UNIT 9

PRICE DETERMINATION
UNDER PERFECT
COMPETITION
 MARKET AND MARKET
STRUCTURE
THE TERM MARKET REFERS NOT NECESSARILY TO A PLACE BUT
ALWAYS TO A COMMODITY AND THE BUYERS AND SELLERS WHO ARE
IN DIRECT COMPETITION WITH ONE ANOTHER.

MARKET STRUCTURE ARE THOSE CHARACTERISTICS WHICH AFFECT

THE NATURE OF COMPETITION AND PRICING.
 PERFECT COMPETITION
PERFECT COMPETITION IS A TYPE OF MARKET STRUCTURE
WHERE MANY FIRMS SELL SIMILAR PRODUCTS – AND PROFITS
ARE VIRTUALLY NON-EXISTENT DUE TO FIERCE COMPETITION.
THERE ARE 5 KEY CHARACTERISTICS A PERFECT COMPETITION HAS:
• MANY COMPETING FIRMS
• SIMILAR PRODUCTS SOLD
• EQUAL MARKET SHARE
• BUYERS HAVE FULL INFORMATION
• EASE OF ENTRY AND EXIT
 PRICE-OUTPUT DETERMINATION
UNDER PERFECT COMPETITION
THE MARKET PRICE AND OUTPUT IS DETERMINED ON THE BASIS OF
CONSUMER DEMAND AND MARKET SUPPLY UNDER PERFECT
COMPETITION. THE FIRMS AND INDUSTRY SHOULD BE IN
EQUILIBRIUM AT A PRICE LEVEL IN WHICH QUANTITY DEMAND IS
EQUAL TO QUANTITY SUPPLIED.
 SHORT-RUN INDUSTRY EQUILIBRIUM
UNDER PERFECT COMPETITION
IS A GROUP OF FIRMS PRODUCING HOMOGENEOUS PRODUCTS IN A
MARKET. ACCORDING TO LIPSEY, "INDUSTRY IS A GROUP OF FIRMS
THAT SELLS A WELL-DEFINED PRODUCT OR CLOSELY RELATED SET
OF PRODUCTS. "

WHEN ITS TOTAL OUTPUT REMAINS STEADY, THERE BEING NO

TENDENCY TO EXPAND OR CONTRACT ITS OUTPUT.
 SHORT-RUN FIRM EQUILIBRIUM
UNDER PERFECT COMPETITION
1. ALL FIRMS USE HOMOGENEOUS FACTORS 5. FIRMS PRODUCE AND SELL DIFFERENT
OF PRODUCTION QUANTITIES.
2. FIRMS ARE OF DIFFERENT EFFIECENCY.       • MARGINAL COST - MARGINAL REVENUE
3. COST CURVES OF FIRMS VARY FROM EACH ANALYSIS
OTHER       • SUPERNORMAL PROFITS
4. ALL FIRMS SELL THEIR PRODUCTS AT THE       • NORMAL PROFITS
SAME TIME PRICE DETERMINED BY DEMAND       • MINIMUM LOSS
AND SUPPLY OF THE INDUSTRY SO THAT THE       • MAXIMUM LOSS
PRICE OF EACH FIRM, P (PRICE) = AR = MR.       • SHUTDOWN STAGE
      • TOTAL COST - TOTAL REVENUE
ANALYSIS
 LONG-RUN INDUSTRY EQUILIBRIUM
UNDER PERFECT COMPETITION

THE INDUSTRY IS IN EQUILIBRIUM IN THE LONG-RUN WHEN ALL

FIRMS EARN NORMAL PROFITS. THERE IS NO INCENTIVE FOR FIRMS
TO LEAVE THE INDUSTRY OR FOR NEW FIRMS TO ENTER IT. WITH ALL
FACTORS HOMOGENEOUS AND GIVEN THEIR PRICES AND THE SAME
TECHNOLOGY, EACH FIRM AND INDUSTRY AS A WHOLE ARE IN FULL
EQUILIBRIUM WHERE LMC = MR = AR (-P) = LAC AT ITS MINIMUM.
 LONG-RUN FIRM EQUILIBRIUM
UNDER PERFECT COMPETITION

THE LONG RUN IS A PERIOD OF TIME IN WHICH THE FIRM CAN

CHANGE ITS PLANT AND SCALE OF OPERATIONS. THUS IN THE LONG-
RUN ALL COSTS ARE VARIABLE AND THERE ARE NO FIXED COSTS.
THE FIRM IS IN THE LONG-RUN EQUILIBRIUM UNDER PERFECT
COMPETITION WHEN IT DOES NOT WANT TO CHANGE ITS
EQUILIBRIUM OUTPUT.