In a competitive market, why do firms tend to set prices similar to their competitors, with only small variations?

• A. Because firms collude to fix prices.
• B. Because firms have significant market power to set any price.
• C. Because products are homogeneous and firms are price takers.
• D. Because government regulations require identical pricing.

Answer: (C)

Verified step by step guidance

1. Understand the nature of a competitive market: In such markets, many firms sell identical or very similar (homogeneous) products.
2. Recognize that firms in perfectly competitive markets are price takers, meaning they accept the market price determined by overall supply and demand rather than setting their own prices.
3. Since products are homogeneous, consumers have no preference for one firm's product over another's based on price or quality, so firms cannot charge more without losing customers.
4. Because of this, firms tend to set prices very close to each other, usually at the market equilibrium price, with only small variations due to minor cost differences or other factors.
5. Note that collusion or government regulations are not necessary explanations here; the key reason is the combination of product homogeneity and the price-taking behavior of firms.