ICAI Notes- Unit 3: Price Output Determination under Different Market Forms | Business Economics for CA Foundation PDF Download

 Page 1


 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.27 
 
 
LEARNING OUTCOMES 
UNIT - 3: PRICE-OUTPUT 
DETERMINATION UNDER 
DIFFERENT MARKET FORMS 
 
 
 
After studying this unit, you would be able to:  
? Describe the characteristics of different market forms namely 
perfect competition, monopoly, monopolistic competition and 
oligopoly and cite the main differences among them. 
? Explain how equilibrium price and quantity of output are 
determined both in the short run and in the long run in different 
markets. 
? Describe what happens in the long run in markets where firms are 
either incurring losses or are making economic profits. 
? Illustrate the welfare implications of each of the market forms. 
The price of a commodity and the quantity exchanged per time period depend on the 
market demand and supply functions and the market structure. The market structure 
characterises the way the sellers and buyers interact to determine equilibrium price and 
quantity.  The existence of different forms of market structure leads to differences in 
demand and revenue functions of the firms. The market structure mostly determines a firm’s 
power to fix the price of its product. The level of profit maximising price is generally 
different in different kinds of markets due to differences in the nature of competition. As 
such, a firm has to closely watch the nature of the market before determining its equilibrium 
price and output. In this unit, we shall discuss the nature of four of the most important 
market structures namely, perfect competition, monopoly, monopolistic competition and 
oligopoly and how these market structures operate to determine short-run and long-run 
equilibrium price and quantity. We shall start our analysis with perfect competition. 
© The Institute of Chartered Accountants of India
Page 2


 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.27 
 
 
LEARNING OUTCOMES 
UNIT - 3: PRICE-OUTPUT 
DETERMINATION UNDER 
DIFFERENT MARKET FORMS 
 
 
 
After studying this unit, you would be able to:  
? Describe the characteristics of different market forms namely 
perfect competition, monopoly, monopolistic competition and 
oligopoly and cite the main differences among them. 
? Explain how equilibrium price and quantity of output are 
determined both in the short run and in the long run in different 
markets. 
? Describe what happens in the long run in markets where firms are 
either incurring losses or are making economic profits. 
? Illustrate the welfare implications of each of the market forms. 
The price of a commodity and the quantity exchanged per time period depend on the 
market demand and supply functions and the market structure. The market structure 
characterises the way the sellers and buyers interact to determine equilibrium price and 
quantity.  The existence of different forms of market structure leads to differences in 
demand and revenue functions of the firms. The market structure mostly determines a firm’s 
power to fix the price of its product. The level of profit maximising price is generally 
different in different kinds of markets due to differences in the nature of competition. As 
such, a firm has to closely watch the nature of the market before determining its equilibrium 
price and output. In this unit, we shall discuss the nature of four of the most important 
market structures namely, perfect competition, monopoly, monopolistic competition and 
oligopoly and how these market structures operate to determine short-run and long-run 
equilibrium price and quantity. We shall start our analysis with perfect competition. 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.28 
3.0  PERFECT COMPETITION 
3.0.0 Features 
Suppose you go to a vegetable market and enquire about the price of potatoes from a 
shopkeeper. He says potatoes are for 
`
 20 per kg. In the same way, you enquire from many 
shopkeepers and you get the same answer. What do you notice? You notice the following 
facts: 
(i) There are large number of buyers and sellers in the potatoes market. 
(ii) All the shopkeepers are selling potatoes at 
`
 20 per kg. 
(iii) Product homogeneity i.e. all the sellers are selling almost the same quality of 
potatoes in the sense that you cannot judge by seeing the potatoes from which 
farmer’s field do they come from. Such type of market is known as per fectly 
competitive market.  
In general, a perfectly competitive market has the following characteristics: 
(i) There are large number of buyers and sellers who compete among themselves. The 
number is so large that the share of each seller in the total supply and the share of 
each buyer in the total demand is too small that no buyer or seller is in a position to 
influence the price, demand or supply in the market. 
(ii) The products supplied by all firms are identical or are homogeneous in all respects so 
that they are perfect substitutes. Thus, all goods must sell at a single market price. 
No firm can raise the price of its product above the price charged by other firms 
without losing most or all of its business. Buyers have no preference as between 
different sellers and as between different units of commodity offered for sale; also 
sellers are quite indifferent as to whom they sell. For example, most agricultural 
products, cooking gas, and raw materials such as copper, iron, cotton, and steel sheet 
etc. are fairly homogeneous. In addition, all consumers have perfect information 
about competing prices.  
(iii) Every firm is free to enter the market or to go out of it. There are no legal or market 
related barriers to entry and also no special costs that make it difficult for a new firm 
either to enter an industry and produce, if it sees profit opportunity or to exit if it 
cannot make a profit. 
 If the above three conditions alone are fulfilled, such a market is called pure 
competition. The essential feature of pure competition is the absence of the element 
of monopoly. Consequently, business combinations of monopolistic nature are not 
© The Institute of Chartered Accountants of India
Page 3


