We divide firms into two groups; price takers and price setters. Price setters are firms that can influence the price of the product by altering their output.
Price takers are firms that have no control over the price of a product. The distinction as to whether one is a price setter or a price taker lies in the distinction of market demand and firm demand. The closer a firm’s demand curve is to the actual market demand, the more of a price setter this firm is.
In the extreme case of a monopoly, the market demand is the same as the firm’s demand because the firm IS the industry. If the firm is a price setter the firm can decrease its output and market price goes up or it can increase its output and market price goes down.
In the case of perfect competition, there are many firms and the individual firm demands look very different from the market demand. These firms are price takers they have no control over the market price. Here’s what this looks like; the demand for a product in a perfectly competitive industry looks the same as the demand for a product and any other industry.
You have a demand curve and a supply curve, they come together and form some equilibrium price. In all of the things that we know about demand and supply apply here. If people’s incomes rise demand increases and the market price goes up. If there’s an increase in the number of producers the supply increases and the market price goes down.
So demand and supply look the way they normally do and when you put them together you get an equilibrium price. A firm’s demand curve looks nothing like the market demand curve. The firm’s demand curve is horizontal what this means is the firm takes the price as a given.
The price of the product in this case let’s say is $10 so the firm can produce a lot of output. It can produce a little output and it has no impact on the price of the product. The market price remains $10 so where does this $10 price come from? Well, it comes from the market demand. In the market supply we put these things together we get a market price of $10.