Price Determination Under Perfect Competition Market

Price Determination Under Perfect Competition

            As is popular known, the force of supply and demand determines price under perfect competition. Prices will be fixed as point share the supply and demand are at equilibrium.

            This is illustrated in Fig. The equilibrium will change by changes in the forces of demand and supply.

Price and Quantity Variability 

            Responses to a change in demand or to a change in supply may be primarily either in price or in quantity. If the demand is highly elastic, consumers will respond readily to price changes by dropping out of the market when prices are raised a little. As a result, must of the adjustments to changes in supply an increase leading to reduction in price and a decrease leading to an increase in price) will be adjustments in quantity purchased if the demand is highly elastic.

            If the demand is inelastic the adjustments will take place primarily in prices. Similarly, if sellers respond readily by greatly increasing their offerings on slight increase in price, or by heavy withdrawals on slight price drop, the adjustments to changes in demand will be large in quantity exchanged. If sellers are quite unresponsive to price in their offerings (if supply is very inelastic) the adjustments to changes in demand will take place largely through shift in price. In view of the above, we may state the following rules and illustrate them.

1.    If demand rises, price goes up and vice versa. For example, in the Fig (a) the demand curve shifts upwards and to the right from DD to D₁D₁ whereas the supply curve remains the same. As a result, the price goes up from OP to OP. However, the sales will increase from OQ to OQ₁

2.    If supply rises, price goes down and vice versa.   For example, in Fig. (b) the supply curve shifts downwards to the right from SS to SS. While the demand curve remains unchanged. The result is that price falls form OP to Op₁ Moreover the sales will increase from OQ to OQ_1.

3.    Given a shift in the demand curve, price will raise less or fall less if the supply curves elastic (flat) Price will rise more or fall more, if the supply curve is inelastic (steep). If rise in price is more, rise in sales will be less; if rise in price is less, rise in sale will be more. For example in fig. (c)

            Demand curve shifts from DD to D¹D¹_. The supply curve S₁S₁ is steep another supply S₂S₂ is rather flat. Both the supply curves cut the original demand curve DD at point E meaning thereby that before the change in demand, price was OP. The Steep supply curve S₁S₁ however, cuts D¹D¹ Curve at point E₁ giving the equilibrium price OP₁ at E₂ giving the equilibrium price as Op₂, which is less than Op₁. The flat supply curve S₁S₂ cuts the new demand curve D¹D^1.

4.    Given a shift in the supply curve, price raises less or fall less if demand curve is elastic. Price will raise more or fall more if demand curve is inelastic. For example, in Fig.(e) SS is the original supply curve. SS is the new supply curve; DD is the step demand curve (indication relatively elastic demand).  The original equilibrium price is OP because SS Curve cuts DD demand.) The original equilibrium price is OP because SS Curve cuts the DD Curve at point E. After the shift in the supply curve, however, the S'S' curve cuts D'D' curve at point E' giving OP as, the equilibrium price which is higher than OP.

5.    If both the demand and supply increase, sales are bound to increase but price may or may not rise. It will rise, if the amount, which would now be demanded at the old price, exceeds the supply that would now be made at the old price Fig.(c) but the price will fall if the amount, which would now be supplied at the price, is more than the amount now demanded at the price Fig. (f). On other words, if at the old price, new demand exceeds the new supply, price will rise but if the new demand is less than the new supply, price will fall.    

6.    An increase in demand with a simultaneous decrease in supply. Will raise price and increase sales if the new demand price for the old equilibrium amount is higher than its new supply price. Similarly, price will rise and sales will diminish if the new supply price for the old amount is higher than its new demand price.