Question

Suppose that the owner and CEO of a firm that operates in a PERFECTLY COMPETITIVE market environment comes to see you for help. She has a few questions to ask you as the company Economist. This question is:

(i)     “At lunch the other day, I overheard an economist at the next table describe our perfectly competitive firm as being a ‘Price Taker’ in the market. Can you carefully and completely explain what it means to be a Price Taker AND why my firm is described that way, please?”

Answer 1

ANSWER-- In a perfect competitive market there are large no of buyers and sellers. Thus the influence of a single seller or buyer on the price is minimal. The price of the product is determined by the forces of market namely demand and supply. Thus the firms accept the price in the market and adjust their supply to maximise their profit. That is why they are called as price takers and also called quantity adjusters.Lowering the price of the commodity will increase the demand of the commodity increasing the profit in the short run but not in the long run. I will illustrate it with an example.For example assume the price of one commodity A as 100 in the market. Assuming that other determinants of demand remaining the same or Ceteris Paribus.When the firm decreases the price of commodity A to 80, there will be a sharp increase in the demand since demand is not under the control of the firm but the supply cannot be immediately increased within the short span to fully meet the demand.Now in the market the demand for the commodity is more than the supply of the commodity, soon the marginal cost of the product starts to increase because the price of the factors such as raw material etc starts to increase, thus the firm is operating under diseconomies of scale, thus there is negative profit in the long run.