UNIT 2

Pricing under perfect market conditions

2.1 Pure Competition: Meaning and Features

According to Prof. Chamberlin, there is said t be ‘Pure competition’ when the first three condition of perfect competition i.e. large number of buyers and sellers, homogenous product & free entry and exit of firm are fulfilled. When monopoly is absent because the first three conditions are fulfilled but the other conditions like perfect knowledge, perfect mobility, absence of transport cost or no Govt. interference are not fulfilled, then the competition would be ‘PURE’ and not ‘PERFECT’.

Features:

1)  Large number of sellers/sellers are price takers:

There are many potential sellers selling their commodity in the market. Their number is so large that a single seller cannot influence the market price because each seller sells a small fraction of total market supply. On the basis of market demand and market supply of the commodity which is accepted by the firms the price of the product is determined, thus seller is a price taker and not a price maker.

2)      Large number of buyers:

There are many buyers in the market. A single buyer cannot influence the price of the commodity because individual demand is a small fraction of total market demand.

3)      Free entry and exit:

New firms can enter and exit the market without any restrictions.

4)      Homogeneous product:

Firms produce and sell identical units of a given product, in purely competitive market, i.e., units of a commodity produced by each of them is uniform, in respect of size, shape, colour, quality, etc. Thus commodities have perfect substitute for each other.

5)      Single price:

In Pure Competition all units of a commodity have uniform or a single price. It is determined by the forces of demand arid supply.

Key takeaways-

2.2 Features of Perfect Competition

Perfect competition refers to ‘A market structure in which there are large number of buyers and sellers with a single uniforms price for the product which is determined by the forces of demand & supply.’ The price prevailing in perfect competition market is equilibrium price.

Definition:

It is identified by the existence of the many firm; they all sell an identical products an equivalent way. The supplier is the one who accepts the price."- Vilas

Such market gains when the request for product of every producer is totally elastic. Mrs Joan Robinson.

It is a market condition with an outsized number of sellers and buyers, similar products, free entry of enterprises into the industry is ideal knowledge between buyers and sellers of existing market conditions and free mobility of production factors between alternative uses. Lim Chong-ya.

Characteristic of perfect competition:-

1) Large number of seller / seller are price takers: There are many potential sellers selling their commodity in the market. Their number is so large that a single seller cannot influence the market price because each seller sells a small fraction of total market supply. The price of the product is determined on the basis of market demand and market supply of the commodity which is accepted by the firms, thus seller is a price taker and not a price maker.

2) Large number of buyers: There are many buyers in the market. A single buyer cannot influence the price of the commodity because individual demand is a small fraction of total market demand.

3) Homogeneous product: The product sold in the market is homogeneous, i.e. identical in quality and size. There is no difference between the products. The products are perfect substitutes for each other.

4) Free entry and exit: There is freedom for new firms or sellers to enter into the market or industry. There is no legal, economic or any type of restrictions. Similarly, the seller is free to leave the market on industry.

5) Perfect knowledge: The seller and buyers have perfect knowledge about the market such as price, demand and supply. This will prevent the buyer from paying higher price than the market price. Similarly, sellers cannot change a different price than the prevailing market price.

6) Perfect mobility of factors of production: Factors of production are freely mobile from one firm to another or from one place to another. This ensures freedom of entry and exit firms. This also ensure that the factors cost are the same for all firms.

7) No transport cost: It is assumed that there are no transport costs. As a result, there is no possibility of changing a higher price on the behalf of transport costs.

8) Non intervention by the government: It is assumed that government does not interfere in the working of the market economy. Price is determined freely according to demand and supply conditions of the market.

9) Single Price: In Perfect Competition all units of a commodity have uniforms or a single price. It is determined by the forces of demand and supply.

Key takeaways –

2.3 Price Determination in Perfect Competition

Price determination under Perfect competition:

The equilibrium price refers to that price at which the demand and supply of a commodity are in equilibrium (equal). In other words Quantity demanded is equal to Quantity supplied. Once equilibrium price is reached here is no tendency for the price to move upward or downwards.

