Q.Describe the characteristics of 'Perfectly Competitive Market'. Explain the determination of price in such market.
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Start your 14-day free trial to unlock the full solution →Perfect competition features many buyers/sellers, a homogeneous product, free entry/exit, perfect knowledge and mobility; the price is set where total market demand equals total market supply, and each firm takes that price as given.
Part A — Characteristics of a Perfectly Competitive Market:
- Very large number of buyers and sellers — There are so many buyers and sellers that no single one can influence the market price; each is a price-taker.
- Homogeneous product — All firms sell an identical product in quality, size and shape, so buyers have no preference among sellers.
- Free entry and exit of firms — Firms can freely enter or leave the industry in the long run, which ensures only normal profit in the long run.
- Perfect knowledge — Buyers and sellers have complete information about prices and market conditions, so a single uniform price prevails.
- Perfect mobility of factors of production — Factors can move freely from one firm/use to another.
- Absence of transport cost — It is assumed there is no transport cost, so the same price rules throughout the market. Because of these features there is a single ruling price, the firm's demand (AR) curve is horizontal, and AR = MR.
Part B — Determination of Price under Perfect Competition:
Under perfect competition the price of a commodity is determined for the market as a whole by the interaction of total (market) demand and total (market) supply. The individual firm cannot influence the price; it accepts the price so determined.
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Market demand — The market demand curve (DD) slopes downward: at a lower price buyers demand more and at a higher price less (law of demand).
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Market supply — The market supply curve (SS) slopes upward: at a higher price sellers supply more and at a lower price less (law of supply).
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Equilibrium price — The equilibrium price is determined at the point where the market demand curve and the market supply curve intersect (point E in a diagram). At this price the quantity demanded equals the quantity supplied, so the market clears.
Adjustment to equilibrium:
- If the price is above the equilibrium, supply exceeds demand (excess supply); sellers cut the price until equilibrium is restored. …
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