Price Taker
An economics term that defines market participants that aren’t able to individually dictate the price of a market.
What is a Price Taker?
Price-takers is an economics term that defines market participants that aren’t able to individually dictate the price of a market. Since the price-taker lacks the power to influence market prices, they generally have to accept the prevailing price of the market.
An example would be a farmer selling corn. Since there are a lot of other farmers in the market selling their corn, there will be a lot of competition. However, all the corn to be sold is pretty similar and identical to each other. There are also low barriers to entry in the market.
This means that if a farmer decides to sell his corn for $.20 more than the market price, no one in the market will buy it. His corn is no different than the next farmer's corn, so the consumer would be paying a $.20 premium for no reason.
The farmers in this market have no market power and must sell their corn at most at the market price.
The four different types of market structures will promote companies to be either price-takers or price-makers. Price-takers usually arise in markets with minimal to no barriers to entry. The firms in these markets may also sell identical or similar products.
In the stock market, individual investors are also considered to be price-takers because they buy or sell stocks at a price listed on the stock exchange. The people who set the bid and offer in security are considered to be market-makers.
Although they can influence the price, market-makers don’t have free reign to set the price at whatever level they want. Supply and demand dictate the prices, along with competition between market-makers.
Price Taker vs. Price Maker
Another key economics term is a price-maker, which can commonly be mixed up with a price-taker.
Don’t let this mix you up; they’re quite different. To keep it simple, a price-maker is the opposite of a price-taker.
Price-makers can influence the market price and affect supply and demand. In other words, they have pricing power.
Price-makers are typically found in imperfectly competitive market structures like monopolies and oligopolies due to the lack of substitutes and competition.
These are markets where one (or a few) firms hold most of the market power. This creates lots of barriers to entry for other firms to join the market. This is why there is a lack of substitutes and competition in the market. Firms are just not able to compete with the established players.
Price-makers are profit maximizers because they will increase output only if their marginal revenue is more than its marginal cost (as long as they’re making a profit).
Markets with price-makers can lead to a lower quality in the products the firms produce and sell. The market becomes all about quantity and speculation in pricing, and firms are willing to give up product quality due to the lack of competition and substitute products.
As mentioned before, price-takers don’t have the market power to influence market prices and aren’t able to affect supply and demand. They have to sell at a price determined by the market.
Price Takers in Perfectly Competitive Markets
Firms in perfectly competitive markets are all price-takers. Perfectly competitive markets are a type of market structure where:
- Firms sell identical products
- There are both a large number of buyers and sellers
- There is information transparency for buyers
- There are no barriers to entry into the market
It is important to note that in actuality, no market is perfectly competitive, but many markets share similar characteristics of a perfectly competitive market.
An example of a perfectly competitive market is the agricultural industry. Imagine a firm producing and selling apples. This firm is a price-taker because:
1. The goods (apples) are homogeneous:
A bushel of apples produced by one farmer will be pretty similar to a bushel produced by another farmer. Since the firms produce similar to almost identical products, there is not going to be any brand loyalty occurring.
2. There are many buyers and sellers:
The apple industry has many firms (or individuals) selling in the market. Likewise, there are many consumers in the market too.
A firm can’t change the price of its goods without expecting a loss in profits due to the many substitutions (of the same product) buyers have available.
3. Buyers can access perfect information:
There is no information asymmetry between buyers and sellers about price discrepancies in this market.
That means that buyers can easily find the lowest prices and won’t purchase from buyers who place a premium on their goods.
4. Low barriers to entry and exit:
There are some barriers to entry in producing apples, but they aren’t substantial. Most farmers can enter the apple market if they please.
On the other hand, firms can easily leave the market as there aren’t many fixed (or infrastructure) costs associated with producing apples.
The market determines the prices in a perfectly competitive market, not an individual firm.
Price Takers in Capital Markets
Capital markets are marketplaces where financial securities and assets are traded. Capital market institutions, like the stock exchange, are designed in such a way to make most participants price-takers.
This is because demand and supply in the market are extremely influential on the price of securities. Although capital markets promote price-takers, large participants can still affect the supply and demand, effectively changing the price of securities.
These prominent participants are known as price-makers. Of course, common people won’t have this ability, so most people who trade daily are price-takers.
So, as described above, a stock exchange is an example of a market where a majority of the participants are price-takers.
Individual investors trade in relatively small quantities. Individually, the impact of their trades has little to no effect on the prices of securities. They’re forced to accept the price of the security given to them and decide whether to trade on that prevailing price.
Small firms don’t have the transaction size needed to affect the market substantially, so they too are considered to be price-takers.
These firms still possess more market power than individual investors. The market power they have is not enough to influence the demand or supply of securities, which results in them being categorized as price-takers.
Price Takers in Monopolies
A monopoly is a market structure in which a single firm controls most of, if not all, of the market power.
The firm with the market power will have no competitors, and the market will have extremely high barriers to entry. If consumers want the product, they must purchase from this singular firm.
This results in a firm having pricing power, meaning that they’re a price-maker. Being the only firm in the market, they can set them to whatever price they please. Consumers must pay for their product as there are no viable substitutes to it.
An example is DeBeers and the diamond industry. DeBeers used to own up to 90% of the raw diamond industry.
This led to DeBeers being able to artificially restrict supply, leading to the price of the diamond increasing. DeBeers could effectively set the price level of the diamonds they sold.
For the sake of the example, let's say another firm is in the diamond market. This firm can’t set its prices higher than DeBeers, or else consumers will go with the trusted brand at a lower price.
This forces the firm to take the price that DeBeers set its diamonds at, making the firm a price-taker.
The monopoly firm in this market will be considered a price-maker because of its ability to control supply and demand, resulting in price control.
On the other hand, the firm with lesser market power is a price-taker because it has to sell at the price that DeBeers sells its products, or consumers would stop purchasing them.
Price Taker FAQs
An individual or firm that accepts the prevailing market price and lacks the market share to influence the price on its own. This applies to most people and companies in real-world markets.
Some characteristics are:
- Relatively small market share
- Homogenous Product
- No switching costs
- Low barriers to entry (or exit)
- Perfect information available about the market
A firm in the former must take the prevailing market price as the firm holds no pricing power. On the other hand, a firm in the latter will hold some market power because they sell differentiated products, leading to them being able to set their own prices.
or Want to Sign up with your social account?