ME U9.pdf

Managerial Economics Unit 9
Manipal University Jaipur Page No. 238
Unit 9 Price Determination under Perfect Competition
Structure:
9.1 Introduction
Case Let
Objectives
9.2 Market and Market Structure
9.3 Perfect Competition
9.4 Price-Output Determination under Perfect Competition
9.5 Short-run Industry Equilibrium under Perfect Competition
9.6 Short-run Firm Equilibrium under Perfect Competition
9.7 Long-run Industry Equilibrium under Perfect Competition
9.8 Long-run Firm Equilibrium under Perfect Competition
9.9 Summary
9.10 Glossary
9.11 Terminal Questions
9.12 Answers
9.13 Case Study
Reference/E-Reference
9.1 Introduction
In the previous unit, we studied revenue analysis and pricing policies. We
saw how costs can influence the pricing behaviour of a firm. In recent years,
where firms are finding it difficult to differentiate themselves from their
competitors, the price fixed by a firm is highly influenced by the pricing
behaviour of its competitors. Effectiveness of a firm’s management lies in its
capacity to analyse the market. Knowledge of market structure and different
kinds of markets is of utmost importance to a business manager in taking
right pricing decisions and planning business activities efficiently. In this unit,
we will be studying price determination under perfect competition.
Case Let (Continued from Unit 8)
Ramesh presented the revenue analysis of his firm; which showed that to
meet its expansion plans, the firm’s profits would be affected by the
interest costs arising from borrowings. However, Ramesh was unable to
explain convincingly the impact of competitors’ pricing strategies on the

prices charged by his firm and consequent revenues. He doubted the
feasibility of forecasting revenues when competitors’ pricing decisions
could not be predicted with adequate levels of confidence. He met his
superior about this issue. Discussions indicated that, in the past few
years, Ramesh’s firm was able to sell higher quantities of its outputs by
responding suitably to competitors’ pricing moves. Ramesh’s superior
stated that this was possible as some of the products sold by his firm
were different from the products sold by other firms in the market. This
set Ramesh thinking about how product differentiation influenced product
pricing in different markets.
Objectives:
After studying this unit, you should be able to:
 analyse the market with respect to its structure of competition
 differentiate between different types of market structures
 explain how firms under perfectly competitive markets maximise their
output
 apply short-run and long-run concepts to price determination in perfectly
competitive markets
9.2 Market and Market Structure
Market, in economics, does not refer to a place or places but to a
commodity and also to buyers and sellers of that commodity who are in
competition with one another, for example, the cotton market may not be
confined to a particular place, but may cover the entire country and, in fact,
even the entire world. Buyers and sellers of cotton may be spread all over
the world.
Thus in common parlance, market refers to a place where sellers and
buyers meet for exchanging goods, but in the language of economics it has
a wider meaning. It refers to a context where buyers and sellers come into
close contact with one another for the settlement of their transactions.
According to Prof. Cournot, the term market is, “not any particular market
place in which things are bought or sold, but the whole of any region in
which buyers and sellers are in such free interaction with one another that
the price of the same goods tend to equalise easily and quickly”. In the

words of Prof. Benham, Market is, “any area over which buyers and sellers
are in such close touch with one another, either directly or through dealers
that the prices obtainable in one part of the market affects the prices paid in
other parts of the market”. For the existence of a market, there is no need
for face-to-face contact between the buyers and sellers to conclude their
transactions. In recent years, means of transport and communication have
developed so fast that buyers and sellers can easily come into close contact
with each other for the settlement of their transactions without establishing a
face-to-face relationship.
The term market hence implies to:
i) Existence of a commodity to be traded.
ii) Existence of sellers and buyers.
iii) Establishment of contact between the sellers and buyers.
iv) Willingness and ability to buy and sell a commodity and
v) Existence of a price at which the given commodity is to be bought and
sold.
Market situation varies in its structure. Market structure refers to
economically significant features of a market, which affect the behaviour,
and working of firms in the industry. It tells us how a market is built up and
what its basic features are. According to Pappas and Hirschey, “Market
structure refers to the number and size distribution of buyers and sellers in
the market for a good or service”. It indicates a set of market characteristics
that determine the nature of market in which a firm operates. Different
market structures affect the behaviour of sellers and buyers in different
ways.
The primary characteristics of markets are as follows:
 The number and size distribution of sellers
 The number and size distribution of buyers
 Product differentiation
 Conditions of entry and exit
The number and size distribution of sellers
A market may consist of many, few or very few sellers. There may be a few
big firms with huge investments or a large number of small firms with limited
investments. Thus, the operating size of the firm may be large or small in a
market. The number and size of sellers influence the working of a market.

