Revision: Microeconomic Theory >> Determination of Equilibrium Price and Output Under Perfect Competition Economics ISC (Commerce) Class 12 CISCE

Definitions: Perfect Competition

According to Mrs Joan Robinson, "Perfect competition prevails when the demand for the output of each producer is perfectly elastic."
"Perfect competition is characterised by the presence of many firms. All of them sell identical products. The seller is the price taker." – Bilas
"Perfect competition prevails when the demand for the output of each producer is perfectly elastic." – Mrs Joan Robinson
"Perfect competition describes a market in which there is a complete absence of direct competition among economic groups." – Ferguson

Key Points: Perfect Competition

Perfect competition is an ideal market where many buyers and sellers trade identical products, and no one can control price.
Firms and buyers are price takers; the price is fixed by industry demand and supply.
Pure competition needs 3 conditions (large numbers, homogeneous product, free entry/exit).
Perfect competition needs 7 conditions (3 basic + perfect knowledge, factor mobility, no selling costs, no transport costs).
The model is used as a benchmark to judge how efficient other markets are.

Key Points: Price Determination 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.

Key Points: Changes in Equilibrium

Equilibrium price and quantity change whenever demand or supply curves shift.
A rightward shift of demand or supply shows an increase; a leftward shift shows a decrease.
With supply fixed, demand and price move in the same direction (direct relation).
With demand fixed, supply and price move in the opposite direction (inverse relation).
Diagrams must show original curves (DD, SS), new curves (D₁D₁, D₂D₂, S₁S₁, S₂S₂), and old/new equilibrium points (E, E₁, E₂) with corresponding prices and quantities.

Key Points: Effect of Simultaneous change in Demand and Supply on Equilibrium Price

Price effect depends on the size and direction of shifts in both demand and supply.
Quantity usually moves in the direction of both curves (↑ if both rise, ↓ if both fall).
Use diagrams to show shifts.
Always check which change (demand or supply) is bigger to predict the final outcome.

Key Points: Time Element in the Theory of Price Determination

The time element is important because it controls how much supply can adjust to demand, and therefore how price is determined.
In the market period, supply is fixed; demand alone determines price.
In the short period, supply adjusts partially; both demand and supply influence price.
In the long period, all factors are variable; cost of production and supply play the main role, giving the normal or natural price.
In the secular period, very long-term forces change basic conditions, so no simple price rule applies.

Key Points: Determination of Equilibrium Prices

Time element (market, short, long period) is essential to explain how quickly supply can respond to demand and how price is determined.
In the market period, supply is almost fixed; demand mainly decides price, especially for perishable goods.
For durable goods in the market period, sellers can hold stock and use a reserve price, influenced by future expectations and storage costs.
In the short period, firms adjust output using existing capacity; demand shifts cause changes in price, output, and short‑run profits or losses.
In the long period, firms can change scale and enter/exit; the normal price is the long‑run equilibrium price where firms earn only normal profit and P = MC = minimum LAC.

Key Points: Normal Price and Law of Returns

The normal price in the long run is determined where price = AC = MC and firms earn normal profits.
The effect of a change in demand on long-run normal price depends on the cost condition of the industry.
Increasing returns (decreasing cost):
The long-run supply curve slopes downward.
When demand increases, normal price falls, quantity increases.
Diminishing returns (increasing cost):
The long-run supply curve slopes upward.
When demand increases, normal price rises, and the quantity increases.
Constant returns (constant cost):
The long-run supply curve is horizontal.
When demand increases, normal price remains unchanged; only the quantity increases.
Thus, with an increase in demand, the long-run normal price may rise, fall, or remain constant, depending on whether the industry is increasing cost, constant cost, or decreasing cost.

Key Points: Comparison between Market Price and Normal Price

Market price is a short‑run, actual price driven mainly by current demand when supply is fixed.
Normal price is a long‑run equilibrium price determined by cost and full adjustment of demand and supply.
Market price oscillates around normal price; in the long run, firms earn only normal profit where Price = minimum LAC.

Key Points: Practical Applications of Tools of Demand and Supply Analysis

Demand–supply tools help analyse government policies like price control, price support and minimum wage laws.
Price control (price ceiling) below equilibrium creates excess demand and shortage; if above equilibrium, it has no effect.
Shortage under price control can cause a black market or require rationing to distribute limited supply.
For agriculture, a price support system using MSP acts as a price floor and protects farmers from very low prices during harvest.
Government buying surplus at MSP stabilises farmers’ income and supports future production.
In labour markets, minimum wage laws protect workers from extremely low wages but may create some unemployment if set above equilibrium.
To reduce unemployment created by high minimum wages, the government must encourage activities that increase demand for labour.

Key Points: Determination of Short Run Equilibrium of a Firm

Industry determines market price via the intersection of DD and SS.
An individual firm under perfect competition is a price-taker and faces a P = AR = MR horizontal demand curve.
Short-run equilibrium of a firm: SMC = MR, and SMC cuts MR from below.
The short-run supply curve of the firm is the rising part of SMC above minimum AVC.

Key Points: Determination of Long Run Equilibrium of a Firm

Long run: all factors variable; firms can freely enter or exit the industry.
In long-run equilibrium under perfect competition:
Each firm earns only normal profit.
Each firm produces at the minimum point of LAC.
$Price = AR = MR = MC = minimum LAC$ .
Industry is in long-run equilibrium when market demand = market supply and there is no tendency for entry or exit.
Supernormal profits cause entry and lower prices; losses cause exit and higher prices; both processes move the industry to normal profit in the long run.