What’s it: A price taker refers to a firm that cannot influence market prices and can only set an output price at the market price. All firms in perfect competition are price taker.
Conversely, in imperfectly competitive markets, some firms have some market power that allows them to charge higher prices. Such power, for example, is through differentiation or domination of supply in the market.
Price taker characteristics
Price takers cannot influence market prices and can only adjust their products to market prices. Several reasons are why this might be.
- Relatively small market share. Under perfect competition, the market consists of many companies competing with each other. Their business size is also relatively similar. Also, the market share of each company to the total supply in the market is meager. So, changes in the firm’s output do not affect supply in the market.
- Homogeneous product. Companies offer similar and identical products. They substitute each other perfectly. Therefore, firms do not have the opportunity to set higher prices, for example, through differentiation. Also, because the product is homogeneous, customer loyalty is absent.
- No switching costs. Consumers can easily switch to competing products if a company charges a higher price.
- Low market entry barriers. Thus, if the company makes a profit by raising the selling price slightly above the market price, it will attract new entrants. Consequently, supply increases and prices fall, returning to market prices.
- Low barrier to exit. The entry of new entrants intensifies competition and lowers market prices. When unable to compete, the company freely exits the market.
- Perfect market information. Both companies and consumers have perfect information about the market, including price, supply, and demand. Therefore, each will tend to have a relatively uniform response.
The difference between a price taker and a price maker
Price takers must accept the market price as their selling price. They don’t have the power to set a price higher than the market price. As a result, each company cannot maximize its profit by increasing or decreasing the price charged.
Conversely, price-makers have the market power to influence prices. They can set prices above the perfectly competitive equilibrium price by influencing market supply or differentiating their offering. Such power applies to firms in the imperfect competition markets.
In a monopolistic competitive market, firms are price searchers. The market consists of many players. The entry and exit barriers are also low. However, they have some market power through differentiation, enabling them to set prices above competitive prices.
Furthermore, under oligopoly competition, firms have relatively high market power. The market is composed of few players, and barriers to entry are also relatively high.
Several players dominate the market, enabling them to influence market supply and prices. Also, companies can take a differentiation strategy to set prices above competitive market prices. Thus, companies in this market tend to be price makers.
In a monopoly market, the firm is the price maker and has absolute power over the market price, quality, and supply. The company is the sole supplier in the market. The barrier to entry is high, so the threat from new entrants is low. Also, the threat of substituted products is low.
Because of these characteristics, the monopoly market is usually under government supervision. In some cases, the government controls the market through state-owned enterprises.
Meanwhile, in a monopsony market, producers are the price takers. Monopsony is a market in which there are only a single buyer and many producers. Therefore, buyers have significant power to lower prices.
Example of a price taker
Price takers appear in perfectly competitive markets. Unfortunately, there is no ideal example of a perfectly competitive market. Two closest examples are the forex and commodity markets.
Investors in the forex market have very little influence on the demand and supply of currencies. In this market, transactions come from many players, each with limited capacity.
In commodity markets, such as palm oil, products are almost identical, and there is a myriad of companies supplying it. Producers don’t have the bargaining power to negotiate prices. They tend to take the benchmark market price as the selling price. Hence, producers are price takers, even though their market does not operate under perfect competition.
The petroleum market is slightly different. Although it is produced as a standardized commodity globally, the barriers to entry are very high. Companies require significant capital costs to operate in the petroleum business, either to build refining facilities or to acquire oilfield concessions. Also, they require specific expertise, for example, to drill or refine oil. Not surprisingly, therefore, the number of oil producers is far less than the number of consumers.
Therefore, even though the product is homogeneous, most petroleum producers are price makers. The emergence of cartels, such as the Organization of the Petroleum Exporting Countries (OPEC), has also increased oil producers’ market power. Through production control, they can keep prices at profitable levels.