Why do individual firms in perfectly competitive markets face horizontal (perfectly elastic) demand curves?

• A. Because the products sold by each firm are highly differentiated from those of other firms.
• B. Because there are barriers to entry that limit the number of firms in the market.
• C. Because firms in perfect competition have significant control over market prices.
• D. Because each firm is a price taker and can sell any quantity at the market price without affecting it.

Answer: (D)

Verified step by step guidance

1. Understand the nature of a perfectly competitive market: it consists of many firms selling identical (homogeneous) products, with no single firm able to influence the market price.
2. Recognize that because products are identical, consumers view the product from any firm as a perfect substitute for another, so firms cannot charge a price higher than the market price without losing all customers.
3. Since each firm is a price taker, it must accept the market price as given and can sell any quantity at that price, which means the demand curve facing the individual firm is perfectly elastic (horizontal) at the market price.
4. Contrast this with markets where products are differentiated or firms have market power, where the demand curve facing a firm is downward sloping because firms can influence prices.
5. Summarize that the horizontal demand curve arises because the firm’s output is a perfect substitute for others, and the firm’s individual supply decisions do not affect the overall market price.