Suppose a firm in a competitive market reduces its output by 20 percent. As a result, the price of its output is likely to
a) decrease by more than 20 percent. b) increase. c) remain unchanged. d) decrease by less than 20 percent.
The correct answer and explanation is:
The correct answer is (c) remain unchanged.
In a perfectly competitive market, there are many firms offering identical products, and no single firm has the market power to influence the price of the product. Firms in such markets are price takers, meaning that they accept the prevailing market price as given. The price of the product is determined by the intersection of aggregate supply and demand in the market.
If a single firm reduces its output by 20 percent, its individual contribution to total market supply decreases. However, in a competitive market, the total supply curve is composed of all firms’ output. The reduction in output by one firm is unlikely to significantly affect the overall market supply. As a result, the price in the market is unlikely to change. This is because the market price is determined by the total supply and demand in the market, not by the actions of a single firm.
In a perfectly competitive market, each firm’s output is small relative to the entire market, and the price is determined by the aggregate behavior of all firms. Therefore, a reduction in output by one firm does not shift the market supply curve enough to affect the price. Consequently, the price remains unchanged despite the firm’s output reduction.
If the market were not perfectly competitive, such as in a monopolistic or oligopolistic market, the firm’s reduction in output could lead to a price increase due to less competition. However, in perfect competition, no single firm has enough market power to influence the price. This is a fundamental characteristic of a competitive market.