Question

If perfectly competitive firms are price takers, and monopolistic, monopolistic competitive, and oligopolistic firms are price searchers, then it follows that three times as many firms in the real world are price searchers than are price takers. Do you agree or disagree? Explain your answer.

Short answer

If the assertion is agreed or disagreed with would largely depend on the distribution of different market structures in reality. In some sectors, there may be more price-searching firms (monopolies, monopolistically competitive firms, and oligopolies), while in others, there may be more price-taking firms (perfectly competitive firms). Therefore, without specific data or references to support the claim, it would be difficult to definitively agree or disagree with the statement.

Step-by-step solution

Understand the Concepts

Understand the concept of price-taker: A price-taker is a firm that has no control over the price of the product it sells - it takes the market price as given. A perfect competition market structure is where firms are price-takers. Understand the concept of price-searcher: A price-searcher is a firm that searches for the price that maximizes its profit because it has some control over the market price. Monopolistic, Monopolistic competitive, and Oligopolistic firms are price searchers.

Understand the Market Structures

Understand different market structures: firms under perfect competition are usually numerous with standardized products. On the other hand, a monopoly, monopolistic competition, and oligopoly represent situations where firms have some level of market power hence can influence prices to their own advantage.

Evaluate the statement

The statement suggests that there are more price searcher firms than price taker firms in the real world. This claim depends on the actual distribution of the firms in different market structures in the real world. If in reality, the markets are dominated by monopolistic, monopolistically competitive, and oligopolistic structures, then the statement is correct. But there are sectors where competition is encouraged and thus might contain numerous price takers.

Key concepts

Price-Taker Firms

A price-taker firm is one that must accept the market price set by the forces of supply and demand; it does not have sufficient market power to influence or set prices. Generally, these firms sell products that are undifferentiated, and many competitors exist offering the same good or service. In a perfect competition market structure, all companies are essentially price-takers.

For students trying to comprehend this concept, imagine a local farmer selling apples in a market where hundreds of other farmers are selling nearly identical apples. The price of apples in this market is determined by how much all buyers are willing to pay and all sellers are willing to accept. An individual farmer cannot charge more than the going rate, or their apples will go unsold as customers can simply buy from another farmer at a lower, market-determined price.

Price-Searcher Firms

Price-searcher firms have the opposite characteristics of price-taker firms; they have some control over the price they charge for their products or services. This is possible because their goods are not perfectly substitutable, and they operate in markets with fewer competitors, such as monopolistic competition or oligopoly structures.

Consider the example of a company with a popular brand for shoes. It enjoys customer loyalty and brand recognition which gives it some leeway to set higher prices than no-name brands, influencing the market price for shoes in its segment.

Perfect Competition

In a market structure of perfect competition, numerous small firms sell identical, or 'homogeneous', products with no single firm having significant market power. These markets are characterized by freedom of entry and exit, perfect information, and no barriers to entry.

In a perfectly competitive market, the concept of being a price-taker is inherent, since there are so many sellers that no single entity can influence the market price. An example is a market for a basic agricultural product, like wheat, where no single farmer can affect the price of wheat – they must accept the current market price.

Monopolistic Competition

Monopolistic competition describes a market structure in which many firms offer products that are similar but not perfect substitutes for each other; there is some product differentiation facilitating market power. Firms here are price-searchers but due to the number of competitors, their market power is diluted.

A classic example is the restaurant industry where each venue offers unique dishes and ambiances that distinguish them from one another, giving them some control over their prices within their local market. However, due to competition, this power is limited.

Oligopoly

An oligopoly is a market structure where a few large firms dominate the market. These oligopolist firms have significant control over their prices due to limited competition and product differentiation. Such markets often have high barriers to entry and can lead to collusion between firms to set prices.

Automobile manufacturing is commonly cited as an oligopoly because of the relatively small number of firms that exert control over market prices within different vehicle segments. Their decisions can have a substantial impact on market dynamics.

Market Power

Market power refers to a firm's ability to influence the price of its product or service within the market. The more market power a firm has, the more it can set a price above its marginal cost, which can result in higher profits.

Market power is directly related to the concept of price-searcher firms; however, it’s critical to understand that market power exists on a spectrum. On one end, perfect competition creates virtually no market power for firms, while a monopoly on the other end allows a single firm total control over pricing. Oligopolies and monopolistic competition lie in between, possessing moderate market power.