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Why is a firm a price taker and not a price maker under perfect market conditions?

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samuel | eNotes Newbie

Posted November 15, 2013 at 12:29 PM via web

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Why is a firm a price taker and not a price maker under perfect market conditions?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted November 15, 2013 at 2:59 PM (Answer #1)

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In perfect market conditions (also called perfect competition) a firm is a price taker because other firms can enter the market easily and produce a product that is indistinguishable from every other firm’s product.  This makes it impossible for any firm to set its own prices.

A price taker is a firm that cannot have any say in setting its own prices.  A price taker simply has to accept the market price.  This is in contrast to a price maker, which can have an influence over the price at which it sells its goods.

In perfect competition, there are two main reasons why a firm cannot get away with setting its prices above the market price.  First, there is no difference between its product and that of every other firm in the market.  Therefore, no one will pay extra for a firm’s product the way that they might pay extra for something like Nike shoes.  Second, if a firm were to succeed in setting a higher price, more firms would enter the market, attracted by the higher profits that were available.  This would increase supply and drive down the price of the firm’s product.

In perfect competition, firms sell homogeneous products and it is easy for a firm to enter the market.  These two factors make it impossible for firms to set their prices above the market price.  This makes them into price takers.

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