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Pricing Under Perfect Competition - Demand Supply

 Pricing Under Perfect Competition - Demand Supply - Basic Framework

Perfectly Competitive Market Equilibrium

            A perfectly competitive market is one in which the number of buyers and sellers is very large, all engaged in buying and selling a standardised product without any artificial restrictions and possessing perfect knowledge of market at a time.

            There are two parties which bargain in such a market the buyers and sellers. It is only when they agree a commodity can be purchased and sold at a certain price. Thus product pricing is influenced both by buyers and sellers that is demand and supply.
           
            The law of demand is applicable to buyers. As per this, when price hikes, demand drops and vice versa. The law off supply applies on the supply side. The law states that supply increases with the hike in price. Thus demand supply is the two counteracting forces which move in the opposite directions. Price is determined at a point where these two forces are equal and that is known as the equilibrium price. Quantity demanded and supplied at this price is called Equilibrium quantity.  When price is less or more than the equilibrium price, there is disturbance in the equilibrium output. But ultimately equilibrium price will prevail.

Let us see an illustration which explain pricing process clearly

Illustration

Price in $

Quantity Demanded

Quantity Supplied

20

240

40

40

200

60

60

160

90

80

120

120

100

80

160

120

40

240

The above tablet gives various prices under volume demand and supply. Construct a graph where the demand and supply intersects each other and show the points of price variations where there is excess demand and supply.

Solution

Equilibrium Determination

  • When the price of a product is $ 20, 240 units are demanded whereas only 40 units are supplied. This show with the decrease in price demand is hiking and supply is dropping.

  • Likewise, when the price is $120, the demand drops to 40 units and supply to 240 units.

  • Hence the point of price at equilibrium is $80, where both demand and supply intersects. Hence the equilibrium demand and supply is 120 units each.

Point where Excess demand occurs

  • Once we derive the equilibrium price, there is no likeliness for it to change. Hence in any time if price becomes lower to $80, the influences of demand and supply will bring it back to $80.

  • For instance, if the price drops from $80 to 60, the demand hikes to 160 units and supply reduces to 90 units. Hence the price at which the excess demand starts is at price $60 and excess demand lasts till the price goes further below that is $20.

Point where Excess supply occurs

  • Less supply of product in relation to increasing demand for them will hike price to $80.

  • Consequently, the demand will drop to 120 units and supply will also hike to 120 units. Thus equilibrium price is re-established.

  • Alternatively, with the price hikes to $100, demand drops to 80 units and supply hikes to 160 units and lasts till the price is high that is $120. Hence excess supply starts at 160 units.

Now let us construct a graph representing the conditions, excess demand, excess supply and the price point where these occur.

           

Solution: Excess demand occurs at price $60, Excess supply occurs at price $100 and Equilibrium occurs at price $80.

Further there is a very significant point to be noted. When every seller tries to sell his product, he has to lower his price a little and others too follow him until the price comes down to $80 and the equilibrium amidst demand and supply is re-established.

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