The number and size distribution of buyers
In a market, there may be large number of buyers. Similarly, a market may
consist of many small buyers or only a few buyers. The total number of
buyers influences the nature of transactions in the market.
Product differentiation
Products sold in the market may be homogeneous, or have substitutes,
close substitutes or remote substitutes. A firm may deliberately differentiate
its product with that of the products of other firms by adopting several
techniques.
Conditions of entry and exit
In a few market situations, new firms may enter the industry or, old firms
may leave the industry at their own free will. In case of other market
situations, there will be deliberate entry barriers.
Thus, the characteristics of market structure give us information about the
nature of working of different markets.
Among the different market situations, perfect competition and monopoly
form the two extremes. In between these two market situations, we come
across a number of market situations which may be collectively termed as
imperfect markets. In these imperfect markets, we notice the elements of
competition as well as monopoly. They are bi-lateral monopoly, monopsony
(one buyer), duopoly (two sellers) duopsony (two buyers), oligopoly
(few sellers), oligopsony (few buyers) and monopolistic competition
(many sellers). Figure 9.1 shows the types of competition.
Figure 9.1: Types of Competition
Market Situation
Perfect
Competition
Imperfect
Competition
Monopolistic Competition, Oligopoly, Duopoly, Bilateral
Monopoly, Monopsony, Duopsony, Oligopsony

The market situations vary in their structure. Different market structures
affect the behaviour of buyers and sellers and firms. Further, prices and
trade volumes are influenced by different types of markets and price - output
determination under different market conditions.
9.3 Perfect Competition
Perfect competition is a comprehensive term which includes pure
competition too. Before we discuss the details of perfect competition, it is
necessary to have a clear idea regarding the nature and characteristics of
pure competition.
Pure Competition is a part of perfect competition. Competition in the
market is said to be pure when the following conditions are satisfied:
 Prevalence of a large number of buyers and sellers.
 The commodity supplied by each firm is homogeneous.
 Free entry and exit of firms.
 Absence of any kind of monopoly element.
Under these conditions, no individual producer is in a position to influence
the market price of the product. According to Prof. E.H. Chamberlin –
“Under Pure Competition, as the individual seller’s market is
completely merged with the general one, he can sell as much as he
pleases at the going price”. Further, he remarks, “Pure competition means
unalloyed by monopoly elements. It is a much simpler and less exclusive
concept than perfect competition”.
Prof. Joel Dean, after going through the features of pure competition,
observes that, “Pure competition does exist in reality but it is a rare
phenomenon”. Hence, it is stated that it is possible to come across pure
competition in our life, for example, in the markets for rice, wheat, cotton,
jowar, fruits, vegetables, eggs, etc., where there are a large number of
sellers and buyers and practically all goods are identical. If we look at the
present market, we notice that even in these cases, there is a possibility of
forming cartels by sellers to influence the market price. Now, we shall turn
our attention to perfect competition.

Meaning and definition of perfect competition
A perfectly competitive market is one in which the number of buyers and
sellers are large, all engaged in buying and selling a homogeneous
product without any artificial restriction and, possessing perfect
knowledge of the market at a time. According to Bilas, “the perfect
competition is characterised by the presence of many firms; they all sell the
same product which is identical. The seller is the price-taker”. According to
Prof. F. Knight, perfect competition entails “Rational conduct on the part of
buyers and sellers, full knowledge, absence of friction, perfect mobility and
perfect divisibility of factors of production and completely static conditions”.
Features of perfect competition
1. Existence of a large number of buyers and sellers
A perfectly competitive market will have large number of sellers and buyers.
Output of a seller (firm) will be so small that it is a negligible fraction of the
output of the industry. Hence, changes in supply made by a particular firm
will not affect the total output and price. Similarly, no single buyer can
influence the price of the commodity because the quantity purchased by him
is a small fraction of the total quantity.
2. Homogenous products
Different firms constituting the industry produce homogenous goods. They
are identical in character. Hence, no firm can raise its price above the
general level.
3. Free entry and exit of firms
There is absolute freedom for firms to get in or get out of the industry. If the
industry is making profits, new firms are attracted into the industry.
Conversely, firms will quit the industry if there are losses. This results in the
realisation of normal profits by all the firms in the long run.
4. Existence of single price
Each unit bought and sold in the market commands the same price since
products are homogeneous.
5. Perfect knowledge of the market
All sellers and buyers will have perfect knowledge of the market. Sellers
cannot influence buyers and, vice versa.

