Market and Perfect Competition

Price Determination
in Different Markets

CHAPTER

UN\T 1: MEAN\NG ·~~D.TYPES,Qf ,:MARKET

(A) MEANING OF MARKET

The term market refers not necessarily to place but always to a commodity and the buyers and

sellers who are in direct competition with one and another.
The elements of a market are:
1. Buyers and sellers
2. A product or service
3. Bargaining for a price
4. Knowledge about market condition
5. Single price at a given time.

(B) Classification of Market

In economics, classifi~ation of market may be on the following basis-
(1) Area

1. l.4)cal Markets : markets for perishable goods-butter, eggs, milk, vegetables
2. Regional Ma·rkets: Semi-durable goods-shirts

3. National Ma•rkets : durable goods and industrial items

4. International Markets: precious commodities-gold, silver .

(Il) Time - Alfered Marshall conceived the " Time" elements in marketing and on ti.me basts
market is classified into :

l. Very short Period market : perishable-supply can not be changed - market supply,-£::

2. S.bort-Period Market : supply can be changed due to law of variable proportion

3. Long-Period Market : supply can be changed unlimited due to law of w~ t~ scale
4. Very long-period or secular peri.od Market: change in factors-populallO. ll, copatal Sllpph·
(Ill) Nature of Transactions

1. Spot Market : goods are physically transacted on the spot
2. Future Market: transaction at future date

(IV) Regulations . ~ot

1 Regulated Market : transactions are regulated by Govt. - stock ·w·~

inar"2._Unregulated Market: No restn.cti·on~ on transactions- free 9'

(V) Volume of Busm. ess r lllJje qunJlU
l. Wholesale Market : commodities are bought and sold in bulk 0

92 .,--

pnce Determination in Different Markets 93

"z. Retail Market : commodities are bought sold in small quantities for ultimate consumers

(Vl) 'Competitions
1. Perfectly competitive : characteristics of Perfect competition market
2. 1JJ1perfect market: characteristics of Monopolistic competition market

1((i) TYPES OF MARKET STRUCTURES:-

. 1. perfect Competition

2. Monopolistic Competition/Imperfect Competition/Monopolistic Market
3. Monopoly/Monopolist Market
4. Oligopoly

(D) •REVENUE:

1. Revenue: The revenue of a firm is its sales, receipts or incomes.

z. Total Revenue (TR): - TR refers to the amount of money, which a firm realized by selling

_certain units of a commodity.

TR = P x Q, for eg. t 5 x 10 units = t 50

3. Marginal Revenue (MR): - MR is the change in TR resulting from the sale of an additional

unit of a commodity.

MR= Change in TR/ Change in Qty. sold MR= Li-TR/LlQ

Or TRn - TRn-1

For ex. P = t 10, Q= 50 units and Pl= t 15, Ql = 52 units then MR will be

MR = Ll{PxQ) LlTR = (15x52) 780-(10x50) 500 = 280 = t 140

LlQ LlQty. Sold 52- 50 2

4. Average Revenue (AR): - AR is revenue earned per unit of output.

AR= TR/Q = P*Q / Q = P

5. ~ AR, TR and Elasticity of Demand: - Relationship among MR, AR, TR and Price
Elasticity of Demand is as under:

MR = AR x -E --l where E = Pn.ce Elast1.c1.ty of demand
E

If E =1 , then MR= 0.

lf E > 1, then MR will be positive.

If E < I then MR will be negative.
Note-- For details please refer point no. 'D' of unit 3 of chapter 4

(J) Behavioral Principles: -

Principle 1. A firm should produce at all if TR from its product is equal to or exceeds its TVC
or~ TR ~ TVC (Price~ AVC). If TR= TVC, firm's maximum loss will be equal to its Fixed

Cost. As we know P x Q = TR and AVC x Q = TVC

Principle 2. It will be profitable for the firm to increase output whenever MR> MC and de-

crease output whenever MR < MC and the firm should continue production till

>(1} MR = MC and

*. (iz) MC curve should cut to MR from below.
0te- The above principles will be applicable on all types of market structures.

