Perfect Competition

Demand as Seen by a Perfectly Competitive Firm

In a state of perfect competition, demand is essentially unlimited for any particular firm's products at the prevailing market price.
When the conditions of perfect competition hold, no firm is large enough to affect market pricing. Therefore, it can be assumed that every unit of a product an individual firm produces will be purchased if offered at the prevailing market price. In other words, the demand curve (the graph showing the relationship between demand for goods and services and their price over time) is perfectly elastic, meaning there is a propensity for consumers to change demand based on price; thus, the demand curve is graphed as a horizontal line. Because no firm is large enough to affect market prices as a whole, prices are arrived at through supply, the amount of goods and services available on the market, and demand, the desire for a good or service. The opposing pressures of supply and demand eventually cause prices to stabilize at an equilibrium point where the market is producing exactly as much of a product as consumers are demanding at the market price. That price is set by the market, at the point where supply and demand for the market are in equilibrium. The firm necessarily takes that price and can sell as much as it produces at that price.

Market Supply and Market Demand with Perfect Competition

Market price (P) is set in the market by the forces of supply & demand. Under perfect competition, a firm faces a horizontal demand curve, implying that it must sell its goods at the market price and that it can sell as much as it can produce at that market price.
For example, suppose a producer grows and sells wheat. In the real world, the market for wheat is nearly perfectly competitive. A consumer cannot tell where a grain of wheat was grown, and a grain from any one producer is as good as a grain from any other producer. Thus, the producer will sell a bushel of wheat for market price, regardless of whether they sell one bushel or one thousand bushels.

Because demand is held to be more or less constant in a situation of perfect competition, firms are free to maximize profit on the basis of the quantity of units produced and the cost of producing them. Over time this quantity stabilizes at an equilibrium level of goods supplied, where the quantity produced makes the cost of producing each unit equal to the equilibrium price set by market conditions.