Microeconomics – Week #5 Lecture 2

Price Takers versus Price Searchers

How competitive a market is determines how much market pricing power firms in aggregate enjoy, as well as the price elasticity of the individual firm's demand curve. As markets get more competitive, efficiency and equity increase. When we assess markets, we base efficiency and equity upon whether it's a market comprised of price takers or price searchers. Price takers are firms who have no market pricing power, no product differentiation from other competitors, and the market is perfectly competitive and efficient and equitable. Price searchers, on the other hand, are firms who have at least some market pricing power, at least some product differentiation from other competitors, and the market is imperfectly competitive leading to losses in efficiency and equity.

Who are the price takers? Firms who produce completely identical goods to which one firm cannot differentiate itself from another firm, not one firm by itself can produce any quantity high enough to affect market price, many producers exist, only short-run economic profits can be attained, and products produced are commodities will be what we call "price takers." The market dictates what each individual firm prices their product. The demand curve for the individual firm will be perfectly horizontal, and it's marginal revenue curve will be one in the same with the demand curve due to price not changing according to output. The optimal point where price takers will produce is where marginal costs equal marginal revenues, just where the marginal cost curve intersects the demand curve/marginal revenue curve. Any price in the short run above the price where marginal costs equal marginal revenues will result in economic profits; due to a lack of barriers to entry, new firms will enter, shifting the supply curve in the market rightward, pulling price back to equilibrium, thus eliminating economic profits in the long run and normal profits existing thereafter.

At what point will the price taker shut down? When price falls below the average variable cost curve. Any price that falls below the average total cost curve where normal profit occurs is a resulting loss to the firm. The firm will continue to produce up to and not beyond the average variable cost curve, because below the AVC indicates the firm cannot cover their average variable costs. Firms start to leave the market when price in the market falls below the equilibrium point, thereby shifting supply back up to equilibrium and normal profits again in the long run.

In summary, we perfect competitors are price takers, while the price searchers are imperfect competitors consisting of monopolistically competitive firms, oligopolies, and monopolies. Perfectly competitive markets provide the most efficiency and equity, ease of entry to the market, and greatest efficient output. Although economic profits cannot be had in the long run by monopolistically competitive, oligopolies and monopolies can, thereby pulling consumer surplus away from consumers to producers. We will delve into each of these market structures in weeks six and seven.