MCom I Semester Managerial Economics Price Determination Under Perfect Competition Study Material Notes
Table of Contents
MCom I Semester Managerial Economics Price Determination Under Perfect Competition Study Material Notes: Meaning and Definition or perfect Competition Price Determinations Under Perfect Competition Equilibrium of a Firm During very Short Period Equilibrium of a Firm during Short Period Cut Throat Competition Effective or Workable Competition Unfair Competition Potential Non-Price Competition
MCom I Semester Business Environment Foreign Investment Study Material notes
PRICE DETERMINATION UNDER PERFECT COMPETITION
MEANING AND DEFINITION OF PERFECT COMPETITION
Perfect competition is a state of market in which there is a large number of buyers and sellers and a homogeneous product, all the buyers and sellers have perfect knowledge of market conditions, factors of production are perfectly mobile and there is no restriction upon the entry and exist of firms. In the words of Mrs. John Robinsons, “Perfect competition prevails when demand for the output of each producer is perfectly elastic. This entails first, that number of sellers is large, so that output of any one seller is negligibly small proportion of total output of the commodity and second, that buyers are alike in respect of their choice between rival sellers, so that the market is perfect.”
Essential Elements of Perfect Competition :
1 Large Number of Buyers and Sellers. There is a large number of buyers and sellers in the market. No individual buyer is in a position to influence demand of the product.
2. Homogeneous Product. All firms produce homogene- ous product. As a result, all the sellers have to sell their product at an uniform price.
3. Free Entry and Exit of Firms. There is no restriction upon the entry of a new firm of exit of an existing firm. Due to this characteristic, all the firms get only normal profit.
4. Perfect Knowledge of the Market. Both the buyers and sellers have perfect knowledge of market conditicus.
5. Perfect Mobility of the Factors of Production. Factors of production are perfectly mobile under perfect competition.
6. Absence of Selling and Transportation Costs. Perfect competition assumes that producers and sellers of a commodity are sufficiently close and as a result, there are no selling and distriubution costs.
7. Uniform Price Policy. All the producers and sellers sell their product at uniform price.
It is to be noted that if only first there conditions prevail in a market and other conditions do not prevail, it constitutes to be pure competition.
PRICE DETERMINATION UNDER PERFECT COMPETITION
Under perfect competition, price of a commodity it determined by the relative forces of demand and supply. In this reference, ‘demand’ means the demand of whole industry and ‘supply means the supply of whole industry. Under perfect competition, and individual producer cannot influence supply and an individual buyer cannot influence demand.
Demand Force
A commodity is demanded by consumers. They demand it because it provides them utility. Every consumer wants to purchase a commodity at minimum price but the maximum price at which he can agree to purchase a commodity, shall be equal to its marginal utility. Demand of commodity will be more at a lower price and less at a higher price.
Supply Force
A commodity is supplied by demand and supply of a commodity are equal. producers. They supply it because they collect revenue by selling it. Every producer wants to get maximum price but the minimum price at which he can agree a to supply it, will be equal to its marginal cost of production. Supply of a commodity will be more at a higher price and less at a lower price.
Price Determination
Quantity Price of a commodity is determined Fig. 20.1. Price Determination Under at the point where demand curve Perfect Competition. intersects supply curve. This is known as equilibrium point and the price is known as equilibrium price. At this point, demand and supply of the commodity are equal. It can be illustrated with the help of following diagram.
In this diagram, quantities of demand and supply have been shown on x-axis and price on y-axis. DD is demand curve and SS is supply curve. These curves intersect each other at point E. It is the point of equilibrium. At this point, price will be OP and quantity will be oQ.
EQUILIBRIUM OF A FIRM DURING VERY SHORT PERIOD
During very short period, supply of a product cannot be changed. Therefore, cost of production does not play any role in price determination during this period. Price is determined by demand alone. If demand increases, price will also increase. If demand decreases, price will also individual firm has to decide the quantity which it wants to produce to produce and sell at the price fixed by the industry. It depends upon the nature of product aster
(i) In case of perishable goods, the quantity of supply remains rice therefore, the firm will have to sell its entire stock at given price. Price on commodity is determined by demand alone. Refer to diagram A.
Fig A shows that under perfect competition, an individual firm has to follow the price policy determined by whole industry. As the supply of perishable goods cannot be changed during very short period, price is determined by demand alone. When demand is DD, price is OP and when demand increases to D, D, price increases to OP. When demand decreases to D2D2 price decreases to OP2. Quantity sold will remain the same at OQ in all the three cases.
(ii) In case of durable goods firm can change the supply of product to the extent of stock available. Refer to Diagram. B.
Fig. B shows that under perfect competition, an individual firm has to follow the price policy determined by whole industry. As the supply of durable Goods can be changed only to the extent of available stock, price is determined mainly by demand. When demand is DD, price will be OP and quantity sold When demand increases to DiDi, price increases to OP, and quantity sold increases to 00. When demand decreases to D2D2, price will decrease to OP2 and quantity sold will decrease to OQ..
