What would happen if a firm in a perfectly competitive market lowers its price below the market price?

It would sell as many units as it wants but earn lower revenue

The correct answer is Option 1: It would sell as many units as it wants but earn lower revenue

Option 1: It would sell as many units as it wants but earn lower revenue. This is the correct answer. In a perfectly competitive market, products are homogenous (identical) and there are many buyers and sellers with perfect information. If a firm tries to charge a price above the market price, it will sell nothing because buyers can get the exact same product from other sellers at the market price. Conversely, if a firm lowers its price below the market price, it can still sell as much as it wants because consumers would flock to the lower price. However, since it can already sell all it wants at the market price, lowering the price simply means it earns less revenue per unit for the same quantity sold, thus reducing its overall profit. There's no incentive for a firm to do this.

Let's evaluate the options:

• Option 2: Buyers would stop purchasing from it. Incorrect. This would happen if the firm raised its price above the market price, not lowered it.

• Option 3: The market price would increase. Incorrect. An individual firm in a perfectly competitive market is too small to influence the overall market price. Its actions do not significantly impact the industry's supply or demand.

• Option 4: Other firms would also lower their prices immediately. Incorrect. While other firms might eventually react if they noticed a significant shift, in a perfectly competitive market, the assumption is that firms already operate at the market price where they earn normal profits (zero economic profit in the long run). There's no incentive for other firms to lower their prices further if they can sell all they want at the prevailing market price. If one firm does lower its price, it will simply capture all the demand at that lower price, but other firms wouldn't necessarily follow suit unless the overall market conditions changed.