UNIT 2 : DETERMINATION OF EQUILIBRIUM PRICE

' IN~ERMINATION OF EQUILIBRIUM PRICE:

of··Law of dema~d, states ~n in~erse relations~p between price and quantity demanded. And law
~ly, states drrect relationship between pnce and quantity supplied. Because of this demand

/i-1'

P ficiency Test: General Econarti~
Common ro ""' p,i,

94 . upwards to the right. The Prict . ft''
ds to the right and supply curve t~:1na\ly determined as the equilibriu~

curve slope~ downwar d d quantity supplied are equa ' .
which quantity demande an

market price. Demand Supply Schedule

r:QUILIBRlUM DEMAND ( UNITS) ANALYSIS
SUPPLY (UNtTS) 1-----:-:-~--:--..
PRICE Excess . ; "

1 50 10 dem~d.· ...
20
40
30 30 P = 3 =D ~ s_
2 ,J
~·, ,.
3 e

· Excess4 C

5
20 40
10 so··' ,· supply ,',"'-
y

In the table and figure, the equilibrium price is s

f 3 because at this price quantity supplied and 5

quantity demanded are equal i.e. 30.

4

(B) EFFECT ON EPl AND EQ DUE TO PRICE 31 - - - - - - - ~ " ' -
CHANGE IN DEMAND AND SUPPLY:

\ Equilibrium price and quantity may change, 2

either it is because of change in demand or 1D
change in supply or changes in both supply and
demand. This ~comes clear from the following:· 10 20 30 40 50 X
QUANTITY.
(1) Changes in Demand : Changes-itrde-
mand includes increase or decrease in demand, It

may be due to change in price of related goods, income, taste y o,
and preference etc. \ -

(a) Increase in demand: If supply curve remain the

same and demand curve shifts rightwards then equi-

librium price and output will increase.

.gIn the figure given, when demand curve shifts upwards P2

(when demand increases), from DD to D1Di, new equilibri- a..
um is established, according to which equilibrium price .rises

to OP1 and output to OQ 1• 0 a~ a 0 1 x
(b) Decrease in demand: If supply curve remain the
Demand & Supply
same and demand curve shifts leftwards then equi-

librium price and output will decrease.

In the figure given, when demand curve .shifts downwards y
(when demand decreases), from DD to D2D2, new equilibrium
is established, according to which equilibrium price and output

decline to OP2 and OQ2• D
(2) Changes in Supply: Like demand, be supply also chang- X

.ges. Changes in supply ~clu~es incre.ase or decrease in supply, It

may be due to .change m ~11:Cie of related goods, cost of produc- (l. I·
l
tion, technology, govt. policies etc.
5.1 aI~ a o,
(a) Increase in supply: If demand remain the same and 0
when supply increases, supply curve shifts clownwards oemand& supply
to the right and in that case, equilibrium price decreases

and output increases.

, '• ' .. ·"". • l. "', ,..,.,)•;'' ..,,.,\
•'
V

1 ,· \/ ' ,, .,. \ l . , ,-,
'
• ·tn the figure given, when supply curve shifts from SS to S131 the equilibriwn price deciines

ffonr'OPto OPl and output increases from OQ to OQ1.,

(h) Decrease in supply: On the other hand, If demand remain the same when supply d·e-

creases, supply curve shifts upwards to the left and in that case equilibrium price increases
and output decreases.

J1i the figure given, when supply curve shifts upwards from SS to S2S2 equilibrium price rises
OQ to OQ2•
from:QP to OP2 and output decreases from

{3) Simultaneous change in supply and demand: Supply and demand both can change in the

sam~ direction or in the opposite. Due to changes in the both, equilibrium price will be determined

whet~ new demand and s~pply curves intersect each other. Whether new price is more or less or

etWa:1 to the old price, depends upon the nature of changes in demand and supply.

