Market Price Determination

Market prices in competitive industries are determined by aggregate supply and demand; individual firms have no control over price. Total industry demand reflects an aggregation of the quantities that individual firms will buy at each price. Industry supply reflects a summation of the quantities that individual firms are willing to supply at different prices. The intersection of industry demand and supply curves determines market price.

Data in Table 10.1 illustrate the process by which an industry supply curve is constructed. First, suppose that each of five firms in an industry is willing to supply varying quantities at different prices. Summing the individual supply quantities of these five firms at each price determines their combined supply schedule, shown in the Partial Market Supply column. For example, at a price of $2, the output supplied by the five firms are 15, 0, 5, 25, and 45 (thousand) units, respectively, resulting in a combined supply of 90 (000) units at that price. With a product price of $8, supply quantities become 45, 115, 40, 55, and 75, for a total supply by the five firms of 330 (000) units.

Now assume that there are actually 5,000 firms in the industry, each with an individual supply schedule identical to one of the five firms illustrated in the table. There are 1,000 firms just like each one illustrated in Table 10.1; the total quantity supplied at each price is 1,000 times that shown under the Partial Market Supply schedule. This supply schedule is illustrated in Figure 10.1. Adding the market demand curve to the industry supply curve, as in Figure 10.2, allows one to determine the equilibrium market price.

Market price is found by equating market supply and market demand to find the equilibrium price/output level. Using the curves illustrated in Figure 10.2, we have

Demand = Supply

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