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How Price Is Determined In Perfect Competition Economics Essay


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In this market structure there are many sellers and buyers. One buyer or seller has no influence on the market price; this is because contribution of individual buyer in the total demand is of fewer amounts almost negligible. The contribution of single supplier in total supply is also almost negligible.so changes in the demand of single buyer or changes in the supply of single supplier will have no effect or influence on the market price.

Buyers and sellers have perfect knowledge about the market. Buyers know what prices are charged for the product in every part of market. Sellers are also aware of the behavior of buyers and other sellers.

How price is determined in perfect competition?

There is one market price in perfect competition firms can't charge different prices as they are selling identical products. In perfect competition the firms and sellers are price takers. The price in perfect competition is determined by market forces which is demand and supply. This is shown in the figure (p1) below.

Fig p1it is shown in the graph that price is determined where demand and supply interacts each other. Price in this graph is p* as at this point supply and demand meets each other.

How output is determined in perfect competition.

Firms that produce under the condition of perfect competition are profit maximizes. They produce till the point where mr=mc this is shown by the figure p1.1

Fig P1.1the demand curve for the product of an individual firm is perfectly elastic. Here mc is the marginal cost of a firm and ac is its average cost. The demand line is equal to marginal revenue and mr is equal to price. Demand line is straight because in perfect competition firms are not price makers they are price takers. In this figure the output is where mr is equal to mc that is q.

Marginal revenue is the increase in total revenue when the quantity sold is changed by one unit.

Average cost is the cost per unit.

Marginal cost is the change in total cost when output is changed by unit.

A pure monopoly

Pure monopoly exists when there is a sole supplier. In pure monopoly the firm is the industry this means that there will be only one supplier of a particular good and service which don't have close substitutes. In pure monopoly there are barriers to entry which prevents other firms to enter the industry.

How price and output is determined in pure monopoly.

Monopolist has the power to either determine the price at which he wants to sell or the quantity which he wants to sell. But the monopolist can't perform both the actions at the same time as they don't have any control on the demand. If the monopolist wants to set a particular price the output will be determined by the demand curve at that point. Similarly if the monopolist wants to sell particular units of output, the price will be determined by the demand curve at which the particular amount of quantity may be sold. The graph p1.1A shows how the price and output is determined in pure monopoly.

as the monopolist is a sole supplier the demand curve for its product will be the total demand curve. The monopolist has power to set the price. The monopolist maximizes its profit so they produce till the point where mr becomes equals to mc so in this case the output is Q1 so the output in pure monopoly is determined where the Mr becomes equals to mc. The demand curve is the average revenue for the firm shown by Ar. Mr is the marginal revenue for a firm mc is marginal the cost and ac is the average cost all of these are explained above. The price is determined in pure monopoly at AR. The price is determined by projecting up from q1 which is which is output to the demand curve and across the vertical price axis which is p1 . In this figure the firm is making supernormal profit as well because the cost per units is p2 and the price is p1. Supernormal profit is shown by the shaded area in the graph.

Supernormal profit is that profit which the firm earns when the price exceeds its average cost.


In this market structure the market is dominated by few large producers that is where small numbers of large firms are responsible for the whole output of the industry

Characteristics of oligopoly

The goods and services that are produced in this market structure are similar and homogeneous for e.g. sugar. This condition is referred to perfect oligopoly. In imperfect oligopoly the products are differentiated for e.g. newspaper.

There are barriers to entry.

Firms in oligopoly can earn supernormal profits.

The prices in this market structure are sticky that is that it doesn't change even when there is change in demand or cost.

The industry is dominated by few large firms.

Oligopolies are price setter not taker.

There is considerable amount of non-pricing competition: that is firm doesn't compete in price because they have either agreed not compete via price that is collusion or either they are afraid that they will lose out in the price war.

How Price and output decisions are determined in oligopoly?

Firms and businesses in oligopoly engage in open collusion in order to increase profits and also reduce any uncertainty. In open collusion the firms agrees on the price to charge, the advertising expenditure that each is going to undertake and the market share that each firm is going to have. The price that is determined in this market structure is stable and is does not change even sometime with increase in demand or cost. The price is determined at that point where the price is well above the average cost. One form of open collusion is cartel cartel. In cartel firms produce separately but act as one firm in determining the price and output. The point at which price and output is determined in cartel is shown by the graph p1.1 b.

The demand curve can also be called the AR which is average revenue. The output is determined where the marginal cost becomes equal to marginal revenue in this graph the output is Q. The price is determined by projecting up from the output which is q to the demand curve (AR) and the vertical price axis that is P. the price is determined at the point which touches AR in this graph the price is p. the space between (a,b,c,d) shows the abnormal profit earned.

Tactic collusion also takes place in oligopolistic competition. In tactic collusion the decision of setting the price is determined by following a dominant firm price lead, this is changing and moving the price in line with the dominant firm price. The other way used to set up price is the Average cost pricing, this involves markup pricing, that is the firm estimate the long run average cost and then add a percentage for profit to set selling price.

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