 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.27 
 
 
LEARNING OUTCOMES 
UNIT - 3: PRICE-OUTPUT 
DETERMINATION UNDER 
DIFFERENT MARKET FORMS 
 
 
 
After studying this unit, you would be able to:  
? Describe the characteristics of different market forms namely 
perfect competition, monopoly, monopolistic competition and 
oligopoly and cite the main differences among them. 
? Explain how equilibrium price and quantity of output are 
determined both in the short run and in the long run in different 
markets. 
? Describe what happens in the long run in markets where firms are 
either incurring losses or are making economic profits. 
? Illustrate the welfare implications of each of the market forms. 
The price of a commodity and the quantity exchanged per time period depend on the 
market demand and supply functions and the market structure. The market structure 
characterises the way the sellers and buyers interact to determine equilibrium price and 
quantity.  The existence of different forms of market structure leads to differences in 
demand and revenue functions of the firms. The market structure mostly determines a firm’s 
power to fix the price of its product. The level of profit maximising price is generally 
different in different kinds of markets due to differences in the nature of competition. As 
such, a firm has to closely watch the nature of the market before determining its equilibrium 
price and output. In this unit, we shall discuss the nature of four of the most important 
market structures namely, perfect competition, monopoly, monopolistic competition and 
oligopoly and how these market structures operate to determine short-run and long-run 
equilibrium price and quantity. We shall start our analysis with perfect competition. 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.28 
3.0  PERFECT COMPETITION 
3.0.0 Features 
Suppose you go to a vegetable market and enquire about the price of potatoes from a 
shopkeeper. He says potatoes are for 
`
 20 per kg. In the same way, you enquire from many 
shopkeepers and you get the same answer. What do you notice? You notice the following 
facts: 
(i) There are large number of buyers and sellers in the potatoes market. 
(ii) All the shopkeepers are selling potatoes at 
`
 20 per kg. 
(iii) Product homogeneity i.e. all the sellers are selling almost the same quality of 
potatoes in the sense that you cannot judge by seeing the potatoes from which 
farmer’s field do they come from. Such type of market is known as per fectly 
competitive market.  
In general, a perfectly competitive market has the following characteristics: 
(i) There are large number of buyers and sellers who compete among themselves. The 
number is so large that the share of each seller in the total supply and the share of 
each buyer in the total demand is too small that no buyer or seller is in a position to 
influence the price, demand or supply in the market. 
(ii) The products supplied by all firms are identical or are homogeneous in all respects so 
that they are perfect substitutes. Thus, all goods must sell at a single market price. 
No firm can raise the price of its product above the price charged by other firms 
without losing most or all of its business. Buyers have no preference as between 
different sellers and as between different units of commodity offered for sale; also 
sellers are quite indifferent as to whom they sell. For example, most agricultural 
products, cooking gas, and raw materials such as copper, iron, cotton, and steel sheet 
etc. are fairly homogeneous. In addition, all consumers have perfect information 
about competing prices.  
(iii) Every firm is free to enter the market or to go out of it. There are no legal or market 
related barriers to entry and also no special costs that make it difficult for a new firm 
either to enter an industry and produce, if it sees profit opportunity or to exit if it 
cannot make a profit. 
 If the above three conditions alone are fulfilled, such a market is called pure 
competition. The essential feature of pure competition is the absence of the element 
of monopoly. Consequently, business combinations of monopolistic nature are not 
© The Institute of Chartered Accountants of India
 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.29 
possible. In addition to the above stated three features of ‘pure competition’; a few 
more conditions are attached to perfect competition. They are: 
(iv) There is perfect knowledge of the market conditions on the part of buyers and 
sellers. Both buyers and sellers have all information relevant to their decision to buy 
or sell such as the quantities of stock of goods in the market, the nature of products 
and the prices at which transactions of purchase and sale are being entered into.  
(v) Perfectly competitive markets have very low transaction costs. Buyers and sellers do 
not have to spend much time and money finding each other and entering into 
transactions. 
(vi) Under prefect competition, all firms individually are price takers. The firms have to 
accept the price determined by the market forces of total demand and total supply. 
The assumption of price taking applies to consumers as well. When there is perfect 
knowledge and perfect mobility, if any seller tries to raise his price above that 
charged by others, he would lose his customers. 
While there are few examples of perfect competition which is regarded as a myth by many, 
the agricultural products, financial instruments (stock, bonds, foreign exchange), precious 
metals (gold, silver, platinum) approach the condition of perfect competition. 
3.0.1 Price Determination under Perfect Competition  
Equilibrium of the Industry: An industry in economic terminology consists of a large 
number of independent firms. Each such unit in the industry produces a homogeneous 
product so that there is competition amongst goods produced by different units. When the 
total output of the industry is equal to the total demand, we say that the industry is in 
equilibrium; the price then prevailing is equilibrium price. A firm is said to be in equilibrium 
when it is maximising its profits and has no incentive to expand or contract production. 
As stated above, under competitive conditions, the equilibrium price for a given product is 
determined by the interaction of the forces of demand and supply for it as is shown in figure 
14 in the next page. 
 
