Why can't an individual producer influence market price in perfect competition?

Question

I’ve been told that under perfect competition, an individual producer is a price-taker and has no influence on the market equilibrium price. But this doesn’t make sense to me since the market equilibrium price is determined by market supply and market demand. The individual producer’s supply schedule would be included in the total market supply schedule, so wouldn’t they indirectly have an influence on the market equilibrium price?

I’ve also been told that an individual firm can sell as much as they want for the market equilibrium price, but this cannot be true. As shown on the market supply and demand graph, there is a finite quantity demanded at the market equilibrium price, so would they not only be able to sell as much as the equilibrium quantity demanded?

Answer 1

Important assumption in perfect competition is that the number of firm is very large. In fact in many IO models you get perfect competition when number of firms goes to infinity.

If the number of firms is effectively infinite then individual supply of a single firm simply does not matter $\infty-1 = \infty$. So even if one firm drops there is still infinity of others.

Note, perfect competition is a model, so simplifying assumptions are being made. A firm in an industry with 10k competitors could have some infinitesimal market power in reality. In a simple model this is assumed away. Later in your studies in an industrial organization class you will encounter models where you can allow for any number of firms and where market power changes depending on that.

Answer 2

It is just an assumption of the model that firms behave as price takers, i.e. as if they have no effect on price. Each firm is assumed to act as if they can sell as much as they like at any given price. Of course, if one firm increases its output and the other firms keep their outputs constant, it will not actually be the case that the price will be unaffected, as the market clearing assumption implies that the market price adjusts with changes in total output. The assumption of the model is just that each firm ignores this when choosing its output.

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To turn things around, do you have a problem with the assumption of the perfectly competitive model that consumers behave as price-takers? The more a given consumer demands, the higher the total quantity demanded. The market clearing assumption then implies the price must change (go up if the supply curve is upward sloping). However the assumption of the model is that each consumer ignores this when choosing their consumption. (There are models where consumers are not price-takers, i.e. models of monopsony and oligoposony. These are demand-side equivalents of monopoly and oligopoly.)

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If each firm were to take into account the effect of an increase in its output on the market price then that would be the Cournot model (of quantity competition), which is a model of oligopoly. In the Cournot model, as the number of firms goes to infinity (entry costs go to zero), the outcome approaches the perfectly competitive outcome (pricing at marginal cost).

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The assumption of price-taking is simply to capture the situation where each producer is so small relative to the market that any reasonable increase in their quantity has no effect on price. This can be formalised mathematically by assuming a continuum of firms. In this case there are infinitely many firms, each producing an infinitesimal amount.

Another rationale for the price-taking assumption of the perfectly competitive model (at least in the case of identical constant marginal costs) is as follows. If each firm were to choose their price (rather than quantity) and consumers went to the lowest-priced firm(s) (as in the Bertrand model of competition with identical products), then the only equilibrium is that all firms price at marginal cost. This is the same outcome as under perfect competition (regardless of the number of firms).