Perfect competition is a market structure characterized by a complete absence of rivalry among the individual firms.
Perfect Market
Perfect competition is a market
structure characterized by a complete absence of rivalry among the individual
firms. A perfectly competitive firm is one whose output is so small in relation
to market volume that its output decisions have no perceptible impact on price.
No single producer or consumer can have control over the price or quantity of
the product.
Characteristic
features of perfect market:
1. Large
number of buyers and sellers
2. Homogeneous
product
3. Perfect
knowledge about the market
4. Ruling
prices
5. Absence
of transport cost
6. Perfect
mobility of factors
7. Profit
maximization
8. Freedom
in decision making
In perfect market, the price of the commodity is
determined based on the demand for and supply of the product in the market. The
equilibrium price and output determination is as shown in the graph.
The demand curve (D) and the
supply curve (S) intersect each other at a particular point which is called the
equilibrium point. At the equilibrium point ‘E’ the quantity demanded and the
quantity supplied are equal (that is OQ quantity of commodity is demanded and
the same level is supplied etc). Based on the equilibrium the price of the
commodity is fixed as OP. This is the fundamental pricing strategy followed in
the perfect market.
Pricing Under Perfect
Competition
Demand and supply curves can be used to analyze the
equilibrium market price and the optimum output.
1.
If quantity demanded is equal to
quantity supplied at a particular price then the market is in equilibrium
2.
If quantity demanded is more than
the quantity supplied then market price may not be stable. i.e., it will rise.
3.
If quantity demanded is less than
quantity supplied then market price is fixed not in a equilibrium position. When the price at which quantity
demanded is equal to quantity supplied, buyers as well as sellers are
satisfied. If price is greater than the equilibrium price, some sellers would
not be able to sell the commodity. So they would try to dispose the unsold
stock at a lower price. Thus the price will go on declining till they get
equalized (Qd = Qs). The various possible changes in Demand and supply are
expressed in the following graphs to understand the price fluctuations in the
market. When the firm is producing its
goods at the maximum level, the unit cost of production or managerial cost of
the last item produced is the lowest. If the firm produces more than this, the
managerial cost will rise. If that firm produces less than that level of
output, it is not taking advantage of the economics of the large scale operation.When
the firm produces largest level of output and sell at the managerial cost, it
is said to be in equilibrium position.There is no temptation to produce more or
produce less level of output. Likewise, when all the firms put together or the
industry produces the largest amount of output at the lowest marginal cost, the
industry is also said to be in the equilibrium Let us assume that the demand
equal to supply Qd = Qs and the equilibrium point ‘E’ determines the price as OP. In the short
run the demand for the commodity increases but the supply remains the same.
Then the demand curve shifts to the right and the new demand curve D1D1 is derived. The demand has
increased from OM quantity to OM1. The new demand curve intersects the supply curve at the new
equilibrium point ‘E1’ and the price of the commodity is increased from OP to OP1. Therefore it is clear that when
demand increases without any change in supply this leads to price rise in the
market. If the demand remains the same and the firm tries to
supply more of the commodity, then the supply curve shifts from SS to S1S1
(Graph - below). Earlier the equilibrium point was ‘E’ and the price of the
commodity was OP. Due to change in supply the equilibrium point has changed
into ‘E1’ which in turn reduced the
price form OP to OP0. Therefore if the firm
supplies more than the demand this leads to price fall in the market.
If the firm changes its supply
due to increase in demand then the possible fluctuations in the price is
explained below. Let us assume that the firm increased its supply 10% , the
demand has also increased but not in the same proportion – it increased only 2%
( ΔQd < ΔQs). From the graph we can understand that the equilibrium point ‘E’
has changed into ‘E1’ which reduced the price of the commodity from OP to OP1.
On the other hand when there is
10% increase in the demand and the supply has increased only to 2%, the new
demand curve D1D1 and the new supply curve S1S1 intersect each other at the new equilibrium point ‘E1’. The price of the commodity is OP
at ‘E’ and it increases from P to P1 and becomes OP1.i.e. When the demand increases more than the supply ( ΔQd > ΔQs )
the price of the commodity will increase.
The following graph explains
clearly that both the demand for the commodity and the supply increases in the
same proportion (i.e. ΔQD = ΔQS).The shift in supply curve and the shift in
demand curve are in the same level and the new equilibrium point ‘E1’ determines the same price OP
level. There is no change in the price when the demand and supply are equal. Tags : Managerial Economics - Market Structure
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