Fig. 14: Equilibrium of a competitive industry 
© The Institute of Chartered Accountants of India
Page 4


 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.27 
 
 
LEARNING OUTCOMES 
UNIT - 3: PRICE-OUTPUT 
DETERMINATION UNDER 
DIFFERENT MARKET FORMS 
 
 
 
After studying this unit, you would be able to:  
? Describe the characteristics of different market forms namely 
perfect competition, monopoly, monopolistic competition and 
oligopoly and cite the main differences among them. 
? Explain how equilibrium price and quantity of output are 
determined both in the short run and in the long run in different 
markets. 
? Describe what happens in the long run in markets where firms are 
either incurring losses or are making economic profits. 
? Illustrate the welfare implications of each of the market forms. 
The price of a commodity and the quantity exchanged per time period depend on the 
market demand and supply functions and the market structure. The market structure 
characterises the way the sellers and buyers interact to determine equilibrium price and 
quantity.  The existence of different forms of market structure leads to differences in 
demand and revenue functions of the firms. The market structure mostly determines a firm’s 
power to fix the price of its product. The level of profit maximising price is generally 
different in different kinds of markets due to differences in the nature of competition. As 
such, a firm has to closely watch the nature of the market before determining its equilibrium 
price and output. In this unit, we shall discuss the nature of four of the most important 
market structures namely, perfect competition, monopoly, monopolistic competition and 
oligopoly and how these market structures operate to determine short-run and long-run 
equilibrium price and quantity. We shall start our analysis with perfect competition. 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.28 
3.0  PERFECT COMPETITION 
3.0.0 Features 
Suppose you go to a vegetable market and enquire about the price of potatoes from a 
shopkeeper. He says potatoes are for 
`
 20 per kg. In the same way, you enquire from many 
shopkeepers and you get the same answer. What do you notice? You notice the following 
facts: 
(i) There are large number of buyers and sellers in the potatoes market. 
(ii) All the shopkeepers are selling potatoes at 
`
 20 per kg. 
(iii) Product homogeneity i.e. all the sellers are selling almost the same quality of 
potatoes in the sense that you cannot judge by seeing the potatoes from which 
farmer’s field do they come from. Such type of market is known as per fectly 
competitive market.  
In general, a perfectly competitive market has the following characteristics: 
(i) There are large number of buyers and sellers who compete among themselves. The 
number is so large that the share of each seller in the total supply and the share of 
each buyer in the total demand is too small that no buyer or seller is in a position to 
influence the price, demand or supply in the market. 
(ii) The products supplied by all firms are identical or are homogeneous in all respects so 
that they are perfect substitutes. Thus, all goods must sell at a single market price. 
No firm can raise the price of its product above the price charged by other firms 
without losing most or all of its business. Buyers have no preference as between 
different sellers and as between different units of commodity offered for sale; also 
sellers are quite indifferent as to whom they sell. For example, most agricultural 
products, cooking gas, and raw materials such as copper, iron, cotton, and steel sheet 
etc. are fairly homogeneous. In addition, all consumers have perfect information 
about competing prices.  
(iii) Every firm is free to enter the market or to go out of it. There are no legal or market 
related barriers to entry and also no special costs that make it difficult for a new firm 
either to enter an industry and produce, if it sees profit opportunity or to exit if it 
cannot make a profit. 
 If the above three conditions alone are fulfilled, such a market is called pure 
competition. The essential feature of pure competition is the absence of the element 
of monopoly. Consequently, business combinations of monopolistic nature are not 
© The Institute of Chartered Accountants of India
 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.29 
possible. In addition to the above stated three features of ‘pure competition’; a few 
more conditions are attached to perfect competition. They are: 
(iv) There is perfect knowledge of the market conditions on the part of buyers and 
sellers. Both buyers and sellers have all information relevant to their decision to buy 
or sell such as the quantities of stock of goods in the market, the nature of products 
and the prices at which transactions of purchase and sale are being entered into.  
(v) Perfectly competitive markets have very low transaction costs. Buyers and sellers do 
not have to spend much time and money finding each other and entering into 
transactions. 
(vi) Under prefect competition, all firms individually are price takers. The firms have to 
accept the price determined by the market forces of total demand and total supply. 
The assumption of price taking applies to consumers as well. When there is perfect 
knowledge and perfect mobility, if any seller tries to raise his price above that 
charged by others, he would lose his customers. 
While there are few examples of perfect competition which is regarded as a myth by many, 
the agricultural products, financial instruments (stock, bonds, foreign exchange), precious 
metals (gold, silver, platinum) approach the condition of perfect competition. 
3.0.1 Price Determination under Perfect Competition  
Equilibrium of the Industry: An industry in economic terminology consists of a large 
number of independent firms. Each such unit in the industry produces a homogeneous 
product so that there is competition amongst goods produced by different units. When the 
total output of the industry is equal to the total demand, we say that the industry is in 
equilibrium; the price then prevailing is equilibrium price. A firm is said to be in equilibrium 
when it is maximising its profits and has no incentive to expand or contract production. 
As stated above, under competitive conditions, the equilibrium price for a given product is 
determined by the interaction of the forces of demand and supply for it as is shown in figure 
14 in the next page. 
 
