Question

Explain the concept of perfect competition and price determination under perfect competition

Answer 1

Perfect competition can be explained as a market structure where there are a large number of sellers selling a homogenous product to a large number of buyers. The number of sellers and buyers is so large that a single buyer or seller is not in a position to influence the price of the product.

Under perfect competition, there is a single ruling market price which is called as ‘equilibrium price’. This equilibrium price is determined by the interaction of market forces of demand and supply. Equilibrium price is basically the price at which demand and supply is the same.

According to Marshall, demand and supply are like two blades of a pair of scissors. Just as cutting of cloth is not possible with the use of one blade, the equilibrium price of a commodity cannot be determined either by the force of demand or by supply alone. Both these forces together determine the price.

1. Scheule

The same can be explained with the help of the following schedule:

Price per kg. of apples (in ₹)	Quantity Demanded (in Kg.)	Quantity Supplied (in Kg.)	Relationship between DD and SS
100	5000	1000	DD > SS
200	4000	2000	DD > SS
300	3000	3000	DD = SS
400	2000	4000	DD < SS
500	1000	5000	DD < SS

Explanation of the schedule:

1. Demand > Supply: At ₹ 100 per kg, the quantity demanded in 5000 kgs while the supply is only 1000 kgs. When the price rises to ₹ 200 per kg, the demand falls to 4000 kgs while the supply rises to 2000 kgs. This is because demand falls with a rise in price (law of demand) and supply rises with a rise in price (law of supply). At this stage, demand is greater than supply.
2. Demand = Supply: When the price rises to ₹ 300 per kg, quantity demanded and quantity supplied becomes equal i.e. 3000 kgs. This is the stage of equilibrium where demand and supply become equal. Hence, ₹ 300 is the equilibrium price.
3. Supply > Demand: When the price rises further from ₹ 300 to ₹ 400 and then from ₹ 400 to ₹ 500, the demand falls to 2000 kgs and 1000 kgs, respectively while the supply increases to 4000 kgs and 5000 kgs, respectively. At this stage, supply is greater than demand.

3. Diagrammatic Representation

Explanation of the diagram:

1. In the above diagram, Y axis represents the price whereas X axis represents the quantity demanded and supplied. 
2. The demand curve DD is a downward sloping curve indicating inverse relationship between price and quantity demanded.
3. The supply curve SS is an upward sloping curve indicating a direct relationship between price and quantity supplied. 
4. The curves DD and SS interest each other at point E which is the 'equilibrium point'. 
5. Therefore, ₹ 300 is the equilibrium price and 3000 kgs in the equilibrium quantity. The equilibrium price is determined by the interaction of the forces of market demand and market supply.