Price Determination under Perfect Competition

Perfect competition refers to a market where large number of buyers and sellers compete among themselves for a homogeneous product. In such a market a single price prevails. Price is determined by the market forces of demand and supply. An individual seller or buyer cannot influence the market price either by selling or buying more. This is because an individual’s contribution to the total output is just like a drop in the ocean. An individual seller is a price taker not a price maker.

There has been a long debate among the economists as to how price is determined in such an ideal market like perfect competition. The Classical led by John Stuart Mill are of the opinion that the cost of production or ‘supply’ of a commodity determines its price. On the other hand Utilitarians led by William Stanley Jevons are of the opinion that the marginal utility underlying a particular commodity, determines its demand and ‘demand’ determines the price. The debate went on for a long time till the arrival of Marshall. Marshall brought a synthesis between two conflicting schools of thought. According to Marshall, neither demand nor supply taken alone can determine price. He compared demand and supply with a pair of scissors. As a piece of paper can he cut with the help of both the blades, similarly under perfect competition, both demand and supply determine the price. Whether supply or demand will be more active depends on the time period under consideration.