In the market represented above in which A, B, and C are the purchasers, let us assume that there are two sellers of the good x, each of whom is attempting to secure for himself as large a share of the business as possible and whose combined costs of production are set forth in the following supply schedule.

The two competing firms D and E can together produce:

2 units of x at a cost per marginal unit of...... $ .60

3 units of x at a cost per marginal unit of.......70

4 units of x at a cost per marginal unit of.......80

5 units of x at a cost per marginal unit of.......90

6 units of x at a cost per marginal unit of............1.00

7 units of x at a cost per marginal unit of............1.10

8 units of x at a cost per marginal unit of............1.20

9 units of x at a cost per marginal unit of...........1.30

From the above table it appears that good x is produced under conditions of increasing costs. While four units of x could be sold at eighty cents each, the cost of producing a fifth unit is ninety cents, and if five units are sold in the same market, the price of the five units must be at least as high as the cost of producing the fifth or marginal unit produced. Again, if a sixth unit is desired, since it can be produced at a cost of one dollar, the market price of each of the six units will be not less than one dollar. It costs one dollar and ten cents to produce the seventh unit and, therefore, if seven units are demanded, the price of each one of the seven units will be at least one dollar and ten cents in spite of the fact that the earlier units were produced at a lower price. If eight units of the good are demanded, the price per unit must be one dollar and twenty cents, so as to cover the cost of producing the eighth unit. Otherwise it will not be produced.

Comparing this supply schedule with the demand schedule given above, we observe that the price of x in this given market will be one dollar per unit, for the reason that if the purchasers attempt to secure it for ninety cents, the producers will be able to furnish only five units at that price, whereas the purchasers desire seven units at ninety cents. Accordingly, they will compete with one another for the five units and drive the price above ninety cents. If the sellers attempt to get one dollar and ten cents per unit, they can sell only five units, since the purchasers desire only five units at that price. But at one dollar and ten cents the producers who are competing with one another in the market will desire to sell seven units. On account of their competition they will drive the price down. At one dollar per unit the purchasers will desire six units of the good. At this price the sellers will be willing to furnish just six units of the good. Therefore, at this point, where supply just meets demand, the price will be fixed. The above illustration is an artificial one in that the cost of production rises so rapidly and so regularly with such small increases in supply. It will serve, nevertheless, to exemplify the principle involved.