Chapter 8: Problem 13

What is a price taker firm?

Short Answer

Expert verified

A price taker firm is a company operating in a perfectly competitive market that has no control over setting its own prices and must accept the prevailing market price for its products or services. These firms typically have characteristics such as a large number of buyers and sellers, homogeneous products, free entry and exit, and perfect information, which collectively prevent any single firm from influencing the market price. Examples of price taker firms include many farmers in agriculture and small artisans like local bakeries and craftsmen.

Step by step solution

1. Define price taker firm

A price taker firm is a company that must accept the prevailing market price for its products or services and has no control over setting its own prices. This typically occurs in a perfectly competitive market where there are many sellers offering identical products or services, and no single company has a significant market share to influence the price.

2. Characteristics of a price taker firm

Some key characteristics of a price taker firm include: 1. Large number of buyers and sellers: In a perfectly competitive market, there are many buyers and sellers. As a result, individual firms have no significant market power, and their actions have little to no effect on the market price. 2. Homogeneous product: Price taker firms sell identical or nearly identical products or services. This means that buyers see no difference between products sold by different firms and will choose based on price alone. 3. Free entry and exit: There are no barriers to entry or exit in a perfectly competitive market, meaning that new firms can enter the market with ease if they believe they can make profits, and existing firms can exit the market if they feel they are not making enough profits. 4. Perfect information: All market participants have access to perfect information about prices, products, and other market conditions, which eliminates any information asymmetry.

3. Price taker firm in a perfectly competitive market

In a perfectly competitive market, price taker firms have no control over the market price. The market price is determined by the interaction of demand and supply. This means that the individual price taker firms have to adjust their production levels based on the market price and cannot influence the price themselves. The optimal quantity to produce for a price taker firm is where the marginal cost (MC) of production equals the market price (P).

4. Examples of price taker firms

Examples of price taker firms are often found in agriculture, where many farmers sell identical products (e.g., wheat, corn, milk) and cannot charge a higher price than the market price. Other examples may include small artisans, such as local bakeries and craftsmen, who sell their products in highly competitive markets where they have no control over the prices. In conclusion, a price taker firm is an economic actor in a perfectly competitive market that must accept the prevailing market price for its products or services and has no control over setting its own prices due to the characteristics of the market, including a large number of buyers and sellers, homogeneous products, free entry and exit, and perfect information.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Perfectly Competitive Market

Imagine a marketplace where buyers and sellers engage in commerce as equals, where no single player can sway the market's balance. This is what economists refer to as a perfectly competitive market. In such a market, numerous firms vie for consumers' attention by selling products that are undifferentiated to the point that consumers perceive them as interchangeable.

Key elements that frame such markets include:

Large number of sellers and buyers, ensuring no single entity can control prices.
Products that are homogeneous, leaving price as the sole differentiator.
Free market entry and exit, which allows firms to compete without onerous barriers.
Full transparency, where everyone has access to all necessary information.

In essence, firms in a perfectly competitive market are like runners in a race on identical tracks — they might reach different speeds (outputs), but the track conditions (market prices) are the same for all.

Market Price Determination

The invisible hand of the marketplace is what dictates the market price determination. Here's how it works: Imagine supply and demand as two forces that meet at a crossroads—this junction is called the equilibrium. It's where the quantity that consumers want to buy equals the quantity that producers want to sell.

How is this equilibrium price tagged?

Demand: Consumers have their say through their willingness to buy at different prices.
Supply: Producers are influenced by their costs and the revenue they anticipate.

When supply equals demand, the market is said to be at equilibrium. The corresponding price is the equilibrium price, the figure that makes sure nothing is left unsold or undemanded. In a perfectly competitive market, this price becomes gospel for price taker firms.

Marginal Cost and Pricing

In the world of business, one guiding principle is king: 'Sell at a price that covers costs and leaves a bit of profit'. The marginal cost is crucial here, representing the cost of producing one extra unit of a good. Firms use it to determine at what point producing more might become too expensive and not worth the price it fetches in the market.

For a price taker firm, this is the strategy:

Producing Units: It will continue to produce more as long as each additional unit adds more to revenue than to costs.
Setting Prices: Since the firm can't set prices, it produces until the marginal cost equals the market price.

When the cost of creating an additional product equals what you can sell it for, you're at your production sweet spot. If the marginal cost goes above the market price, it's a signal to stop production, as it would lead to losses.