Q.Explain the meaning of Perfect Competition. Illustrate the mechanism of Price Determination under Perfect Competition.
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Start your 14-day free trial to unlock the full solution →Perfect competition is an ideal market form with a large number of buyers and sellers, a homogeneous product, free entry and exit, perfect knowledge and perfect mobility of factors, resulting in a single ruling price. The price is determined where the market demand curve and the market supply curve intersect, i.e. where quantity demanded equals quantity supplied (the equilibrium price).
Meaning of Perfect Competition
Perfect competition refers to a market situation in which there are a very large number of buyers and sellers dealing in a homogeneous (identical) commodity, and no individual buyer or seller is large enough to affect the market price. Each firm simply accepts the price set by the market; it is therefore called a price-taker.
Features / characteristics
- Large number of buyers and sellers: each one's share of total demand or supply is negligible.
- Homogeneous product: goods are identical in size, shape, quality, so buyers have no preference.
- Free entry and exit: firms can enter or leave the industry without any barrier.
- Perfect knowledge: buyers and sellers have complete information about prices.
- Perfect mobility of factors of production.
- No transport cost and no selling cost.
- A single, uniform price rules throughout the market.
Mechanism of Price Determination
Under perfect competition the price of a commodity is determined by the interaction of the forces of market demand and market supply.
- The market demand curve slopes downward from left to right (because of the Law of Diminishing Marginal Utility): more is demanded at a lower price.
- The market supply curve slopes upward from left to right: more is supplied at a higher price.
The following schedule illustrates how equilibrium is reached:
| Price (Rs.) | Quantity Demanded | Quantity Supplied | Pressure on price |
|---|---|---|---|
| 5 | 100 | 300 | Surplus -> price falls |
| 4 | 150 | 250 | Surplus -> price falls |
| 3 | 200 | 200 | Equilibrium |
| 2 | 250 | 150 | Shortage -> price rises |
| 1 | 300 | 100 | Shortage -> price rises |
The equilibrium price is Rs.3, where quantity demanded (200) equals quantity supplied (200). Graphically it is the point where the downward-sloping demand curve and the upward-sloping supply curve intersect.
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