Question

What is a "price taker" firm?

Short answer

A price taker firm is a firm that has no influence over the market price of the goods or services it sells and must accept the prevailing market price. It has no market power and faces a perfectly elastic demand curve. Price taker firms can be found in perfectly competitive markets with a large number of buyers and sellers, and homogeneous products. Examples include small family-owned farms or individual grocery stores. To maximize profit, a price taker firm can choose an output level where marginal cost (MC) equals marginal revenue (MR), i.e., MC = MR.

Step-by-step solution

Definition of a Price Taker Firm

A price taker firm is a firm that has no influence over the market price of the goods or services it sells. It accepts the market price as given, since it is unable to change the market price individually. A price taker firm has no market power and faces a perfectly elastic demand curve, meaning that it can sell any quantity of its product at the prevailing market price.

Market Conditions for Price Taker Firms

Price taker firms can be found in perfectly competitive markets, where there are a large number of buyers and sellers, and the products being sold are homogeneous or very similar. Since there are many firms offering nearly identical products, and the buyers have full information about the products and prices, no single firm can significantly influence the market price. In order to sell its product, each firm must accept the prevailing market price.

Examples of Price Taker Firms

Examples of price taker firms can include small family-owned farms or individual grocery stores. If we consider a small farmer who grows and sells wheat, there are many other farmers who are also selling wheat in the market. Therefore, an individual farmer cannot influence the market price for wheat; they must accept the market price for their product. Similarly, a grocery store typically faces competition from numerous other stores selling similar goods. They cannot set their own prices without the risk of losing customers to more competitive competitors. In both cases, the firms are considered price takers.

Implications for Price Taker Firms

For a price taker firm, the optimal production decision is determined by the intersection of its marginal cost (MC) and the market price which is equal to its marginal revenue (MR), i.e., MC = MR. To maximize its profit, a price taker firm can choose the output level at which this condition is satisfied.