Equilibrium Price Determination in the Market Period and Short Period Under Perfect Competition
The Market Period Price Determination
The market period is a very short period in which the supply of a commodity is fixed. It is the variations in demand that determine the price in such a market period. The time period is so short that supply is not responsive to demand. This market period may be an hour, a day or a few days, or even a few weeks depending upon the type of the commodity under consideration as to whether it is a perishable or semi-durable one.
Market price is the price prevailing in the market period and this price is not fixed. The market price fluctuates many times depending on the nature of the commodity and demand.
Marshall explains the market price in the following words: “The market value is often more influenced by passing events and by causes whose action is fitful and short-lived than by those which work persistently.”
The determination of market price is explained separately for perishable and durable commodities.
The fundamental feature of the market period is that the supply of a commodity is fixed and cannot be altered. In this case, the supply curve of each firm is a vertical straight line. Since the individual supply curve is a vertical straight line, the market supply curve that is obtained by aggregating all individual supply curves must also be a vertical straight line. Hence, in case of perishable commodities such as fish, milk, vegetables, flowers etc., the supply is limited to the existing stocks. Therefore, during the market period, demand is more important than supply in determining the price of perishable commodities. In other words, utility is more important than cost.
Figure 1 depicts the price determination of a perishable commodity like fish. MS is the supply curve, which is a vertical straight-line representing perfectly inelastic supply. DD is the initial demand curve which intersects the supply curve MS at E. The equilibrium price is OP and the quantity demanded and supplied is equal to OM. Now due to a sudden rise in the demand for fish from DD to D1D1, the new equilibrium is established at E1 and the price increases to OP1. If demand decreases, the demand curve becomes D2D2, and the new equilibrium price becomes OP2.
If the commodity under consideration is a durable commodity, the supply curve cannot be a vertical straight line throughout its length, because some of the goods can be preserved or held back from the market and carried over to the next period. Then there will be two critical price levels. At one price, the seller will be prepared to sell the entire stock. If the price is below a particular level, the seller does not sell the entire quantity buy holds back the stock for a better time. The price below which a seller refuses to sell is called his reservation price. There are several factors, which influence the reserve price of a seller.
1. Durability of the Commodity
The durability of the commodity is the basic factor in influencing the reserve price. The more durable a commodity is, the higher will be its reserve price.
2. Future Price
The reserve price also depends upon the seller’s expectations regarding its future price. If the seller anticipates the price to rise in future, he will fix a higher reserve price and vice versa.
3. Liquidity Preference
Liquidity preference implies the desire to keep ready cash. A strong liquidity preference will induce the seller to clear the stock of goods even at a lower price. On the other hand, if the liquidity preference is weak, the reserve price will be higher.
4. Storage Expenses
The longer the time and greater the cost involved in storing the commodity, the lower will be the reserve price and vice versa.
5. Future Demand
If the seller expects a high demand for the product in future, he will fix a high reserve price and vice versa.
6. Future Cost of Production
If the cost of production of the commodity is expected to fall in future, the seller will fix a lower reserve price.
7. Time for New Supply
The time required for new supplies to reach the market will also have a bearing on the reservation price. If the time gap is longer, a higher reserve price will be fixed.
8. Past Cost
Some obstinate sellers attach too much importance to past costs and refuse to sell at a price below that cost. This tendency on the part of the seller may end in greater loss.
TES is the supply curve, which indicates that the firm will refuse to sell anything below the price OT, and up to the price OP the quantity offered for sale increases with an increase in price. At price OP, the whole stock is offered for sale, but above this price, supply remains the same. From this point E the supply curve becomes a vertical straight line. To put it in other words, even if a higher price is offered by the buyers, the sellers are unable to supply accordingly.
If the demand curve is D1D1, and it intersects the supply curve TES at point E1, the equilibrium price is OP1. The sellers sell OM1 quantity. They withhold M1M quantity. A shift in the demand curve from D1D1 to DD shows an increase in demand, and along with it the new equilibrium price rises from OP1 to OP. the entire stock is sold. If the demand increases from DD to some higher level such as D2D2 the quantity sold remains at OM level. But the price rises to OP2. Thus, the further increase in demand beyond DD will have only the effect of raising the price, and the quantity supplied remains unchanged.
During the market period, on account of the haggling and bargaining of the buyers and the sellers, price is tossed hither and thither like a shuttle-cock according to the relative strength of the two parties.
The Short Period Price Determination
The short period refers to that period in which supply can be adjusted to a limited extent. The short period has been defined by Stigler as “the period in which the rate of production is variable, but in which there exist a fixed plant.”
In the short run, the fixed factors like machinery, plant etc. cannot be altered. Variable factors may be increased or decreased according to the changes in demand. As a result, the short period supply curve will be elastic to some extent. The short period price is determined by the interaction of the forces of short-run demand and supply. It can be shown with the help of the following figure 3.
DD is the initial demand curve and MPSC is the market period supply curve. Both intersect at point E. the market price is OP and the quantity supplied is OM. A shift in demand curve from DD to D1D1 represents an increase in demand. The market price will also rise from OP to OP1. The short period supply curve (SPSC) shows that, in the short period, supply is able to adapt itself somewhat to a limited extent to the changed demand conditions. The new demand curve D1D1 intersects the SPSC at OP2 price. Now the quantity supplied is OM1. The new short-run equilibrium price becomes OP2, which is higher than the initial market price OP, but it is not so high as the second market period price OP1. The short-run supply has also increased from OM to OM1.