Forms of market in one look
A market is any set-up where buyers and sellers meet and trade. Markets differ in how many sellers there are and how alike their products are.
- Perfect competition: very many sellers, identical product.
- Monopoly: only one seller, no close substitute.
- Monopolistic competition: many sellers, slightly different products (brands of soap).
- Oligopoly: a few big sellers (mobile networks).
This lesson studies perfect competition, because it is the simplest case of price set by demand and supply.
Features of perfect competition
- Very large number of buyers and sellers. Each one is tiny compared with the whole market.
- Homogeneous (identical) product. Wheat from one seller is the same as from another.
- Free entry and exit. New firms can join; losing firms can leave. No legal or cost barrier.
- Perfect knowledge. All buyers and sellers know the price everywhere.
- Perfect mobility of goods and factors, and no transport cost differences.
Why a firm is a price taker
If one firm charges even a little more, buyers go to others selling the same thing, so its sales fall to zero. If it charges less, it loses money it did not need to lose, since it can sell all it wants at the market price. So the firm accepts the market price. Its demand curve is a horizontal line at that price (perfectly elastic), and price = average revenue = marginal revenue.
Try it at home
Visit a mandi or grocery row. Note the price of one item (say onions) at 5 stalls. Are they almost the same? Why can one stall not charge double?
Market equilibrium: how price is decided
Equilibrium means a state of rest. In a market it is the price at which quantity demanded = quantity supplied (Qd = Qs). That price is the equilibrium price and the amount traded is the equilibrium quantity.
Excess demand and excess supply
- If price is above equilibrium, Qs > Qd. This is excess supply. Sellers cut prices to sell, so price falls.
- If price is below equilibrium, Qd > Qs. This is excess demand. Buyers compete and offer more, so price rises.
This push and pull is the "invisible hand": it moves price to where Qd = Qs.
Solving with equations
If Qd = a − bP and Qs = c + dP, set them equal: a − bP = c + dP, so P* = (a − c) ÷ (b + d). Put P* back in either equation to get Q*.
Equilibrium with a fixed number of firms vs free entry
With a fixed number of firms (short run), equilibrium is simply where market demand meets market supply. With free entry and exit (long run), firms keep entering while there is supernormal profit and leave when there is a loss, so price settles at the minimum of average cost and each firm earns only normal profit.
Effect of demand and supply shifts (short run)
A shift means the whole curve moves because something other than the good's own price changed (income, tastes, prices of related goods, input costs, technology, weather).
Demand shifts
- Demand increases (curve right): excess demand at old price → price ↑, quantity ↑.
- Demand decreases (curve left): excess supply → price ↓, quantity ↓.
Supply shifts
- Supply increases (curve right): excess supply → price ↓, quantity ↑.
- Supply decreases (curve left): excess demand → price ↑, quantity ↓.
Both shift together
- Both increase: quantity surely ↑; price ↑, ↓ or same depending on which shift is bigger.
- Both decrease: quantity surely ↓; price depends.
- Demand ↑, supply ↓: price surely ↑; quantity depends.
- Demand ↓, supply ↑: price surely ↓; quantity depends.
Equal shifts in the same direction leave price unchanged; equal shifts in opposite directions leave quantity unchanged. Try this in the free-play step.
Board exam tip
Questions ask for a diagram plus the chain: shift → excess demand/supply at old price → change in price → new equilibrium. Always write all four links.
Key formulas and definitions
- Market equilibrium: Qd = Qs
- If Qd = a − bP and Qs = c + dP: P* = (a − c) ÷ (b + d)
- Excess demand = Qd − Qs (when price is below equilibrium)
- Excess supply = Qs − Qd (when price is above equilibrium)
- Price taker firm: P = AR = MR (horizontal demand curve)
- Demand ↑ → P ↑, Q ↑; Supply ↑ → P ↓, Q ↑
Worked examples
1. Qd = 100 − 2P and Qs = 2P. Find the equilibrium price and quantity.
Set Qd = Qs: 100 − 2P = 2P → 100 = 4P → P = ₹25. Q = 2 × 25 = 50 units.
2. In the same market, find the excess demand or supply at P = ₹15 and at P = ₹35.
At ₹15: Qd = 100 − 30 = 70, Qs = 30 → excess demand 40. At ₹35: Qd = 30, Qs = 70 → excess supply 40.
3. Demand becomes Qd = 120 − 2P, supply stays Qs = 2P. Find the new equilibrium.
120 − 2P = 2P → P = ₹30; Q = 60. Demand rose, so price rose (25 → 30) and quantity rose (50 → 60).
4. Supply becomes Qs = 20 + 2P, demand stays Qd = 100 − 2P. Find the new equilibrium.
100 − 2P = 20 + 2P → 80 = 4P → P = ₹20; Q = 60. Supply rose, so price fell and quantity rose.
5. Qd = 200 − 4P and Qs = 50 + 6P. Find P* and Q*.
200 − 4P = 50 + 6P → 150 = 10P → P* = ₹15. Q* = 200 − 60 = 140 units (check: 50 + 90 = 140).
6. Both demand and supply increase by 20 at every price: Qd = 120 − 2P, Qs = 20 + 2P. What happens?
120 − 2P = 20 + 2P → P = ₹25 (unchanged); Q = 70. Equal shifts in the same direction: price stays, quantity rises.
Common mistakes
- Saying 'demand rises because price falls'. That is a movement along the curve, not a shift. A shift needs a non-price cause.
- Mixing up the supply-shift result: more supply makes price FALL, not rise.
- Thinking a perfectly competitive firm can set its own price. It is a price taker.
- Forgetting that when both curves shift, one of price or quantity is uncertain unless the sizes are given.