Fig. 14: Equilibrium of a competitive industry 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.30 
In Fig. 14, OP is the equilibrium price and OQ is the equilibrium quantity which will be sold 
at that price. The equilibrium price is the price at which both demand and supply are equal 
and therefore, no buyer who wanted to buy at that price goes dissatisfied and none of the 
sellers is dissatisfied that he could not sell his goods at that price. It may be noticed that if 
the price were to be fixed at any other level, higher or lower, demand remaining the same, 
there would be no equilibrium in the market. Likewise, if the quantities of goods were 
greater or smaller than the demand, there would not be equilibrium in the market. 
Equilibrium of the Firm: The firm is said to be in equilibrium when it maximizes its profit. 
The output which gives maximum profit to the firm is called equilibrium output. In the 
equilibrium state, the firm has no incentive either to increase or decrease its output.  
Firms in a competitive market are price-takers. This is because there are a large number of 
firms in the market who are producing identical or homogeneous products. As such these 
firms cannot influence the price in their individual capacities. They have to accept the price 
determined through the interaction of total demand and total supply of the commodity 
which they produce.  
This is illustrated in the following figure: 
 
Fig. 15: The firm’s demand curve under perfect competition 
The market price OP is fixed through the interaction of total demand and total supply of the 
industry. Firms have to accept this price as given and as such they are price-takers rather 
than price-makers. They cannot increase the price above OP individually because of the fear 
of losing its customers to other firms. They do not try to sell the product below OP because 
they do not have any incentive for lowering it. They will try to sell as much as they can at 
price OP. 
As such, P-line acts as demand curve for the firm. Because it is a price taker, the demand 
curve D facing an individual competitive firm is given by a horizontal line at the level of 
market price set by the industry. In other words, the demand curve of each firm is perfectly 
© The Institute of Chartered Accountants of India
Page 5


 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.27 
 
 
LEARNING OUTCOMES 
UNIT - 3: PRICE-OUTPUT 
DETERMINATION UNDER 
DIFFERENT MARKET FORMS 
 
 
 