· in this context, the followi~g tfuee con4itfons have ·b~e~'~iscussed,where both supply and

deniaJl.P have increased. ·

I

(~) H increase or decrea~e in demand and ,supply both are.equal, there will be no change

in the equilibrium.price but equilibrium output, would change in the direction in which

· • supply and demand change. For example,,if supply and demand increase, output would
increase and vice-versa. In diagram I, it has been -shown that when demand and supply

both increase equally, output increases but price remains the same. .
.' (_b) H increase in demand is more than the increase 'in supply, equilibrium pri~e will in-

. crease. This becomes dear from diagram II given below..However, output would change

•,·,. _ in the direction in which both supply 'and ·dem~d change;

(~) H increa~e is supp~y is more than iqcreas·e in.~emand; eq~ilibrium price will fall as
1

, shown in the diagram III. y

.. ~

Y.,

s

.gCl) p

a. 1

s

.61'---------♦x XL - _ - 1 ._ __.___ _

Quantity O a . 01
Quanijty

S. Daigram I Daigr~m !I Daigram Ill

~- .. ·i

'- ~

~ummary of effect on Ep and EQ due to change in demand and supply: We can summaries

.to.th~ ~~ove changes as follows- C.ban~e;'ih . Gtmdhi~m .-.'. -Oh@~.-ju 1·,:.Cl\• i&.
chiiiiii, lnDel!Wid
(a) t sypply . . Ej , -· · · '.13411 ··':'

tt

(b) i -1, t

t(a)
r ·(b) , --
>' --

(a) t i No change t

.(b) t t %L\D>%.L\S i t.

f(c) t %AD<%L\S .

!·~~.common
Proficiency Test: Genera\ Ee" ..

""'~ I

96

UNIT 3: PR\C.E,OUT\'UTMDAERTKEREMT IFNOARTMIOSN U.NDER DIFF.F,R.F.N I

PERFECT c oMPETITlON MARKET

EANING Of PERfECT coMPET\i\ON:
{A) M . _ _ , etitive when demand and supply forces operate ft•

A market 1s sa1d to be _pc,fect\y com~ t price is uniform for the whole market. There .~ti\

to determine the market pnce. ~\ns ma: .~ d no market concentration. isIii

restrict-ion on entry, no product d1fferent1at1on an

Characteristics (Features): - .. . ..

A market, to be perfectly competitive, must com~ly with certa1~ ~ssentlal cond1ttons.

1.Large number of buyers and sellers: In a perfectly c~mpet1tlve market, there are a\arg:
number of buyers and sellers and each demand an~ supply 1s a small P~~ of the ~otal markt1

demand and supply of the product. As a result, no smgle buyer or seller 1s able to influenceth:

market price of the product. As a result, no fmn is in a, dominant position to -influence the markei

price of the product. So the firm will accept the price decided by the whole market.

2.Bomogenous product: In this, all the firms produce and supply identical products. All the

products are thus perfect substitutes for one another.

3._Free entry and exit: In perfect competition, there are no restrictions en the entry of nevi

~ mto the market or on ~he exit of existing firms from t)l.e market. lf the existing;firms are

making supernormal profits m the short run, then in the long run new. ti11J)s wi).l enter the market

an~ ~us to com?ete away ~e profits. On the other hand, if firms are, making losses then some
existmg firms will leav.e the mdustry m· the_ long nm. In th.1s way fu'rn· ma·y earn-' super·rp,r'o··fits, nor-
ma1 p4ur·poPftieot-,sa.ale-nc·ttdklionn.sioi·swesa, em.u1 g.teh·•eIansbhaorpterrufencbt\uYt m the fong run firm w1'll earn ·J·USt normal profit..
compet·iti·ve buyers and sellers possess complete
.....d. market,
ofW.IJ the pricUe4perevaoilrinmgatinionthe mouatrkthete. market cond.iti·ons. Both buyers and sellers are fully a-ware

5.Perfect mobility: In a perfectly c . . .
mobile. Buyers have no preference b ~mpeti~ve market, factors of pr-9duction are com~ete\y

commodity offered for sale; also seller: ar~en ~l~ere_nt sellers and as betwe~n different uruts of

