Question

What is the difference between a price taker and a price setter? Which do you think a firm would prefer to be? Why? How does monopoly differ from perfect competition?

Answer 1

Answer

Price taker means that this firm will set price determined by the market like perfect competitive firms. This price taker firm has no control over price and it will charge only those price that is determined by the market.

Price setter means that that whatever price that will prevail in the market is set the by the firm. This price taker firm has high control over price or has high market power. Example of price setter firm is Monopoly firm.

As Price setter firm has high control over price and has high market power and thus a firm will prefer to be a price setter. (Note : For social point of view , Social welfare maximizes when firms behave like a price setter).

Monopoly : He is the only firm in the market. He has full control over price Demand faces by the monopolist is downward sloping and less elastic because of not availability of close substitutes. In order to maximize profit a monopolist produces that quantity at which MR = MC where MR = marginal revenue and MC = marginal cost.

Perfect Competition : In a perfect competition there are large number of firms and buyers in the market. Each firm has no control over price. Demand faces by the perfect competitive firm is horizontal and perfectly elastic. In order to maximize profit a perfect competitive firm produces that quantity at which P = MC where P = marginal revenue and MC = marginal cost. Quantity produced by a perfectly competitive firm is more in perfect competitive firm than monopolist and Price charged by a monopolist is higher than price charged by a perfect competitive firm.