Price and Output Determination

 

Price determination under perfect competition-Role of time

Price of a commodity in an industry is determined at that point where industry demand is equal to industry supply. Marshall laid emphasis on the role of time element in the determination of price. He distinguished three periods in which equilibrium between demand and supply was brought about viz., very short period or market period; short run equilibrium and long run equilibrium.

 

Market period

Price is determined by the equilibrium between demand and supply in market period. In the market period, the supply of commodity is fixed. The firms can sell only what they have already produced. This market period may be an hour, a day or few days or even few weeks depending upon the nature of the product. So far as the supply curve in a market period is concerned, two cases are prominent-one is that of perishable goods and the other is that of non perishable durable goods.

For perishable goods like fish, vegetables etc. the supply is given and cannot be kept for the next period; therefore, the whole of it must be sold away on the same day whatever be the price. The supply curve will be a vertical straight line.

Supply Curve ngp bcca 1st year

QS is the supply curve. OQ is the quantity of fish available. DD is the market demand curve. The equilibrium price OP is determined at which quantity demanded is equal to the available supply i.e. at the point where DD intersects the vertical supply curve QS. If demand increases from DD to D1D1 supply remaining the same price will increase from OP to OP1. On the contrary, if there is a decrease in demand from DD to D2D2 the price will fall and the quantity sold will remain the same.

If the commodity is a durable good, its supply can be adjusted to demand. If the demand for commodity declines the firms will start building inventories, while on the other hand, if demand goes up the firms will increase their supplies out of the existing stocks. The firm can keep on supplying out of its existing stocks only upto the availability of stocks. If demand increases beyond that level, the firm cannot supply any additional quantity of the good. Thus the supply curve for the durable goods is upward sloping upto a distance and then becomes vertical. A firm selling a durable good has a reserve price below which it will not like to sell. The reserve price, is influenced by the cost of production.

Supply Curve B ngp bcca 1st year

SRFS is the supply curve of the durable goods. OM1 is the total amount of stock available. Upto OP1 the quantity supplied varies will I price. At OS price, nothing is sold.

It is the reserve price. At OP1 price, the whole stock is offered for sale. DD is the demand curve. Price ul determined at OP at which quantity demanded is equal to the quantity supplied. At this price OM quantity is sold. If demand increases form DD to D1 D1 the price will increase to OP1 and the whole stock will be sold. If the demand decreases from DD to D2D2 the price will fall to OP2 and the amount sold will fall to OM2.

Short run equilibrium

In the short period the firm can vary its supply by changing the variable factors. Moreover, the number of firms in the industry cannot increase or decrease in the short run. Thus the supply of the industry can be changed only within the limits set by the plant capacity of the existing firms. The short period price is determined by the interaction of short period supply and demand curves. The determination of the short run price is shown in figure

short run price A ngp bcca 1st year

 

DD is the demand curve facing the industry. MPS is the market period supply, curve and SRS is the short run supply curve of the industry. If there is an increase in demand form DD to D1D1 the market price will increase from OP to OP1. The supply of the commodity will be increased by intensive utilisation of fixed factors and increasing the amount of variable factors. So in the short run price will fall to OP3 at which new demand curve D1D1 intersects the short run supply curve SRS. Thus OP3 is the short run price and quantity supplied has increased from OM to OM1.

Long-run equilibrium

In the long run, supply is adjusted to meet the new demand conditions. If there is an increase in demand, the firms in the long run will expand output by increasing the fixed factors of production. They may enlarge their old plants or build new plants.

Moreover, in the long run new firms can also enter the industry and thus add to the supplies of the product. The determination of price in the long run is shown in figure

Long run price ngp bcca 1st year

LRS is the long run supply curve; MPS is the market period supply curve and SRS is the short run supply curve. DD is the market demand curve and OP is the market price. If there is an increase in demand from DD to D1D1 the market price will increase from OP to OP1. In the short run, however, the firms will increase output. Price in the short run will fall to OP2 at which D1D1 intersects the short run supply curve SRS. In the long run new firms will enter the industry. As a result output will increase and price will fall to OP3. Thus OP3 is the long run price.

 

 

 

 

 

 

References

http://www.slideshare.net/kpiyushlucky/my-presentation-25609486

http://www.enotes.com/homework-help/what-meant-by-equilibrium-firm-industry-indicate-110671

http://en.wikipedia.org/wiki/Economic_equilibrium

http://www.jstor.org/discover/10.2307/2224727?uid=3738256&uid=2129&uid=2&uid=70&uid=4&sid=21103408765307

http://www.investopedia.com/exam-guide/cfa-level-1/microeconomics/equilibrium-short-long-run.asp

http://studypoints.blogspot.in/2011/05/equilibrium-of-industry-under-perfect_545.html

http://www.economics.utoronto.ca/osborne/2×3/tutorial/

http://www.s-cool.co.uk/a-level/economics/market-structure-1/revise-it/short-run-and-long-run-equilibrium

 

 

 

 

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