6. Uniform price: As a conseq fqmte md1fferent as to whom they sell.
commodity throughout the market uaetnce .o the a.bove cond1' t·ions, there·is a unifonn pn·ce fior the

tries to raise his price above that char:e~i~ent~omt of time. Under such conditions if any seller

7. No govt. restrictions: The Govt d y e o~hers, he would loose his customers. .

termined by the market demand and su~ ~e~ot 1~terfere in the price determination. Price 1s d&

i~.~-l~dust~ Is price maker and t\r! ere is no price control imposed by the G~vt. e

on!eqwlibnum pomt where market demand i price taker: The industry will decide the pnoe
price decided by the market. So we can sas etqhual_to market supply and each firm will accept e
Y at industry 1· s pri·ce · · e taker.
9. Short run and co .. maker and firm. 1s pnc : 0or·
profits and losses Long run: 1n perfect\ firm may earn super profits,
mal in the short run but ·y mpetitive market

the Long run firm will earn just normal pro~ Y ·

in the long run. In the long run, LAR = LMR

=P =LMC ""' LAC and ther-e wilt be optimum

allocation of resources because output will be

produced at minimum cost.

1O. P = AR = MR = DD: In a perfectly pAICE 00

competitive market, demand curve of the firm PR1ce _________AR_ ~ -

will be perfectly elastic and this curve is also
known as price, average revenue and mar•

ginal revenue curve. X

11. Examples: Perfect competi?on o - - -- - --:::
market is a myth because at the assumptions

·--- ·----

P!j~~petermination in Different Markets 97

. :(

·: ·~~;:Wh.iqh ~1is sxstem i~ based are never foWld in the real world market conditions. But we can take
om&examples 1.e. agncultural and share market.

S: J:.z/Fjrm's and Industry Demand Curve - _In perfect competition Firms demand curve will

be horizontal deman_d curve but lndu~t,y demand curve will b_e negative sloped. .

· 13. Transporation cost and selling costs are not foWld m perfect compeltton market.

(B)~::PURE OR FREE COM~~TITl~N: . . ' '. . . . ..

_Jf:b'Dly the first three conditions.exist, it will be treated as PURE or ~E compet1tton. These

·tln:®.la..Lrea-rge number of buyers and ,seller~ '(,/. \\L rL--

2. Homogenous product -' . ., \
i Free entry and exit of finns , ,,

(G}'PRICE DETERMINATION:- (lndust~ ·is price maker and firm is price taker)

(TR, AR, MR, Price and De~and Curve under ·pe~ect.competitfon) ·

.) Under perfect competition, the industry will decide the price at the equilibrium point where

market demand is equal to market supply _and each firm will accept the price decided by the indus-
try. So we can say that industry is price maker and firni 'is price take~. . : •

·~-· · , . · lnd~stry ;. Price Malter ·, · · . ·

, ...... ' .~.✓• • .., .;_ ,•,ty.;,•..., -~•t ·.~J...... .._ :o- -~\'\.·•·: ... 1.,,.. 11 , • - , .. :, ,,, ,.,., ~'t - - ., < •.• ,, ~·._-.. ,, .-. . ... .,.... _ -· · •• •• _ ~

1

Price , :,~,r·r. , ·Dem~,~-:() , · ·,. · _· .S:up~ly _\r,:,.r ~-:<.:c,: .~nalysis
1

' ,,;:•z; 1' l\~,'.·r~l . (. {J.p.Jt§), ' .,;\,) . •>< . ' . {Pmts). . i ,-~~,}: Vi t,u\" i'.i_ •

1 50 1.0',• .: .-•~) \ Excess

2 . 40 :,n .~ ,-:i-, ':\ .'_. 20 demand
-~- •'

