Price Taker Definition
A price taker is an individual or a firm that has no control over the prices of goods or services sold because they usually have small transaction sizes and trade at whatever prices are prevailing in the market.
Examples of Price Taker
Below are some of the examples of a price taker.
Let us look at the air travel industry. There are multiple airlines that provide flight services from one destination to the other. The basic fare for all these airlines would be almost identical. The difference could come in the form of additional services such as meals and priority check-in etc. If one airline is charging a much higher amount than its peers for the same category of products, people would just buy tickets from the lower-priced airline.
Another example could be a financial services company. These companies charge a certain price for providing services to their clients. Now, these clients are aware of the prices charged by different companies, so they would avoid any company that is charging higher than the others. The prices could vary for providing special services which would be added to the basic ones, but the prices of similar services would remain at the same level as their competitors.
Price Takers in Capital Market
Capital MarketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets. institutions such as stock exchanges are by design made in a way that most participants are Price Takers. The price of securities is heavily influenced by the demand and supply, but there are large participants such as institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples. who can change this demand and supply, in turn influencing the prices of the securities. They are known as Price Makers. Other than these participants, most of the people who trade even on a daily basis are price takers.
We can, therefore, take a stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ. as a general example of a market where most participants are price takers.
- Individual Investors: Individual Investors trade in very small quantities. Their transactions have none to negligible impact on the prices of the securities. They take whatever prices are prevailing in the market and trade on those prices.
- Small Firms: Small Firms are also price takers because their transactions are also unable to influence market prices. Granted, they have relatively more power and influence in the market compared to individual investors, but it is still not enough to shift them into the price-makers category as they are still unable to influence the demand or supply of the securities.
Price Takers (Perfect Competition)
All firms in a perfectly competitive marketPerfectly Competitive MarketPerfect competition is a market in which there are a large number of buyers and sellers, all of whom initiate the buying and selling mechanism. Furthermore, no restrictions apply in such markets, and there is no direct competition. It is assumed that all of the sellers sell identical or homogenous products. are Price Takers for the following reasons:
- Large Number of Sellers – In a perfectly competitive market, the number of buyers for any product is large. They sell identical products and hence it is next to impossible for a single seller to influence the price of the products. If any seller tries to do that, they run a risk is significant losses because no buyer would buy from a seller that prices his products higher than the others.
- Homogenous Goods – In a perfectly competitive market, the goods are identical in nature. There is no inclination for a buyer to buy from one specific seller. A seller can have pricing power if there is product differentiation. But in this case, everybody is selling the same product so the buyers can go to any seller and purchase it.
- No Barriers – There are no barriers to entryBarriers To EntryBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant. and exit in a perfectly competitive market. Firms can enter and exit whenever they want to. Hence they have no pricing power and become price takers.
- Information Flow – There is a seamless flow of information in a perfectly competitive market. Buyers are aware of the prices of goods that exist in the market. Therefore, if a buyer tries to charge higher than the prevailing price in the market, the buyers find out and will not buy from the seller trying to sell at a higher price than the others. So the buyer is forced to accept the prevailing price in the market.
- Profit Maximisation – Sellers try to sell the goods at a level where their profit can be maximized. This is usually the level where the Marginal CostMarginal CostMarginal cost formula helps in calculating the value of increase or decrease of the total production cost of the company during the period under consideration if there is a change in output by one extra unit. It is calculated by dividing the change in the costs by the change in quantity. of producing the goods is equal to the Marginal RevenueMarginal RevenueThe marginal revenue formula computes the change in total revenue with more goods and units sold." The value denotes the marginal revenue gained. Marginal revenue = Change in total revenue/Change in quantity sold. from selling the product. The Marginal Revenue is also the Average Revenue, or the Price, of the product because all the units of that product are being sold at the same price.
Price Takers (Monopoly/Monopolistic)
As opposed to Perfect Competition, there are one or two firms in the market that have a monopoly over the products in a monopolistic economy. Those firms have immense pricing power and can do whatever they want to. Therefore, the rest of the firms become price takers automatically. Let’s take an example:
In the soft drinks market, Coca Cola and Pepsi lead the market. They set the prices for their products and enjoy heavy market shares. Now suppose there is another company that exists in the market. That company cannot set the price of its products higher than these two because in that case, the buyers would just go to the trusted brands that already enjoy a huge market share. This company would have to take the price set by Coke and Pepsi in order to stay in the market, otherwise, it will incur the huge loss of business and revenue.
Entities that cannot influence the price of goods or services on their own are forced to become Price Takers. This happens due to many reasons such as a large number of sellers, homogenous goods, etc. In a perfectly competitive market, all firms are price takers and in monopolistic competition, most firms are price takers.
In a perfectly competitive market, firms will sell the products as long as Marginal Revenue is equal to the Marginal Cost. If the Marginal Revenue falls below the Marginal Cost the firm will be forced to shut down.
This has been a guide to what is Price Taker and its definition. Here we discuss the reasons why all the firms in a perfectly competitive market are price takers along with the examples. You can learn more from the following articles –