Price Determination Under Perfect Competition

• In perfect competition, the price of a commodity is determined by the interaction of market demand and market supply.
• The price at which quantity demanded is exactly equal to quantity supplied is called the equilibrium price.
• At the equilibrium price, both buyers and sellers are satisfied and there is no tendency for the price to rise or fall.

• Alfred Marshall explained price determination with the example of a pair of scissors.
• A cloth can be cut only when both blades of the scissors work together.
• Similarly, price in the market is determined by both demand and supply; it is useless to ask which one is “more important”.
• Sometimes demand may play a bigger role (for example, when tastes or incomes change quickly), and at other times supply may play a bigger role (for example, when the cost of production changes).
• Therefore, both demand and supply together determine the equilibrium price.

Interpretation

1. As price rises from ₹100 to ₹200, quantity demanded falls (from 5000 kg to 4000 kg) and quantity supplied rises (from 1000 kg to 2000 kg).
2. At the price of ₹300, quantity demanded and quantity supplied are both 3000 kg, so ₹300 is the equilibrium price and 3000 kg is the equilibrium quantity.
3. At prices above ₹300 (₹400, ₹500), supply is greater than demand (excess supply).
4. At prices below ₹300 (₹100, ₹200), demand is greater than supply (excess demand).

1. On the X‑axis: quantity of apples.
2. On the Y‑axis: price per kg of apples.
3. DD is a downward‑sloping demand curve, showing an inverse relationship between price and quantity demanded.
4. SS is an upward‑sloping supply curve, showing a direct relationship between price and quantity supplied.
5. The curves intersect at point E.
   At E, the equilibrium price = ₹300 and the equilibrium quantity = 3000 kg.
   At any price above E, there is excess supply.
   At any price below E, there is excess demand.
6. Market forces push the price towards this intersection point E.

Total demand (market demand)

• Demand means the quantity of a commodity that consumers are willing and able to buy at different prices during a given period.
• Each unit of a commodity has a “demand price”, the price at which it can be sold to some buyer.
• Other things being equal, when price falls, quantity demanded increases; when price rises, quantity demanded decreases.
• A fall in price:
  i. induces existing buyers to buy more,
  ii. brings in new buyers, and
  iii. may create substitution and income effects.

Total supply (market supply)

• Supply means the quantity of a commodity that producers are willing to offer for sale at different prices during a given period.
• It is not the total stock but only the part that producers are ready to sell at given prices.
• Each unit of a commodity has a “supply price”, the price at which it is offered for sale.
• Other things being equal, when price rises, quantity supplied increases; when price falls, quantity supplied decreases.

Explanation

• At price ₹20, quantity demanded = quantity supplied = 6 units → equilibrium price and equilibrium quantity.
• If the price is above ₹20, say ₹25:
  i. Buyers demand only 4 units but sellers supply 8 units (excess supply).
  ii. Sellers compete among themselves to sell, so the price falls towards ₹20.
• If the price is below ₹20, say ₹15:
  i. Buyers demand 8 units but sellers supply only 4 units (excess demand).
  ii. Buyers compete among themselves to buy, so the price rises towards ₹20.
• Thus, price adjusts until demand equals supply, and equilibrium is reached.

Industry equilibrium

• In perfect competition, the industry (all firms together) determines the market price by the intersection of market demand and market supply.
• In Fig. 2, the industry demand curve DD and supply curve SS intersect at point E, giving equilibrium price OP.

Firm’s price under perfect competition

• Under perfect competition, each individual firm is a price taker, not a price maker.
• In Fig. 2, the firm faces a horizontal demand curve at price OP.
• The firm can sell any quantity of its output at price OP but cannot charge more or less than OP.
• The firm’s demand curve is also its average revenue (AR) and marginal revenue (MR) curve under perfect competition.

• Price under perfect competition is determined by the interaction of market demand and market supply.
• Equilibrium price is the price at which quantity demanded equals quantity supplied; equilibrium quantity is the corresponding quantity.
• At prices above equilibrium, there is excess supply and price tends to fall.
• At prices below equilibrium, there is excess demand and the price tends to rise.
• Marshall compared demand and supply to the two blades of a pair of scissors; both are essential for price determination.
• In perfect competition, the industry determines the price, and each firm is a price taker and must accept that price.