In micro-economic theory, the supply and demand model attempts to describe, explain and predict the price and quantity of goods sold in competitive markets. This model assumes that markets are perfectly competitive i.e. there are many buyers or sellers, none of whom have the capacity to influence the price of goods or services on offer. A simple supply and demand model is as shown below. The slope of the demand curve indicates that a greater quantity will be demanded when the price is lower. Similarly, the supply curve shows that as prices rise, firms will produce more goods or offer more or better services. The point where these curves meet is the equilibrium point.
A market is said to be in perfect competition when no producer or consumer has the market power to influence prices. In such a market, prices of goods would instantly shift to the point of equilibrium as illustrated in the supply and demand graph. In competitive market economies, actual prices tend to the equilibrium prices at which demand equals supply. At the point of equilibrium there is no incentive to change either the price or the quantity. (Stiplitz J & Drifill J, 1993, p 73).
Since the price is fixed as the result of interaction of supply and demand, nothing producers can do will aff...
that there is no product differentiation.
Perfect and Complete Information - all firms and consumers know the prices set by all others.
Equal Access - all firms have access to production technologies, and resources are perfectly mobile.
Free Entry - any firm may enter or exit the market as it wishes.
Since the price is fixed as the result of interaction of supply and demand, nothing producers can do will affect the price and for every unit that sells results in a marginal revenue. They are in a perfect competition, price = marginal revenue = average returns (Whitehead, p 105). Demand has a very direct and immediate effect of prices since the supply factor will always have some lead time, i.e. till adequate stocks are built up or surplus stocks disposed off. This temporary shortage or excess has a bearing on prices. A temporary shortage has the effect of boosting prices, and under the influence of these profits there is an increase in production until supplies one again catch up with demand and until a new equilibrium point is reached, as shown in the figure below. Conversely a drop in demand lowers prices and eventually leads to decreased supply. Thus competition results in a higher output at a lower rice.
A monopoly is defined as a persistent market situation where there is only one producer of a particular product or service. They are characterized by a lack of economic competition for the goods or services provided including the lack of viable substitutes. As per the Wikipedia Encyclopedia, the primary characteristics of a monopoly are as follows:
Single seller - single firm is the sole producer of a product or service.
No close substitutes - the product or service is unique.
Price maker - a single firm