Explain how price is determined in a perfectly competitive market with fixed number of firms.

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Solution

In a perfectly competitive market, equilibrium price is determined by the forces of market demand and market supply. Market demand refers to the sum total of demand for a commodity by all the buyers in the market. Whereas market supply refers to the sum total of supply of a commodity by all the firms in the market. Considering market demand schedule (or market demand curve) on the one hand, and market supply schedule (or market supply curve) on the other, we identify equilibrium price as the one where market demand = market supply, or where market demand curve and market supply curve intersect each other.

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