We assume that competitive firms are price takers Explain wh

We assume that competitive firms are \"price takers.\" Explain what this means. What is keeping competitive firms from setting prices? Is this a plausible assumption? For which industries is it a likely assumption? For which is it not plausible?

Solution

Perfectly competitive firms are price-takers, which means that they accept the market price as fixed. In this case, we say that the firm has no market power.Every firm in perfect competition is very small compared to the overall size of the market. Consumers do not distinguish between the products of one firm over another, so consumers will only purchase at the lowest price, or the market price if there is only one price. With perfect competition, the competition means that all inefficient firms have been weeded out of the industry; only those which can cover their costs can survive. The competition means that the market price will allow for normal profits but no economic profits, which means that the individual firm cannot lower its prices to attract more customers: lower prices means that the firm cannot continue to cover its costs, and it would have to go out of business. The individual firm also cannot raise its prices, because it will lose its customers to the competition. With each firm selling identical products, there is no customer loyalty. The customer will migrate to the firms with the lower prices. No single firm is large enough to influence the market price through its own output. As a result, each firm’s demand curve is horizontal.

This is an plausible statement.In the other three market structures(oligopoly,monpoly and monopolistic competition) firms choose the price that they charge. In this case, the firm has market power.The lack of market power implies that firms charge a price equal to the marginal cost of production. Market power implies that firms mark up price above marginal cost. Even though there are many sellers in a monopolistically competitive market, they still exercise some market power because the products are differentiated.Perfect competition features many sellers selling an identical product, in addition to easy entry and exit in the long-run. Since there are a large number of sellers all selling an identical product, each firm has no price-setting power.That the firm is a price-taker and each individual firm has no influence on the market price.