Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is the shape of the demand curve in a perfectly competitive market?

1. Diagonal line increasing from left to right

2. Perfectly horizontal line

3. Perfectly vertical line

4. S-shaped curve

The correct answer is: Perfectly horizontal line

In a perfectly competitive market, the demand curve is represented as a perfectly horizontal line. This horizontal orientation signifies that a firm is a price taker, which means it cannot influence the market price but must accept it as given. In such markets, there are many buyers and sellers offering identical products, leading to a situation where the price is determined by the overall market supply and demand. Since each firm sells such a small fraction of the total market output, they can sell as much as they want at the market price, but if they attempt to charge a higher price, they would sell nothing because consumers can easily purchase the same product from competitors at the market price. Therefore, the demand curve facing the individual firm is perfectly elastic, represented by the horizontal line. In contrast, a diagonal line increasing from left to right would imply that as price increases, the quantity demanded also increases, which is characteristic of individual consumer demand, not that of a firm in perfect competition. A perfectly vertical line indicates a perfectly inelastic demand, indicating that consumers will purchase the same amount regardless of price changes, which isn’t applicable in a competitive market. The S-shaped curve indicates varying elasticity at different price levels, which does not reflect the nature of demand for a firm under