PRICE DETERMINATION UNDER PERFECT COMPETITION

1. PRICE DETERMINATION UNDER PERFECT COMPETITION

2. Perfect Competition Perfect competition is a market in which there are many firms selling identical products with no firm large enough relative to the entire market to be able to influence market price.

3. Assumptions of perfect competition • Large number but small size of buyers and sellers • Homogeneous products • Perfect knowledge • Free entry and exit of firms • Free from checks • Perfect mobility • Lack of transport costs • Lack of selling costs • Same price

4. Pure and perfect competition According to Prof. Chamberlin a pure and perfect competitive market has the following characteristics: • Large number of buyers and sellers • Homogeneous products • Free entry and exit of firms • Free from checks • Lack of selling costs • Lack of transport costs

5. Demand and Revenue Curve in Perfect Competition • Under perfect competition or average revenue of the product is equal to marginal revenue which also represents the demand curve which is perfectly elastic means the firm can sell any amount of goods at the existing price.

6. Price determination under perfect competition • Under perfect competition price is determined by the industry and not the firms. Equilibrium price i.e. the point at which the market demand is equal to the market supply is determined by the industry. And the price so determined becomes the price of the firms under perfect competition thus a firm is called a price taker and not price maker under perfect competition.

7. Price determination

9. Effect of change in demand on price Supply remaining the same if demand increases the price also rises and if demand decreases price also falls. In other words price changes in accordance to demand.

10. Effect of change in supply on price Demand remaining unchanged, if supply increases price falls and if supply decreases price rises. In other words price varies inversely with the supply.

11. Importance of time element in price determination According to Marshall shorter the period, greater will be the influence of demand on price, and longer the period greater will be the influence of supply in the determination of price.

13. Determination of market price • Meaning: The price of a commodity that prevails in the market at a particular time. • Determination of market price: Since in very short period supply remains more or less ineffective so demand determines the price. Thus with the increases in demand price increases and vice versa. It is divided into two parts i.e. • Perishable goods • Durable goods

14. Perishable goods Goods which perish or go out of fashion very quickly are called perishable good. Supply of such goods changed according to the demand. And thus price increases with increase in demand and vice versa.

15. Durable goods Supply of such goods can be increased or decreased in very short period only up to the existing stocks. So price will be determined at the point demand is equal to supply.

16. Price determination in short period In short period the industry can increase the supply up to existing capacity of the firms. The firm will continue to produce in the short period even when they are incurring loss of AFC because even if the firm shuts-down it has to incur the losses of fixed costs. Thus the supply curve will be relatively more elastic than that of very short period.

17. Price determination in long period Normal price is that price which tends to prevail in a market when full time is given to the forces of demand and supply to adjust themselves. If in case demand falls short of supply the price of the commodity and hence profits from it will rise. This will induce more firms to enter the industry and produce more, increased demand will reduce the prices to normal and vice versa.

18. Normal price and laws of return • Normal price and law of increasing returns: law of increasing returns means law of decreasing costs. In long run due to increased production the firm enjoys several economies which bring down the marginal cost and average cost of production. Normal price being equal to marginal cost also comes down. price quantity

19. 2) Normal price and laws of decreasing returns: law of decreasing returns means law of increasing costs. When in long run due to increased production the industry suffers several diseconomies which increases the marginal and average cost of production. This in turn increases the normal price

20. 3) Normal price and law of constant returns: law of constant returns means law of constant costs. This implies that with the increase in production there is no change in the marginal or average costs which means the normal price also remains constant irrespective of the increase in demand or production.

21. Difference between market price and normal price

22. Ideal properties of perfect competition • Output at minimum cost: a firm produces at minimum cost in short run and at minimum average cost in long run. (price= minimum LAC) • Consumer pays minimum price: here the price paid by consumer is equal to marginal cost of the product (AR=MR=LMC=Minimum LAC) • Full utilization of resources: in the long run all the resources are used to their fullest. • Firms get only normal profits: in the long run the firms earn only normal profits which means no exploitation of the consumer.

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