6. Perfect mobility of factors of production
Factors of production are free to move into any industry or occupation in
order to earn higher rewards. Similarly, they are also free to come out of the
occupation or industry if they feel that they are under remunerated.
7. Full and unrestricted competition
Perfectly competitive market is free from all sorts of monopoly and oligopoly
conditions. Since there are a large number of buyers and sellers, it is difficult
for them to join together and form cartels or form organisations. Hence,
each firm acts independently.
8. Absence of transport cost
All firms will have equal access to the market. Market price charged by the
sellers should not vary because of the difference in the cost of
transportation.
9. Absence of artificial government controls
The government should not interfere in matters pertaining to supply and
price. It should not place any barriers in the way of smooth exchange. Price
of a commodity must be determined only by the interaction of supply and
demand forces.
10. The market price is flexible over a period of time
Market price changes only because of changes in either demand or supply
force or both. Thus, price is not affected by the sellers, buyers, firm, industry
or the government.
11. Normal profit
As the market price is equal to the cost of production, firms in perfectly
competitive markets can earn only normal profits. Normal profits are those
which are just sufficient to ensure the firms stay in business. It is the
minimum reasonable level of profit which the entrepreneur must get in the
long run. It is a part of the total cost of production because it is the price
paid for the services of the entrepreneur, i.e., profit is an item of expenditure
for a firm.
Special features of perfect competition
i) It is an extreme form of market situation rarely found in the real world.
ii) It is a mere concept, a myth, an illusion and purely theoretical in
nature.

iii) It is a hypothetical model.
iv) It is an ideal market situation.
Reasons for the study of perfect competition
1. It is used as a yardstick against which all other models can be compared
and evaluated.
2. It is quite accurate and useful in explaining and predicting the behaviour
of a market and a firm under certain circumstances.
3. It is a good simplified model for beginners to start with. Its study is
useful to prepare a ground for future study of imperfect markets.
4. It is a useful model to compare the actual with the ideal; what is and
what ought to be.
5. It helps us to understand optimum allocation of resources in an ideal
market.
9.4 Price – Output Determination under Perfect Competition
(General Model)
Studying the price - output model under perfect competition is quite
interesting. In case of the industry, under a perfectly competitive market,
market price of the product is determined by the interaction of supply and
demand. The market price is not fixed by the buyer or the seller, firm,
industry or by the government. It is only the market forces, i.e., demand and
supply determines the equilibrium price of the product. This peculiar feature
is seen only under perfect competition.
Alfred Marshall compared supply and demand to the blades of a scissor.
Just as both the blades work together to cut a piece of cloth, both supply
and demand interact with each other to determine the market price at which
exchange takes place. In the process of price determination, supply is not
more important than demand or, demand is not more important than supply.
Both forces play an equally important role.
Table 9.1 depicts how the price is determined in the market by the
interaction of demand and supply.

Table 9.1: Price Determination Based on Demand and Supply
Price in
Rs.
Demand
in Units
Supply in
Units
State of Market
Pressure on
Price
10 1000 9000 Surplus S > D Downward
8 3000 7000 Surplus S > D Downward
6 5000 5000 Equilibrium S =D Neutral
4 7000 3000 Shortage D > S Upward
2 9000 1000 Shortage D > S Upward
From the table, it is clear that equilibrium price is determined at Rs. 6.00
where demanded quantity is exactly equal to quantity supplied i.e., 5000
units. Figure 9.2 shows the equilibrium output.
Figure 9.2: Equilibrium Output
In the case of any industry, interaction of supply and demand will determine
the equilibrium market price. In Figure 9.2, P indicates OR as equilibrium
price and OQ as equilibrium output. The price at which demand and
supply are equal is known as equilibrium price. The quantity bought
and sold at the equilibrium price is known as equilibrium output.
In the figure, equilibrium price is determined at the point P where both
demand and supply are equal. The upper limit of the price of a

