PRICE
DETERMINATION
UNDER PERFECT
COMPETITION
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Perfect Competition
Perfect competition is defined as a market situation where
there are a large number of sellers of a homogeneous
product. An individual firm supplies a very small portion
of the total output and is not powerful enough to exert
any influence on the market price.
Similarly, a single buyer, however large, is not in a position
to influence the market price.
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Features of Perfect Competition
Existence of a large number of buyers and sellers
Absence of government controls
Homogenous products
Normal profits
Free entry and exit of firms
Existence of single price
Perfect knowledge of the market
Perfect mobility of factors of production
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Determination of market price under Perfect
Competition
Market price in a perfectly competitive market is determined by the
interaction of the forces of market demand and market supply. Market
demand means the sum of the quantity demanded by individual buyers
at different prices.
Similarly, market supply is the sum of quantity supplied by the individual
firms in the industry. Each seller and buyer takes the price as
determined. Therefore, in a perfectly competitive market, the main
problem for a profit-maximizing firm is not to determine the price of its
product but to adjust its output to the market price so that profit is
maximized.
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ILLUSTRATION
Price of Quantity Quantity
Commodity- Supplied of demanded of Price Determination
x Commodity- Commodity-
X(dozen) X(dozen) 6
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Price
5 50 10
2
4 40 20
0
3 30 30
10 20 30 40 50
2 20 40 Quantity
1 10 50 Demand Supply
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Equilibrium of a Perfectly Competitive Firm
● Short Run Case
● Long Run Case
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Short Run:
● Firm under Perfect Competition is a Price Taker and not a Price Maker
● The Firm's Demand Curve is its Average Revenue Curve as AR=MR=Price.
● The Firm can maximize its profit by adjusting its output.
● The firm in short run earns Super-normal profits.
● The firm may incur losses depending on its cost conditions.
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Long Run:
● In long run the free entry and exit of the firms assure that the Super-normal profit and
losses will disappear.
● In case new firms enter the industry the Cost Curves (AC&MC) of will shift upwards, on
the other hand Revenue Curves (AR&MR) will shift downwards.
● Hence, squeezing the super-normal profits to zero.
● Similarly, in case of net loss, the exit of some firms will bring in Normal-Profit for
remaining firms.
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Shutdown Point for a Perfectly Competitive Firm
● Shutdown Point for a Perfectly Competitive Firm is the situation whereby, it is able to
cover only its variable cost and no part of its fixed cost.
● The firms continues to produce even in case of losses in order to cover some part of the
fixed costs i.e. until they reach the shutdown point.
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Supply Curve
There lies a relationship between the variation in the prices and quantity supplied by the firm
or industry. This relationship has been illustrated below.
A. Supply Curve of a Firm
B. Supply curve of an Industry
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Price Determination in Perfectly Competitive
Industry
● Market Period: In market period the supply is fixed. Variations in demand determines
the price of the product. However the pattern is different in the case of perishable and
durable goods.
Perishable goods Durable goods
Supply can not be adjusted to Supply can be adjusted to demand
demand. to some extent.
Supply curve is perfectly inelastic Supply curve is upward slopping,
initially. but later on becomes
vertical.
The prices are determined only on The prices are initially determined
the basis of demand. by both demand and supply, but
later on it depends only on demand.
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●
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● Short Run:
a) Supply can be varied only to some extent.
b) Number of firms cannot increase or decrease.
c) Price is the result of interaction of short period demand and supply
curve.
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Long Run:
a) The firm can fully adjust the supply to meet the change in the demand.
b) New prices in long run may or may not be in the direction of change in demand.
c) The new price may be more than, less than or equal to initial price depending upon
whether the industry operates under increasing, decreasing or constant cost conditions.
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Market Supply Curve
● As we notice that if market demand curve shifts, the market supply curve and
equilibrium point also shift. When we join two such equilibrium points, we get long run
market supply curve.
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CONSEQUENCES OF PERFECT COMPETITION
● It ensure
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