatives offered at the market price.
Under perfect competition, products are homogeneous (identical) and market participants possess perfect information. As a result, the demand curve facing an individual firm is horizontal (perfectly elastic). If an individual firm attempts to charge any price above the prevailing market price, consumers will immediately shift all their purchases to rival sellers, causing the firm's sales to drop to zero.

Step-by-Step Solution

1
Identify the market structure and its key assumptions
The scenario describes a perfectly competitive market due to standardized products (homogeneous goods) and numerous buyers and sellers.
Recognizing the underlying market structure establishes the firm's pricing power and demand curve features.
2
Determine the elasticity of demand facing the individual firm
The demand curve facing an individual perfectly competitive firm is perfectly (infinitely) elastic (Ed=∞E_d = \infty).
Because goods are identical and participants have perfect knowledge, consumers can instantly purchase from other sellers at the equilibrium price.
3
Analyze the impact of charging a price above equilibrium
Setting price P>PequilibriumP > P_{equilibrium} leads to quantity demanded falling immediately to zero (Q=0Q = 0).
Price-taking firms must take the market price as given; charging even slightly higher eliminates all sales.

Key Concept

Price-Taker Status and Infinitely Elastic Demand in Perfect Competition
Estimated Time:1m 15s
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Topics

Perfect Competition: Characteristics and Assumptions

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