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The determination of prices and output levels is very much affected by the competitive structure
of the market. Here “Competitive Structure” is a phrase which refers to the nature and extent of
the monopolistic elements that are present in any particular market situation.
MARKET STRUCTURE
PERFECT IMPERFECT
PERFECT COMPETITION
An industry is said to be operating under perfect competition when the following conditions are
satisfied.
i. Large number of firms: There must be a large number of firms in the industry. Each
firm controls only a very insignificant share of total output, so that any action ( addition
to/removal from the market) on its own part will have little or no effect on the price and
the output of the whole industry. The same holds good in the case of customers.
ii. Homogeneous Product: Each firm in the industry must be making a product which is
accepted by buyers as being identical or homogeneous, with that made by all the other
producers in the industry. This ensures that no producer can put his price up above the
general level.
iii. Freedom of Entry and Exit: Any individual or company with the funds and inclination
must be able to enter the industry without artificial hindrances being erected against him,
and any owner of a firm in the industry, who wants to leave the field, is free to do so.
iv. Independent Decision Making: Firms can take independent decisions. There should not
be any collusion or agreement between firms in decision making.
v. Perfect Knowledge about the Market: There is perfect knowledge on the part of all
producers, consumers and resource owners regarding the conditions prevailing in the
market.
vi. Perfect Mobility of Factors: There is perfect mobility of factors of production among
different firms in the industry and among different industries in response to peculiarly
signals and transport costs are ignored.
vii. No Government Intervention: in a perfectly competitive market, there are any
Government interventions with the working of the market system. There is no licensing
system regulating the entry of the firms to the industry, no regulation of market prices.
Perfect competition is an uncommon phenomenon in the real business world. Perfect competition
model has been the most popular model used in economic theories due to its analytical value as it
provides a starting point and analytical frame work for pricing theory.
Market Price in a perfectly competitive market is determined by the market forces – Market
Demand and Market Supply.
Market Demand: It refers to the demand for the industry as a whole. It is the sum of the
quantity demanded by individuals and consumers at different prices.
Market Supply: It is the sum of the quantity supplied by the individual firms in the industry.
In a perfectly competitive market the main problem for a profit maximizing firm is not to
determine the price of its product but to adjust its output to the market price so that profit is
maximum.
Price determination depends on the time taken by the supply position to adjust itself to the
changing demand conditions.
Pricing in Market Run: Price determination under perfect competition is analyzed under three
different time periods:
In a market Period, the total output of a product is fixed. Since the stock is fixed, the supply
curve is perfectly inelastic. That is the price is determined solely by the demand condition.
Supply remains an inactive agent.
In case of supply determined price, supply curve shifts leftward causing rise in price of the Short
supply goods. This phenomenon is illustrated in figure 1.
Figure1
Given the demand curve DD’ and supply curve S2, the price is determined at OP. Demand curve
remains the same, the fall in supply makes the supply curve shift leftward to S1. As a result price
increases from OP1 to OP2.
The other examples of very short run markets may be daily fish market, stock market, and coffin
markets during a period of natural calamities etc.
The figure1 shows the price determination for the industry by the demand
curve DD and supply curve SS, at the price OP1 or PQ. The price is fixed for all the
firms in the industry.
Given the price PQ (=OP1) an individual firm can produce and sell any
quantity at this price. But any quantity will not yield maximum profit. Given their
cost curves the firms are required to adjust their output to the price PQ so that they
maximize their profit.
The process of firm’s output determination and its equilibrium are shown
in figure 2. We know that the profit is maximum at the level of output where
MR=MC. Since price is fixed at PQ, firm’s AR=PQ. If AR is given MR=AR. The firms
MR is shown by AR=MR line. Firm’s upward sloping MC curve intersects AR=MR at
point E. At point E, MR=Mc. Point E is firm’s equilibrium point. An ordinate EM
drawn from point E to the horizontal axis determines the profit maximizing output at
OM. At this output firm’s MR=MC. This satisfies the necessary condition of
maximum profit. The total maximum profit has been shown by the area P1TNE. The
total profit may be calculated as PROFIT= (AR-AC)Q.