After studying this unit, you would be able to:  
? Describe the characteristics of different market forms namely 
perfect competition, monopoly, monopolistic competition and 
oligopoly and cite the main differences among them. 
? Explain how equilibrium price and quantity of output are 
determined both in the short run and in the long run in different 
markets. 
? Describe what happens in the long run in markets where firms are 
either incurring losses or are making economic profits. 
? Illustrate the welfare implications of each of the market forms. 
The price of a commodity and the quantity exchanged per time period depend on the 
market demand and supply functions and the market structure. The market structure 
characterises the way the sellers and buyers interact to determine equilibrium price and 
quantity.  The existence of different forms of market structure leads to differences in 
demand and revenue functions of the firms. The market structure mostly determines a firm’s 
power to fix the price of its product. The level of profit maximising price is generally 
different in different kinds of markets due to differences in the nature of competition. As 
such, a firm has to closely watch the nature of the market before determining its equilibrium 
price and output. In this unit, we shall discuss the nature of four of the most important 
market structures namely, perfect competition, monopoly, monopolistic competition and 
oligopoly and how these market structures operate to determine short-run and long-run 
equilibrium price and quantity. We shall start our analysis with perfect competition. 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.28 
3.0  PERFECT COMPETITION 
3.0.0 Features 
Suppose you go to a vegetable market and enquire about the price of potatoes from a 
shopkeeper. He says potatoes are for 
`
 20 per kg. In the same way, you enquire from many 
shopkeepers and you get the same answer. What do you notice? You notice the following 
facts: 
(i) There are large number of buyers and sellers in the potatoes market. 
(ii) All the shopkeepers are selling potatoes at 
`
 20 per kg. 
(iii) Product homogeneity i.e. all the sellers are selling almost the same quality of 
potatoes in the sense that you cannot judge by seeing the potatoes from which 
farmer’s field do they come from. Such type of market is known as per fectly 
competitive market.  
In general, a perfectly competitive market has the following characteristics: 
(i) There are large number of buyers and sellers who compete among themselves. The 
number is so large that the share of each seller in the total supply and the share of 
each buyer in the total demand is too small that no buyer or seller is in a position to 
influence the price, demand or supply in the market. 
(ii) The products supplied by all firms are identical or are homogeneous in all respects so 
that they are perfect substitutes. Thus, all goods must sell at a single market price. 
No firm can raise the price of its product above the price charged by other firms 
without losing most or all of its business. Buyers have no preference as between 
different sellers and as between different units of commodity offered for sale; also 
sellers are quite indifferent as to whom they sell. For example, most agricultural 
products, cooking gas, and raw materials such as copper, iron, cotton, and steel sheet 
etc. are fairly homogeneous. In addition, all consumers have perfect information 
about competing prices.  
(iii) Every firm is free to enter the market or to go out of it. There are no legal or market 
related barriers to entry and also no special costs that make it difficult for a new firm 
either to enter an industry and produce, if it sees profit opportunity or to exit if it 
cannot make a profit. 
 If the above three conditions alone are fulfilled, such a market is called pure 
competition. The essential feature of pure competition is the absence of the element 
of monopoly. Consequently, business combinations of monopolistic nature are not 
© The Institute of Chartered Accountants of India
 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.29 
possible. In addition to the above stated three features of ‘pure competition’; a few 
more conditions are attached to perfect competition. They are: 
(iv) There is perfect knowledge of the market conditions on the part of buyers and 
sellers. Both buyers and sellers have all information relevant to their decision to buy 
or sell such as the quantities of stock of goods in the market, the nature of products 
and the prices at which transactions of purchase and sale are being entered into.  
(v) Perfectly competitive markets have very low transaction costs. Buyers and sellers do 
not have to spend much time and money finding each other and entering into 
transactions. 
(vi) Under prefect competition, all firms individually are price takers. The firms have to 
accept the price determined by the market forces of total demand and total supply. 
The assumption of price taking applies to consumers as well. When there is perfect 
knowledge and perfect mobility, if any seller tries to raise his price above that 
charged by others, he would lose his customers. 
While there are few examples of perfect competition which is regarded as a myth by many, 
the agricultural products, financial instruments (stock, bonds, foreign exchange), precious 
metals (gold, silver, platinum) approach the condition of perfect competition. 
3.0.1 Price Determination under Perfect Competition  
Equilibrium of the Industry: An industry in economic terminology consists of a large 
number of independent firms. Each such unit in the industry produces a homogeneous 
product so that there is competition amongst goods produced by different units. When the 
total output of the industry is equal to the total demand, we say that the industry is in 
equilibrium; the price then prevailing is equilibrium price. A firm is said to be in equilibrium 
when it is maximising its profits and has no incentive to expand or contract production. 
As stated above, under competitive conditions, the equilibrium price for a given product is 
determined by the interaction of the forces of demand and supply for it as is shown in figure 
14 in the next page. 
 
