Question

What is meant by Equilibrium Price ? How Equilibrium Price is determined under Perfect Competition ?

Hint:

An individual firm under perfect competition is a "Price Taker."
It must accept the equilibrium price determined by the industry and cannot change its own price without losing all customers.

Answer 1

Step 1: Understanding the Concept:
In a competitive market, equilibrium represents a state of "rest" where market forces are balanced.
The equilibrium price is also known as the "Market Clearing Price" because at this price, there are no frustrated buyers or sellers.
Step 2: Detailed Explanation:
The determination involves the interaction of two forces:
1. Market Demand: Represents consumers; slopes downward (inverse relationship with price).
2. Market Supply: Represents producers; slopes upward (direct relationship with price).
The Process:
- The Intersection: The point where the Demand (D) and Supply (S) curves cross is the equilibrium point (E). The corresponding price on the Y-axis is the Equilibrium Price (\(P_e\)).
- Case of Excess Supply: If the price is above equilibrium, quantity supplied exceeds quantity demanded. To clear stock, sellers reduce prices until they reach equilibrium.
- Case of Excess Demand: If the price is below equilibrium, quantity demanded exceeds quantity supplied. Buyers bid up the price, causing it to rise back to equilibrium.
Step 3: Final Answer:
Under perfect competition, the market price is determined solely by the aggregate behavior of all buyers and sellers where market demand equals market supply.