Q.Why is a firm under perfect competition called a 'price taker'? Explain with reference to its average revenue and marginal revenue.
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Start your 14-day free trial to unlock the full solution →The term 'price taker' describes a firm that has no power at all to set or influence the price of what it sells, and must instead take the price as a fact fixed by forces outside its own control. Under perfect competition, this is exactly the position every firm is in, and the reason follows directly from the large-numbers feature of the market: because a very large number of essentially identical sellers together make up total industry supply, any single firm's own output is far too small a fraction of that total to shift the market price even slightly, however much or little the firm chooses to produce. The price is instead determined at the level of the whole industry, by the intersection of total market demand and total market supply, and every individual firm simply accepts whatever price that intersection produces.
This has a precise consequence for the demand curve facing an individual firm, which is drawn not as the industry's own downward-sloping demand curve but as a horizontal straight line at the prevailing market price. The firm can sell any quantity it wishes at that price — since its extra output makes no visible dent in total supply — but cannot sell even a single unit above that price, since buyers can turn immediately to any of the countless other identical sellers offering the same product at the going rate, and has no reason to sell below it either, since it can already sell all it wants at the market price. Because every additional unit sold therefore adds exactly the same amount, the market price, to the firm's total revenue, average revenue (revenue per unit sold) and marginal revenue (the addition to total revenue from one mor …
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