Fig. 14: Equilibrium of a competitive industry 
© The Institute of Chartered Accountants of India
  
 
 
BUSINESS ECONOMICS  
 4.30 
In Fig. 14, OP is the equilibrium price and OQ is the equilibrium quantity which will be sold 
at that price. The equilibrium price is the price at which both demand and supply are equal 
and therefore, no buyer who wanted to buy at that price goes dissatisfied and none of the 
sellers is dissatisfied that he could not sell his goods at that price. It may be noticed that if 
the price were to be fixed at any other level, higher or lower, demand remaining the same, 
there would be no equilibrium in the market. Likewise, if the quantities of goods were 
greater or smaller than the demand, there would not be equilibrium in the market. 
Equilibrium of the Firm: The firm is said to be in equilibrium when it maximizes its profit. 
The output which gives maximum profit to the firm is called equilibrium output. In the 
equilibrium state, the firm has no incentive either to increase or decrease its output.  
Firms in a competitive market are price-takers. This is because there are a large number of 
firms in the market who are producing identical or homogeneous products. As such these 
firms cannot influence the price in their individual capacities. They have to accept the price 
determined through the interaction of total demand and total supply of the commodity 
which they produce.  
This is illustrated in the following figure: 
 
Fig. 15: The firm’s demand curve under perfect competition 
The market price OP is fixed through the interaction of total demand and total supply of the 
industry. Firms have to accept this price as given and as such they are price-takers rather 
than price-makers. They cannot increase the price above OP individually because of the fear 
of losing its customers to other firms. They do not try to sell the product below OP because 
they do not have any incentive for lowering it. They will try to sell as much as they can at 
price OP. 
As such, P-line acts as demand curve for the firm. Because it is a price taker, the demand 
curve D facing an individual competitive firm is given by a horizontal line at the level of 
market price set by the industry. In other words, the demand curve of each firm is perfectly 
© The Institute of Chartered Accountants of India
 
 
  PRICE DETERMINATION IN DIFFERENT MARKETS 
 
 
4.31 
(or infinitely) elastic. The firm can sell as much or as little output as it likes along the 
horizontal price line. Since price is given, a competitive firm has to adjust its output to the 
market price so that it earns maximum profit. Let us see in table 4 where demand and supply 
schedule for the industry were as follows: 
Table 4: Equilibrium price for industry 
Price (
`
) Demand (units) Supply (units) 
1 60 5 
2 35 35 
3 20 45 
4 15 55 
5 10 65 
Equilibrium price for the industry is determined through the interaction of demand and 
supply is ` 2 per unit. The individual firms will accept ` 2 per unit as the price and sell 
different quantities at this price. Let us consider the case of firm ‘X’. Firm X’s quantity sold, 
total revenue, average revenue and marginal revenue are as given in Table 5. 
Table 5: Trends in Revenue of a Competitive Firm 
Price (
`
) Quantity Sold Total Revenue Average 
Revenue 
Marginal 
Revenue 
2 8 16 2 2 
2 9 18 2 2 
2 10 20 2 2 
2 11 22 2 2 
2 12 24 2 2 
Firm X’s price, average revenue and marginal revenue are equal to ` 2. Thus, we see that in 
perfectly competitive market a price-taking firm’s average revenue, marginal revenue and 
price are equal. As a result, when the firm sells an additional unit, its total revenue increases 
by an amount equal to its price. 
AR = MR = Price. 
Conditions for equilibrium of a firm: As discussed earlier, a firm, in order to attain 
equilibrium position, has to satisfy two conditions as below: (Note that because competitive 
firms take price as fixed, this is a rule for setting output, not price). 
(i)  The marginal revenue should be equal to the marginal cost. i.e. MR = MC. If MR is 
greater than MC, there is always an incentive for the firm to expand its production 
© The Institute of Chartered Accountants of India