3

4 40 '·,_ . ·Excess

5 50 supply

Equilibriurp. pric·e;for the industry fixed through the interaction of the demand and supply
· i.e. ~ 3 per-unit. ' \.-
~ Firm - Price Taker .·

l>rlce(p) . Qu.~qti!y

I

Sqld(Q)

2 6 3 f

,' j j •; I

·3

. _I I

y INDUSTRY · ·· FlflM
(Price Marker) y (Price Taker)
Paj(;)E
',I 5 D ; .I

·S · ·cos, ')

4 : Rl;Y.~NUE .
PRICE

3r - - -- -1[ AA=MR=PRICE=DD
2

D ~ -- _ _____·-x
50 X 0
0 10 20 30 40 QUANTITY
QUANTITY

-~) ;:

Common Proficiency Test: Genetal Econo"",

98 _ \!~

It.is clear from the above table and figure that in .a perfectly compet~tive inarket ~lfr .i

AR=MR=PRICE = DD and the AR curve is also k_nown as deman~ c~e (DIJ)'. In the ?bovea~'

1•t 1.s a1so c1ear that Industry demand curve is negative sloped and Firm s demand curve rs- hon·z·o&nu~rcl

line.

(D) PRICE AND OUTPUT DETERMINATl~N / EQUILIBRIUM OF THE FIRM ~

Under perfect competition a firm fa_ces ~?nzontal demand ~~e or ~ curve ~erfectly eias~

tic demand curve). Since perfectly compettttve firm sells ,ad~1t1onal uruts of output at the s., .

pri~e., ~R curve coin~ides with AR cu~e. MC cu~e 1s _U sha_p_ed: Now in order- tQ_,b~~

equilibmpn, the :finn wdl compare MC with MR. It will be m eqmhbrnun at the level of outp

at which it is earning maximum profits or incurring minimum losses. Ut

It can attain equilibrium only when conditions are satisfied:

(i) The Marginal Cost should be equal to the Marginal Revenue i.e. MC= MR

(ii) Its MC curve must cut its MR curve from below i.e. its MC curve must be rising at th
point of equilibrium. ·e

One additional condition also must be satisfied in case of loss that P > AVC.-

If MR is ~eater than MC, there is always an incentive .for the firm to expand its producti:

further and gam by sale of additional units. If~ is less than MC, th~-finn--wiU have reduce'outp:~

INDUSTRY FIRM
Y (Price Maker) y (Pric_e Taker)

D COST
REVENUE

S PRICE

PRICE

s

Q ..____ _ _ _ _ _ _ _~D

,QUANTITY X o - - - - - - ,'!.;·..._ _...J.;;;.._ _ _ _ _ _X

since addition·al •~•..,,~tn add·s more to cost tha O. UA~T;IT· Y
where h-1.R =MC. ·n to revenue. Profits are maxµm,lIIl only at the PQint

. Consider figure given above in whi h D SS are the industry demM? -~~ supply cuzyes"
wbic~equilib~ate,at E to set the ~ket pri:e ·as~~nd
MR~::d Ascthuetsu~ruts
OP.Jm:ce as _gi~en and considers P~line as d : P. The firm ofperfectly oompet1t1.v.e m~ustry adopt$

are pnces to at the same level, ·t· ~All) c~e,,whiQh i~ p,e~eqtly el~$tjc at l>. all
onzontal hne equ~l t~ AR bne, NQte dmt Mccurve-
curve at two pla~s T an4 E res

;~r;_:fum. Wltl be in equilibrium at E since at ge:;~ely. Bu~ T cannot be the pQs.ltion of c:,ql:lilibriurn. The
(E) SHORT-~~N ;E~~l~JEJRIUM OF THE is cutting the MR cUNe from b<,low.

:t:•:es a~cost.and total.revenue. The equilibrju~
The firm ·18 m ~uilibnum wb.en it m · · .

Jts Prnfits defined th~ diff'erenc~ betw~~n total

:C~;:}1rand TC CW'Ve$ or by using MR and MC e rm may be ~hown in two ways. Either by U~tng TR
The ,conditions for the equilibrium
(a) MC ~ MR and We use MR and MC ciirves. approacb h~re.
· · m are

.(b) MC must cu.t the MR curv:e from below.