product/service is determined by the demand. This price should not exceed
‘what the market can bear’. In short, the price of the product / service should
not exceed the value of its benefit to the buyers (price should not be more
than the utility of product / service).
The lower limit of the price is determined by the production cost. In the long
run, the price should not fall below production costs of making and
distributing the product / service. With reference to the industry, the point P
can be regarded as the position of stable equilibrium. Even if there are
changes in the price, there will be automatic adjustments in supply and
demand, restoring the original equilibrium position. When the price rises
from OR to OR1 supply exceeds demand, there will be excess supply over
demand. The excess supply of goods pushes down the price from OR1 to
OR, the original price.
Similarly, when price falls from OR to OR2, demand exceeds supply, excess
demand over supply in its turn pushes up the prices from OR2 to OR - the
original price. Thus, interaction between demand and supply determines the
market price.
Under perfect competition, a firm will not have any independence to fix the
price of its own product. The industry is the price - maker or giver and a firm
is a price - taker or price acceptor and quantity adjuster. As a part of the
industry, it has to simply charge the price which is determined by the
industry. If it charges a higher price it will lose its sales and, if it charges a
lesser price, it will incur losses.
In case of a firm, the price line which is equal to AR and MR, will be
horizontal and parallel to OX - axis. This is because; the same price has to
be charged by the firm for all the units supplied, irrespective of changes in
the demand. Hence,
Difference between a firm and an industry
Basically, there is a difference between a firm and an industry. A firm is a
single manufacturing unit producing and selling either a commodity or
a service. It is a part of the industry and is called as a business enterprise.
Business is an economic activity and a business unit is an economic unit
Equilibrium or Market Price = AR = MR

and an individual producing unit. It converts inputs into outputs. These
production units are organised and run by people either as individuals or as
members of households or, as a group of people. It is basically an
income-generating unit. It buys inputs like raw materials, labour, capital,
power, fuel, etc and produces goods and services for the consumers. It
organises and combines all kinds of resources and plans for the use of
these resources in the best possible manner.
Profit making is the basic objective of a firm. The traditional and
conventional objective of a firm was profit maximisation and now, the main
objective is profit optimisation.
A business firm is a legal entity on the basis of ownership and contractual
relationship organised for the production and for the sale of goods and
services.
Many firms producing similar or homogeneous goods or services
collectively make an industry. The term industry refers to a set or group
of firms engaged in the production of a particular product or a service. For
example, Reid and Taylor, Digjam, Reliance Industries, Raymond Ltd., etc
are all firms producing textiles. Such firms put together constitute the textile
industry in India. Thus, an industry is engaged in the production of
homogeneous goods that are substitutes for each other, use common raw
materials, have similar processes, etc. All firms engaged in providing the
same kind of services or doing a common trade or business constitute
an industry, for example, banks, hotels, etc. An industry is a particular line
of productive activity in which many firms are engaged, each adopting its
own production and pricing policies to its best advantage.
9.5 Equilibrium of the industry and the firm under perfect
competition
Short-run Industry Equilibrium under Perfect Competition
The term ‘Equilibrium’ in physical science implies a state of balance or rest.
In economics, it refers to a position or situation from which there is no
incentive to change. At the equilibrium point, an economic unit is
maximising its benefits or advantages. Hence, there will always be a
tendency on the part of each economic unit to move towards the equilibrium
condition. Reaching the position of equilibrium is a basic objective of all
firms.

In the short period, time available is too short and hence all types of
adjustments in the production process are impossible. As a plant capacity is
fixed, output can be increased only by intensive utilisation of existing plants
and machineries or by having more shifts. Fixed factors remain the same
and only variable factors can be changed to expand output. Total number of
firms remains the same in the short period. Hence, total supply of the
product can be adjusted to demand only to a limited extent.
In the short run, price is determined in the industry through the interaction of
the forces of demand and supply. This price is given to the firm. Hence, the
firm is a price taker and not a price maker. On the basis of this price, a firm
adjusts its output depending on the cost conditions.
An industry under perfect competition in the short run, reaches the position
of equilibrium when the following conditions are fulfilled:
1. There is no scope for either expansion or contraction of the output in the
entire industry. This is possible when all firms in the industry are
producing an equilibrium level of output at which MR = MC. In brief, the
total output remains constant in the short run at the equilibrium point.
Thus, a firm in the short run has only temporary equilibrium.
2. There is no scope for the new firms to enter the industry or existing firms
to leave the industry.
3. Short run demand should be equal to short run supply. The price so
determined is called as ‘subnormal price’. Normal price is determined
only in the long run. Hence, short run price is not a stable price.
9.6 Short-run Firm Equilibrium under Perfect Competition
A competitive firm will reach equilibrium position at a point where short run
MR equals MC. At this point, equilibrium output and price is determined.
The firm in the short run will have only temporary equilibrium. The short run
equilibrium price is not a stable price. It is also called as a sub - normal
price.

