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Price Determination in A Perfectly Competitive Market With Fixed Number of Firms

Market equilibrium is reached when the quantity demanded by consumers equals the quantity supplied by producers at a single price, where there is no incentive for further trading. If the market price is above or below the equilibrium price, there will be excess supply or excess demand respectively, causing the price to change until equilibrium is reached. Equilibrium price and quantity in a perfectly competitive market are determined by the intersection of market demand and supply when the number of firms is fixed in the short run. Changes to demand or supply curves, such as from income changes, will result in a new equilibrium price and quantity.

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Samruddhi Doshetty
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124 views

Price Determination in A Perfectly Competitive Market With Fixed Number of Firms

Market equilibrium is reached when the quantity demanded by consumers equals the quantity supplied by producers at a single price, where there is no incentive for further trading. If the market price is above or below the equilibrium price, there will be excess supply or excess demand respectively, causing the price to change until equilibrium is reached. Equilibrium price and quantity in a perfectly competitive market are determined by the intersection of market demand and supply when the number of firms is fixed in the short run. Changes to demand or supply curves, such as from income changes, will result in a new equilibrium price and quantity.

Uploaded by

Samruddhi Doshetty
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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DEFINITION

Market equilibrium is defined as the state of rest that is determined by the rational
objectives of the consumers and the producers (i.e. maximization of satisfaction and profit
respectively). It is a state where the aggregate quantity that all the firms want to sell are
purchased by consumers, i.e. market supply equals market demand. At this situation, there
is no incentive or tendency for any change in quantity demanded, quantity supplied and
price.

If the market price is above the equilibrium price, there occurs the situation of excess
supply.

(ii) If the market price is below the equilibrium price, there occurs the situation of excess
demand.

PRICE DETERMINATION IN A PERFECTLY


COMPETITIVE MARKET WITH FIXED NUMBER OF
FIRMS.
When the number of firms in a perfectly competitive market is fixed, the firms are operating
in the short-run. The equilibrium price is determined by the intersection of market demand
curve and supply curve. It is the price at which the market demand equals market supply.

Thus, the invisible hands of market operate automatically whenever there exist excess
demand and excess supply; ensuring equilibrium in the market.
AFFECT ON EQUILIBRIUM PRICE AND QUANTITY
AFFECTED WHEN INCOME OF THE CONSUMERS
A) INCREASES
B) DECREASES
(a) Increase in income of consumers

If the number of firms is assumed to be fixed, then the increase in consumers’ income will
lead the equilibrium price to rise.

(b) Decrease in the income of consumers


The decrease in consumers’ income is depicted by leftward parallel shift of demand curve
from D1D1 to D2 D2. there will be an execs supply resulting the price to fall.

Q. If the price of a substitute Y of good X increases, what impact does it have on the
equilibrium price and quantity of good X?
ANSWER:

X and Y being substitute goods, if the price of Y increases, then it will reduce the demand
for Y and people will switch to X, which will raise the demand for X. Thus, the demand curve
will shift from D1D1to D2D2 . At the existing price P1, there will be an excess demand. Due to
the pressure of excess demand, the existing price will increase. Consequently, the new
equilibrium occurs at E2, where the new demand curve D2D2 intersects the supply curve
S1S1. The new equilibrium price is P2, which is higher than P1 and equilibrium quantity is q2,
which is higher than q1. Therefore, due to the increase in the price of substitute good Y, the
equilibrium price of X will rise and equilibrium output of X will also be higher.