(c)P~AVC

followInm· tghes,.short run a competitive depending· u·pon 1·ts average cost c·.ond.1-t1·o"U""' fulJl ro11y earn ""'e

· ~-

r~ " \ . ''·
"t :ti~s~It0to\~186~
Prfa8 oet~rmination in Different Markets· profits its average revenue are more 99
(a) Super, profits: When a firm earn supemonnal than its

, ave.cage total cost or say AR > ATC. Super profits also called Economic Profits, abnonnal profits
: andaupet' normal profits.

tfectl (b) Normal ~r~fits: Wh~n the firm j~st meets its average total cost, it earn normal profits and

at th. Y~ tlrl&norroal profit 1_8 mcluded ~ averag~ topil co~ts. Normal profit is normal rate of return on capital

er toeb\ and thetemwieration for the_nsk bearmg function of the entrepreneur. Here AR= ATC. It is also

e} Of~~ caUedB.E.P(Break-even~Pomt) means No Loss No (superfProfit. It is called Marginal Firm.

1\ {o). Losses: A firm m ~e short run may incur (super)losses if AR < ATC. When a firm is

jnCl)O"Ulg.fosses then firm will try to minimize its losses and to minimize losses firm will cover

roM variable costs, then losses may be equal to or part of fixed costs, If firm is unable to meet its

ist,z ~ble cost, it will be better for it to shut down.
iat \
'Y y SMC y SMC SAC

SMC SAC /
SAC
B A/
,
Produ~ p pr - - - - - , '
AR/MR F=..... _=__=_=,, ,/=E~- - - ARJMR
Uce.0~ w ,I
OB ,,I

f I

0 _., ,OUTPUT M X0 M OUTPUT XO M OUTPUT X

Figure (a) Figure (b) Figure (c)

hi the above figures a firm is in s~ort-run equilibrium position and firm can makes super

~ ' normal profits or losses depending upon the level of the ATC. As Ate is below the AR

• ~rium in the (figure a) the firm earns exces·s/ super pro.fits (equal to the area PEAB) be-

~.AR > AC i.e. EQ>AQ. If, however, the ATC is above the ·AR (figure c) the firm makes a

._. {equal to the area PEAB) because AR<AC i.e. EQ<AQ. In the latter case ifATC just

cov~ the AR, we get normal profits (figure b) beGause AR = ATC i.e. EQ = EQ, which is in-

¢)uded in the costs.

ti(poid F. LONG RUN EQUILIBRIUM OF THE FIRM: Normal profit (LAR = LAC):: - In

4'f.Jong run the firms will be earning just NORMAL ~.ROFITS, which are included in the AC.

ir~ free entry and exit of firms. To earn normal Profits, LAR should be equal to LAC or say

tAl=, LAC INDUSTRY y

y FIRM

(Price Maker) (Price taker)

D $ COST

REVENUE

PRICE LA

DX xL __ _ _ _ __ . ._ _ _ _ _

0

~ the above figure industry has decided the price 'P' and firm has taken over the same price
~t the same time firm is earning just normal profits because at E1 point LMR = LMC = LAR

C.

c

100

In the long run, following conditions are sa

(i) The output is produced at the minimum

(ii) Consumers pay the mini1nw11 possible p

(iii) Full utiliza6on of plants is possible, MC
(iv) There is no wastage of resources.

(v) Fim1s earn only nonnal profits i.e. AC =

(vi) Finns maximize profits i.e. MC = MR, b
(vii) In the long run LMC = LMR = P = LAR

(viii) "When LAC falls LAC> LM(; and .when

common Proficiency Test: Genera/ 6conor.,-

atisfied : .. f

m feasible cost or m1mmum LAC i

price. t
r
C =AC b

:• , . t

= AR. - ,

but level ofproiits will be normal

R,= LAC = SMC = SAC
' >- I.
iAc1tAC raises LMC >