Figure 9.3: Short term equilibrium
The competitive firm, in the short run, will not be in a position to cover its
fixed costs. But it must recover short run variable costs for its survival and
continuance in the industry. A firm will not produce any output unless the
price is at least equal to the minimum AVC. If short run price is just equal to
AVC, it will not cover fixed costs and hence, there will be losses. However,
it will continue in the industry with the hope that it will recover the fixed costs
in the future.
Y
MC
P1

MR = MC
AR = MR
X
0
Output
Cost
&
Revenue
P


Figure 9.4: Short term equilibrium
If price is above the AVC and below the AC, it is called as “Loss
minimisation” zone. If the price is lower than AVC, the firm is compelled to
stop production altogether.
While analysing short term equilibrium output and price, apart from making
reference to SMC and AVC, we have to consider AC also. If AC = price,
there will be normal profits. If AC is greater than price, there will be losses
and, if AC is lower than price, then there will be supernormal profits.
In the short run, a competitive firm can be in equilibrium at various points
E1, E2 and E3 depending upon cost conditions and market price. At these
various unstable equilibrium points, though MR = MC, the firm will be
earning either supernormal profits or incurring losses or earning normal
profits.
In the case of the firm:
1. At OP4 price, the firm will neither cover AFC nor AVC and hence it has
to wind up its operations. It is regarded as shut-down point.
2. At OP1 price, OQ1 is the equilibrium output. E1 indicates the price or
AR = AVC only. It does not cover fixed costs. The firm is ready to
S
D
E
S
D
P 3
B
P2
P1
P4
E3

E2

E1

SAC
AVC
AR1=MR1
AR=MR
SMC
Q1 Q2 Q3

Industry Firm
Q 0
R
0
Price
Cost
/
Revenue
AR2=MR2
A
AR3=MR3
Output
Demand & Supply
Y
Y

suffer this loss and continue in business with the hope that the
price may go up in the future.
3. At OP2 price, OQ2 is the equilibrium output. E2 indicates the
price = AR = AC. At this point MR is also equal to MC. At this level of
output, total average revenue = total average cost. Hence, the firm is
earning only normal profits. It is also known as Break - even point of
the firm, a zone of no loss or no profit. The distance between two
equilibrium points E2 and E1 indicates loss-minimisation zone.
4. At OP3 price, OQ3 is the output produced by the firm. At E3, MR = MC.
But AR is greater than AC. For OQ3 output, the total cost is OQ3AB.
The total revenue is OQ3E3P3. Hence, P3E3AB is the total
supernormal profits.
Thus, in the short run, a firm can either incur losses or earn supernormal
profits. The main reason for this is that the producer does not have
adequate time to make all kinds of adjustments to avoid losses in the short
run.
In case of the industry, E indicates the position of equilibrium where short
run demand is equal to short run supply. OR indicates short run price and
OQ indicates short run demand and supply.
9.7 Long-run Industry Equilibrium under Perfect Competition
In the long run, there is adequate time to make all kinds of changes,
adjustments and readjustments in the production process. All factor inputs
become variable in the long run. Total number of firms can be varied and
plant capacity also can be changed depending upon the nature of
requirements. Economies of scale, technological improvements, better
management and organisation may reduce production costs substantially in
the long run. Hence, production can be either increased or decreased
according to the needs of the individual firms and the industry as a whole. In
short, supply of the product can be fully adjusted to meet its demand in the
long period.
In the long run, an industry, will be reaching the position of equilibrium under
the following conditions:
1. At the point of equilibrium, the long run demand and supply of the