EQUILIBRIUM OF A FIRM DURING SHORT PERIOD
During short period, supply of a commodity can be changed to the extent of production capacity. Production capacity cannot be changed during this period. Therefore, there may be three situations during this period-(i) A firm may earn abnormal profit; (ii) A firm may earn only normal profit (Normal profit is also known as zero profit because it is considered to be a part of cost of production); and (iii) A firm may suffer loss.
During short period, price of a product will be determined at the point at which marginal cost and marginal revenue are equal. At the point of equilibrium, if average cost curve (AC curve) is below marginal cost curve (MC Curve), the firm will get abnormal profit. If both the AC and MC curves are lying at the point of equilibrium, the firm will get normal pront.
EMC curve at the point of equilibrium, the firm will suffer loss. These three situations can be illustrated with the help of three diagrams as w e
In these diagrams, AC is average cost curve. MC is marginal cost curve AR is average revenue curve, MR is marginal revenue curve and E is the point of equilibirum
Fig. (A) AC is below the MC curve at the point of equilibrium. Thus, EPEP, is excess profit earned by firm.
Fig. (B) AC and MC are equal at this point. So, firm will earn only normal profit (Zero profit).
Fig (C) AC is above the MC at the point of equilibrium. So, firm will suffer a loss equal to EP EP.
Equilibrium of a Firm During Long Period. During long period, a firm can change the supply of its product according to the change in demand. Therefore, a firm can earn only normal profit during this pericd. Both the average cost and average revenue will be equal at this point. It can be illustrated with the help of following diagram:
In above diagram, AC is average cost curve, MC is marginal cost curve, AR is average revenue curve, MR is marginal revenue curve and E is the point of equilibirum. Both the AC and MC curves intersect each other at point E. So the firm will eam only normal profit during this period.3. Differentiate between equilibrium of firm and equilibrium of industry under perfect competition.
Ans. Under perfect competition, a firm is only a part of an industry and an industry is an aggregate of different firms. An industry is only an abstract term. Equilibrium of industry directly means the equilibrium of firms working in it. Difference Between Equilibrium of Firm and Equilibrium of Industry
4. Write short note on the following:
(1) Cut-Throat Competition,
(2) Unfair Competition,
(3) Effective or Workable Competition,
(4) Potential Competition,
(5) Non-Price Competition. Ans.
(1) CUT-THROAT COMPETITION
When the producers or sellers of a product reduce the price of their product to the extent that it does not recover the cost or production also, it is called cut-throat competition. In other words, it can be said that when selling price of a product is less than its cost of production, it is called cut-throat competition. Under this situation, the firm has to suffer a price-war also.
Under this situation of competition, the price-war is so serious have to sell their product at a price below the cost. Effect of this situation is tha the small firms have to exist the industry. For this reason, it is called coca competition. Rate-war between Indian and British Shipping Companies of 1939 is a brilliant example of cut-throat competition.
(2) UNFAIR COMPETITION
Unfair competition is that form of competition in which a competitor is in a better position than other competitors. Under this form of competition the following practices are adopting by a competitor to discourage other competitors :
1 To attract buyers of his product by telling that the product of other competitors is of inferior quality.
2. To discourage the sale of other competitors by abusing them.
3. To discourage or tease the selling agents of other competitors.
4. To misguide the selling agents of other competitors by giving them some incentives.
5. To know the secrets of other competitors and to misuse them.
6. To discourage competitors by filing a false and fabricated case against.
7. To induce the employees of other competitors to go on strike so that their production schedule may be disturbed.
8. To enter into an agreement with the suppliers of raw materials so that the competitors may not get raw materials in adequate quantity at reasonable price.
9. To adopt any other policy or tact’s so that competitors may be discouraged and their production and distribution schedule may be disturbed.
(3) EFFECTIVE OR WORKABLE COMPETITION
Though the concept of perfect competition is not a real concept because the conditions of perfect competition are not satisfied in practical business life, but there may be effective or workable competition among the producers or sellers of a product. Such type of competition can be possible only when the buyers are in a position to influence the price or quality of product. Following are the conditions which should be satisfied for effective competition :
1 The commodity of all the producers and sellers should be close substitutes for each other.
2. Buyers should have sufficient information on these substitutes so that their behavior may not be affected by the lack of substitutes.
3. There should be a large number of sellers in the market.
4. Every producer or seller should be free to determine his independent production and price policy.
5. There should be a possibility of potential competition by other competitors.
Effective competition cannot be successful when the number of sellers in a market is small or when the amount of capital required for business is so large that the competitors may be compelled to enter into an agreement.
(4) POTENTIAL COMPETITION
Potential Competition is the market situation in which there is no restriction over the entry and exit of firms. New firms can enter into the market at any time and existing firms can leave the market at any time. Non-availability of key resources, need of heavy amount of capital, high cost of production, complicated technique of production, restrictions of licence etc., and high cost of transportation are the factors which do not allow potential competition. Potential competition is very helpful in the solving the problems caused by the absence of perfect competition.
(5) NON-PRICE COMPETITION
There may be several basis of competition among the firms producing a particular product. When these firms compete with each other on a base other than price, it is called Non-price Competition. Important bases of non-price competition are to improve the quality of production, to improve the packing of product, to sell the product on easy terms, to provide the facilities of home delivery, to provide better after-sale services etc.