According to Marshall both Demand and Supply are essential in determination equilibrium price. Like the two blades of a scissor that cut piece of paper, demand and supply are important part in determining equilibrium price. Both the blades are useless when they are applied individually. Thus demand and supply are equally important in determining equilibrium price.

This can be explained with the help of following table:

In the above table there is Price, Quantity demanded, Quantity supplied, Market condition and change in price. When the price is Rs. 5 Quantity demanded 120 units and quantity supplied 40 units, there is a shortage and pressure on the price is upward (rises). This conditions same at price of Rs. 10. When price is Rs.20 Quantity demanded is 60 units and Quantity supplied is 100 units, there is surplus in the market and pressure on price is downward (decrease). This condition same at price of Rs.25. When the price is Rs. 15 the quantity demanded is equal to the quantity supplied. It is equilibrium price. At this price the market is cleaned, that is neither surplus nor shortage in the market. At the equilibrium price demanded is equal to supply.

Key takeaways –

2.4 Equilibrium of Firm and Industry in Short Run and Long Run

Equilibrium refers to when the firm has no inclination to expand or to contract its output. The producer can attain equilibrium under two situations.

The Marginal Revenue-Marginal Cost Approach-

Profit depends on revenue and cost. Thus equilibrium revolves around revenue and cost. According to the MR-MC approach, a producer is said to be in equilibrium when:

MC is greater than MR after the MC=MR Output Level

MC= MR is a necessary condition, but its is not enough to ensure equilibrium. This condition happens more than one output level.

To ensure equilibrium, it has to be supplemented by the condition that MR should be less than MC after this level

Producer’s Equilibrium when Price remains Constant-

Price remains constant under conditions of perfect competition. Here price is equal to AR. When price is constant, revenue from each additional unit is equal to AR. It means AR curve is same as MR curve. The firm attains equilibrium when two condition are fulfilled , that is firm aims at producing that level of output at which MC is equal to MR and MC is greater than MR after MC = MR output level.

Producer’s Equilibrium when Price is not Constant-

When there is no fixed price, price falls with an increase in output. The producer sells more units at a lower price. In this case MR slopes downwards.  The firm aims at producing that level of output at which MC is equal to MR and MC is greater than MR.

Short run and long run supply curves-

Supply curve shows the relationship between price and quantity supplied. According to Dorfman, “Supply curve is that curve which indicates various quantities supplied by the firm at different prices”.

Supply curve can be divided into two parts as:

Short run supply curve of a firm:

Under Short run , fixed cost remains constant, supply can be changed by changing the only the variable factors. Thus the firm has to bear fixed cost id it is shut down.  Thus in short run, goods are supplied at price is either greater or equal to average variable cost. Average revenue is equal to marginal revenue under perfect competition. Hence the firm will produce at the point where marginal revenue and marginal cost are equal.

Prof. Bilas has defined it in simple words, “The Firm’s short period supply curve is that portion of its marginal cost curve that lies-above the minimum point of the average variable cost curve.”

From the above figure we can see that, the firm will not be covering its average variable cost, at price less than OP. At price OP, OM is the supply. MC and MR cut at point A, OM is equilibrium output. If price rise to OP1, the firm will produce OM1 output. This short run supply curve of a firm starts from A upwards i.e., thick line AB.

Long run supply curve:

Under long run, the supply curve changes by changing all the factors of production. The firm produces only at minimum average cost in long run. In this case, long run marginal cost, marginal revenue, average revenue and long run average cost are equal. The firm enjoys normal profit.

Optimum production is the point where minimum average cost is equal to marginal cost. Long run supply curve is a portion where marginal cost curve that lies above the minimum point of the average cost curve.

Optimum point is the Point E, as at this point MR=LMCAR minimum LAC.  The portion of LMC above point E is called long run supply curve

Key takeaways-

References