products of the industry must be equal to each other. This will determine
the long run normal price.
2. There will be no scope for the industry to either expand or contract
output. Hence, the total production remains stable in the long run.
3. All the firms in the industry should be in the position of equilibrium. All
firms in the industry must be producing an equilibrium level of output at
which long run MC is equated to long run MR. (MC = MR).
4. There should be no scope for entry of new firms into the industry or exit
of old firms from the industry. In brief, the total number of firms in the
industry should remain constant.
5. All firms should be earning only normal profits. This happens when all
firms equate AR (Price) with AC. This will help the industry in attaining a
stable equilibrium in the long run.
9.8 Long-run Firm Equilibrium under Perfect Competition
A competitive firm reaches the equilibrium position when it maximises its
profits. This is possible when:
1. The firm would produce that level of output at which MR = MC and MC
curve cuts MR curve from below. The firm adjusts its output and the
scale of its plant so as to equate MC with market price.
2. The firm in the long run must cover its full costs and should earn only
normal profits. This is possible when long run normal price is equal to
long run average cost of production. Hence,
3. When AR is greater than AC, supernormal profits are earned. This leads
to the entry of new firms, increase in the total number of firms,
expansion in the output, increase in the supply, fall in the price and fall in
the ratio of profits. This process will continue till supernormal profits are
reduced to zero. On the other hand, when AC is greater than AR, the
industry will be incurring losses. This leads to the exit of old firms,
Price = MC = MR
Price = AR = AC

decrease in the number of firms, contraction in output, rise in price, and
rise in the ratio of profits. Thus, losses are avoided by automatic
adjustments. Such adjustments will continue till the firm reaches the
position of equilibrium when AC becomes equal to AR. Thus, losses and
profits are incompatible with the position of equilibrium. Hence,
4. The firm is operating at its minimum AC making optimum use of
available resources.
Figure 9.5: Long run equillibrium
In the case of the industry, E is the position of equilibrium at which LRS =
LRD, indicating OR as the equilibrium price and OQ as the equilibrium
quantity demanded and supplied.
In case of the firm, P indicates the position of equilibrium. At P, LMR = LMC
and LMC curve cuts LMR curve from below. At the same point P, the
minimum point of LAC is tangent to LAR curve. Hence,
D
LRD
LRS
S
E

R
P

LMC
LAC
AR=MR
Q
0
0
Output
Cost
/
Revenue
Price
Industry Firm
Q
X
Y
Demand & Supply
Y
Price = MR = MC = AR = AC
LAR = LAC

A competitive firm in the long run must operate at the minimum point of the
LAC curve. It cannot afford to operate at any other point on the LAC curve.
Otherwise, it cannot produce the optimum output or, it will incur losses.
Time plays an important role in determining the price of a product in the
market. As the time under consideration is short, demand will have a more
decisive role than supply in the determination of price. Longer the time
under consideration, supply becomes more important than demand in the
determination of price.
The price determined in the long run is called as normal price and it remains
stable.
Market price
Market price refers to that price which is determined by the forces of
demand and supply in a short period where demand plays a major role and
supply plays a passive role. Market price is unstable.
Normal price
Normal price is determined by demand and supply forces in the long period.
It includes normal profits also and it is stable in nature.
Activity:
Select a competitive firm and determine the price of a product in the
market and check its equilibrium position when it maximises its profits.
Hint: Refer section 9.8
Self Assessment Questions
Fill in the blanks:
1. The firms can earn only normal profit under ___________ competition.
2. Under perfect competition, demand curve is a ______________ line.
3. Regardless of the cost structure of firms in a competitive market, in the
long run, the marginal firm will earn __________ profit.
4. When new firms enter a perfectly competitive market the short-run
market supply curve shifts ______.
5. For any given price, a firm in a competitive market will maximise profit
by selecting the level of output at which price intersects the ______
curve.

True or false:
6. In competitive markets, firms increasing their product prices earn larger
profits. (True/False)
7. In perfectly competitive markets, firms are unable to differentiate their
product from that of other producers. (True/False)
8. For a firm in a perfectly competitive market, marginal revenue is always
equal to average revenue. (True/False)
9. A profit-maximising firm in a perfectly competitive market will earn zero
accounting profits in the long run. (True/False)
10. The marginal firm in a competitive market will earn zero economic profit
in the long run. (True/False)
9.9 Summary
Let us recapitulate the important concepts discussed in this unit:
 The organisation and functioning of a firm is determined by the type of
market in which it is operating.
 A market structure is characterised by the number of buyers and sellers,
nature of the commodity dealt with, the scope for entry and exit of firms
and the determination of price.
 Perfect competition exhibits an ideal market situation, where there are a
large number of buyers and sellers, the commodity dealt with is
homogeneous, there is free entry and exit of firms into and out of the
industry, and a uniform price prevails in the market.
 In the long run Price is equal to MR=AR=MC=AC. The firms can make
normal profit only in the long run.
9.10 Glossary
Firm: A single manufacturing unit producing and selling either a commodity
or service.
Industry: All firms engaged in providing the same kind of service or doing a
common trade or business.
Market: A commodity and buyers and sellers of that commodity who are in
competition with one another.

