Association of Chartered Certified Accountants (ACCA) Certification Practice Test

How do perfectly competitive firms typically respond to market prices?

1. They set the price higher than competitors

2. They are price makers

3. They adjust production to meet the market price

4. They ignore market prices

The correct answer is: They adjust production to meet the market price

In a perfectly competitive market, firms are considered price takers, meaning they have no control over the market price of their products or services. These firms face a perfectly elastic demand curve at the market price, and therefore they must accept the prevailing market price if they wish to sell their goods. As a result, the typical response of perfectly competitive firms to market prices is to adjust their level of production to match the output level where marginal cost equals the market price. This ensures that they maximize their profits or minimize losses. By increasing or decreasing their production in response to changes in market prices, these firms align their operations with the market's dynamics, effectively ensuring that they remain competitive and viable in the long run. Other responses, such as setting prices above competitors or being price makers, do not apply in a perfectly competitive framework because firms cannot influence the overall market price; they must instead respond to it by adjusting their quantity produced. Ignoring market prices is also contrary to the nature of perfect competition, as firms would typically not be able to sell their products unless they adhere to the market price.