Q4Managerial Economics & Financial Accounting
Question
"Under perfect competition the seller is a price taker whereas under monopoly he is the price maker". Explain.
Answer
Perfectly competitive firms are too small to influence price, while monopolists control the entire market supply and thus dictate price.
Under perfect competition, there are thousands of sellers selling an identical product. The total market supply and market demand determine the equilibrium price. A single individual firm's output is so microscopic compared to the total market that altering its production has zero effect on the market price. The firm must simply "take" the prevailing market price, or it will sell nothing.
Under a monopoly, there is only one single seller constituting the entire industry, and the product has no close substitutes. Because the monopolist controls 100% of the market supply, they have complete power to dictate the price. They can choose to restrict supply to artificially drive the price up, making them a "price maker."