How are the equilibrium price and quantity affected when

(a) both demand and supply curves shift in the same direction
Equilibrium Equilibrium
Cases Figure
Price Quantity

1) Increase in
Dd = Increase Unchanged Increases
in supply

2) Increase in
Dd more than Increases Increases
increase SS

3) Increase in
Dd less than Falls Increases
increase in SS

4) Decrease in
Dd = decrease Unchanged Falls
in SS
5) Decrease in
Dd more than Falls Falls
decrease in SS

6) Decrease in
Dd less than Increases Falls
decrease in SS

(b) demand and supply curves shift in opposite direction

Cases Equilibrium Equilibrium Figure


Quantity
Price

1. Increase in Dd = Increase Unchanged


decrease in SS
2. Decrease in Dd = Unchanged Increase
increase in SS

3. Decrease in Dd < Decrease Increase


increase in supply

4. Decrease in Dd > Decrease Decrease


increase in supply

5. Increase in Dd < Increase Decrease


decrease in SS
6. Increase in Dd > Increase Increase
decrease in SS

OBJECTIVES OF MARKET
EQUILIBRIUM
Learning ojectives:
 what is market equilibrium ?
Market equilibrium is a market state where the supply in the market is equal to the
demand in the market. The equilibrium price is the price of a good or service when the
supply of it is equal to the demand for it in the market.
 how do demand and supply interact to clear the market ?

 what happens if there is a change in demand or supply or


both ?
Supply and demand is an economic model of price determination in a market. ... If
demand increases and supply remains unchanged, then it leads to higher equilibrium
price and higher quantity. If demand decreases and supply remains unchanged, then it
leads to lower equilibrium price and lower quantity.
 what is consumer surplus ?
Consumer Surplus is the difference between the price that consumers pay and the
price that they are willing to pay. On a supply and demand curve, it is the area between
the equilibrium price and the demand curve

 what is producer surplus ?


Producer surplus is defined as the difference between the amount theproducer is
willing to supply goods for and the actual amount received by him when he makes the
trade.

Equilibrium in the Supply/Demand


Curve
The point where the supply and demand curves cross is market equilibrium. This is the
point where the market is at its most efficient – where the quantity of goods produced
equals the demand for them – and it should be the price point your business aims to
achieve. The market tends to move towards equilibrium over time, as business owners
adjust their prices in response to demand and buyers adjust their demand to prices. Market
equilibrium tends to be a fluid target so it’s important to continue analyzing market
conditions.

Movements Along the Curve


A movement along the supply and demand curves take place in response to short-term
market changes. These are temporary fluctuations that are expected to disappear relatively
shortly. For example, consider ice cream sales on a hot day. The demand for ice cream
would be expected to increase in warm weather, possibly to the point of a temporary
shortage. Once temperatures cool off, ice cream demand would return to normal levels,
restoring the supply and demand balance.

Shifts in the Curve


Shifts in the supply and demand curves take place in response to long-term market
changes. These are changes to market conditions that are expected to alter the supply and
demand landscape permanently. Imagine there is a medical study that determines that
doughnuts are actually healthy for you. The long-term demand for doughnuts would be
expected to increase and would potentially be followed by a corresponding rise in prices to
balance out the increased demand. Managing the supply and demand for your business’s
products and services is one of the most important factors to achieving financial success.
The supply and demand curve is constantly changing. Your business should be constantly
evaluating these elements to ensure that it’s satisfying market demand without being over-
or under-supplied.

Example #1
Company A sells Mangoes. During summer there is a great demand and equal

supply, hence the markets are at equilibrium. Post-summer season, the supply

will start falling, demand might remain the same. Company A to take

advantage and to control the demand will increase the prices. Once the prices

are high, the demand will slowly drop, bringing the markets again to

equilibrium.

New Equilibrium point: Equilibrium price may change due to changes in either

the supply or demand Variables. Demand and supply variables change due to

external factors that include higher prices, availability of cheaper substitute

goods, changes in income, changes in raw material prices and overhead costs,

technology changes, government policies, seasonality of products, disruption

in the economy, etc. Hence, the above factors might push the prices and

reach a new equilibrium point.


Example #2
An increase in earnings will increase the disposable income in the hand of

consumers and thereby increasing demand. Due to an increase in earnings,

the demand has gone up by certain units. In this case, demand and supply are

equal to each other. The increase in demand has raised the prices and reached

a new equilibrium.

As noted above, a rise or fall in consumer earnings impacts the demand and
prices.

BIBLIOGRAPHY
 quickbooks.intuit.com
 investopedia.com
 mindtools.com
 quickbooks.intuit.ca

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