Market structure: Economically significant features of a market, which
affect the behaviour, and working of firms in the industry.
Normal profits: Profits which are just sufficient to ensure the firms stay in
business.
Perfectly competitive market: Market in which the number of buyers and
sellers are large, all engaged in buying and selling a homogeneous product
without any artificial restriction and, possessing a perfect knowledge of the
market at a time.
9.11 Terminal Questions
1. What are the primary characteristics of markets that categorise the
market’s structure?
2. Distinguish between a firm and an industry.
3. What is perfect competition? Explain how an industry’s equilibrium price
is determined under perfect competition in the short run.
4. When should a firm in perfectly competitive market shut down its
operation?
5. Explain the equilibrium of a firm under perfect competition in the long
run.
9.12 Answers
Self Assessment Questions
1. Perfect
2. Horizontal
3. Zero Economic
4. Right
5. Marginal cost
6. False
7. True
8. True
9. False
10. True

Terminal Questions
1. The number and size distribution of sellers, the number and size
distribution of buyers, product differentiation, conditions of entry and exit
are all primary characteristics of market structure. Refer to section 9.2.
2. A firm is a single manufacturing unit producing and selling either a
commodity or a service. Many firms producing similar or homogeneous
goods or services collectively make an industry. Refer to section 9.4.
3. A perfectly competitive market is one in which the number of buyers and
sellers are large, all engaged in buying and selling a homogeneous
product without any artificial restriction and, possessing perfect
knowledge of the market at a time. Refer to section 9.5.
4. At OP4 price, the firm will neither cover AFC nor AVC and hence it has
to wind up its operations. It is regarded as shut-down point. Refer to
section 9.6.
5. A competitive firm reaches the equilibrium position when it maximises its
profits. Time plays an important role in determining the price of a product
in the market. Refer to section 9.8.
9.13 Case Study
The growing market economies have virtually eliminated markets which
operate under perfect competition conditions. The presence of brands,
government regulations and controls, dominance of a few large players
and increasing focus on product differentiation has led more markets
towards imperfect competition conditions. However, a few examples that
approximate perfect competition can be seen.
In the modern world, stock markets are commonly quoted as an example
of a scenario where perfect competition conditions exist. For a given
stock, various bidders quote their prices and a market price is identified.
In most cases, individual buyers and sellers have no impact on the
market price of the stock. The stock can be bought and sold easily
indicating that the resource is liquid in nature. However, the perfect
competition conditions are compromised by the presence of large
institutional buyers and insider trading that occurs due to imperfect
information among buyers.

Another example of a market that approximates perfect competition is
street markets for commodities such as vegetables. However, a pre-
condition for perfect competition is that the product characteristics
(quality, grade, variety, etc.) should be undifferentiated. Street food
markets are another example wherein perfect competition conditions
could exist.
Discussion Questions:
1. Why do firms have to explore ways (for example, by differentiating
their offerings) to move away from perfect competition conditions?
2. Exercise: In your town, can you identify certain conditions that
approximate perfectly competitive markets?
3. Are they moving towards imperfect competition?
Source: Author-created
References:
 Chamberlin E. H. (1957). Towards a More General Theory of Value,
New York: Oxford University Press.
 Dean J. (1951). Managerial Economics, Englewood Cliffs, NJ, Prentice
Hall.
 Bilas R. A., (1971). Microeconomic Theory, Tokyo, McGraw-Hill
Kogakusha.
 Alfred M. (1920). Principles of Economics, 8th
Ed, Macmillan & Co.
E-Reference:
 www.economictimes.com – retrieved on 15th
January 2012

ME U9.pdf

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Similar a ME U9.pdf

Similar a ME U9.pdf (20)

Más de Sankaranarayanan196410

Más de Sankaranarayanan196410 (8)

Último

Último (20)

ME U9.pdf