Question

Why is a perfectly competitive firm called a price taker?

Hint:

A perfectly competitive firm is a price taker because it has no control over the price and must accept the market price as determined by supply and demand.

Answer 1

A perfectly competitive firm is called a "price taker" because it has no control over the market price of the product it sells. In a perfectly competitive market, there are many firms selling identical or homogeneous products, and each firm is too small to influence the market price. The price is determined by the forces of supply and demand in the market, and each firm must accept this price.

Step 1: Characteristics of Perfect Competition.
Perfect competition is a market structure where the following conditions prevail:
- Many Buyers and Sellers: There are numerous firms and consumers in the market, and no single firm can control the price.
- Homogeneous Products: All firms sell identical products, and consumers have no preference for one firm's product over another.
- Free Entry and Exit: Firms can freely enter or exit the market without barriers.
- Perfect Information: All participants have perfect knowledge of prices, products, and market conditions.

Step 2: Price Determination in Perfect Competition.
In a perfectly competitive market, the price of a good is determined by the interaction of supply and demand in the entire market. Since each firm produces an identical product, it cannot charge a higher price than the market price, as consumers will simply buy from another firm. As a result, firms must accept the market price as given. This is why such firms are called "price takers."

Step 3: No Market Power.
A perfectly competitive firm has no market power to influence the price. The firm's output is so small compared to the overall market that even if it changes the quantity it supplies, the price will remain unchanged. The firm must accept the market price for its product and can only decide the quantity it wants to produce and sell at that price.