Principles of Economics and Management

Chapter: 3 Markets

3.1 Markets; meaning, types of markets & their characteristics (Perfect

Competition, Monopoly, Monopolistic Completion, Oligopoly)
Markets 3.2 National Income; meaning, stock and flow concept, NI at current price,
NI at constant price, GNP, GDP, NNP,NDP, Personal income, disposal
income.

3.1 Introduction of Markets

 Market is a means by which the exchange of goods and services takes place as a
result of buyers and sellers being in contact with one another, either directly or
through intermediating agents or institutions.
 A market is a group of buyers and sellers, where buyers determine the demand and
sellers determine the supply, together with the means whereby they exchange their
goods or a service is called the market.
 For example vegetable market, or cereals market, where buyers come to buy and
sellers come to sell their products.
 In modern business environment, the market is used in a wider context. The market
of the products and services has not remained to a specific place.

3.1.1 Meaning of Market

Prof. R. Chapman has beautifully defined market as under: “The term market refers not
necessarily to a place but always to a commodity and the buyer and sellers who are in
direct competition with one another.”

According to Prof. Benham, “A market means any area over which buyers and sellers
are in such close touch with one another, either directly or through dealers that the
price obtainable in one part of the market on the prices paid on the other parts.”

The world renounced marketing guru Philip Kotler defines market as under: “Market
means a combination of actual and potential users.”

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3.1.2 Types of Markets and their Characteristics

1. Perfect Competition Market

 Perfect competition indicates a state of market with large number of buyers and
sellers and thus the individual buyer or seller is incapable of influencing the price.
 Because of large number of buyers the quantity picked up by individual buyers is
negligible and they are not in a position to dictate their terms with the sellers or
suppliers.
 Also, the quantity commanded by the suppliers is negligible and thus they are
incapable of dictating their terms.
 The efficient market where goods are produced using the most efficient
techniques and the least amount of factors.
 This market is considered to be unrealistic but it is nevertheless of special interest
for imaginary and theoretical reasons.

Characteristics of Perfect Competition Market

 A large number buyers and sellers – A large number of consumers with the
willingness and ability to buy the product at a certain price, and a large number of
producers with the willingness and ability to supply the product at a certain price.
 No barriers of entry and exit – No entry and exit barriers make it extremely easy
to enter or exit a perfectly competitive market.

 Perfect factor mobility – In the long run factors of production are perfectly
mobile, allowing free long term adjustments to changing market conditions.
 Perfect information/knowledge - All consumers and producers are assumed to
have perfect knowledge of price, utility, quality, and production methods of
products.
 Zero transaction costs - Buyers and sellers do not incur costs in making an
exchange of goods in a perfectly competitive market.
 Profit maximization - Firms are assumed to sell where marginal costs meet
marginal revenue, where the most profit is generated.
 Homogeneous products - The products are perfect substitutes for each other. I.e.,
-the qualities and characteristics of a market good or service do not vary between

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different suppliers.
 Non-increasing returns to scale - The lack of increasing returns to scale (or
economies of scale) ensures that there will always be a sufficient number of firms
in the industry.
 Property rights - Well defined property rights determine what may be sold, as
well as what rights are conferred on the buyer.
 Rational buyers - buyers capable of making rational purchases based on
information given.

2. Monopoly Market

 The term monopoly is a combination of two Greek terms, mono means single and
poly means seller. Thus, monopoly refers to a state of market with a single seller or
single supplier.
 It represents the opposite of perfect competition.
 This market is composed of a single seller who will therefore have full power to set
prices. So that they are price maker and not price taker.
 As far as buyers are concerned, there is large number of buyers in a monopoly
market. So buyers are in a weaker bargaining position.

Characteristics of Monopoly Market

 Single seller: In a monopoly, there is one seller of the good that produces all the
output. Therefore, the whole market is being served by a single company, and for
practical purposes, the company is the same as the industry.
 No substitutes: in the monopoly, no close substitute available, so buyers have to buy
that product only.
 High Barriers to entry as suppliers: Other sellers are unable to enter the market of
the monopoly.
 Price Maker: Decides the price of the good or product to be sold, but does so by
determining the quantity in order to demand the price desired by the firm.
 Price Discrimination: happens when a firm charges a different price to different
groups of buyers for an identical good or service. Example: 10% discount for
students.

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 Generation of super normal profit: As supplier is single he will generate more

profit than normal business.

3. Monopolistic Competition/ Imperfect Competition Market

 The perfect competition and the monopoly are the extreme state of market structure
which is unrealistic in real world.
 The monopolistic competition explains the real situation of the modern economic life
of modern business world.
 This market is formed by a high number of firms which produce a similar good that
can be seen as unique due to differentiation that will allow prices to be held up
higher than marginal costs.
 For example medicines, cosmetics, and tooth-paste.
 In other words, each producer will be considered as a monopoly thanks to
differentiation, but the whole market is considered as competitive because the
degree of differentiation is not enough to undermine the possibility of substitution
effects.

Characteristics of Monopolistic Competition Market

 Large number of buyers: There are large numbers of buyers who are demanding
specific products which have close substitutes. They also switch over to other close
substitutes in case of unfavorable market developments.
 Large number of suppliers: there are large numbers of supplier but less than the
perfect competition.
 Product differentiation: The concept of the homogeneous products of perfect
competition is changed to close substitutes with product differentiation and
resultant market segmentation tactics of marketing are restored to by competing
firms.
 Less entry and exit barrier: There are few barriers to entry and exit.
 Huge advertisement budget: in monopolistic competition advertisement is need
much more otherwise close substitute will replace market.
 Price sensitivity: It is highly elastic. So slight change in price will divert the
consumer.

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 Concept of group or chain: Under the monopolistic competition, a mild course of

unification is resorted through group companies or chain shops, franchises etc.

4. Oligopoly Market

 In oligopoly market structure the total market demand is shared among few giant
players. For example two wheeler markets there are Hero, Honda, Bajaj, Mahindra
etc.
 If there are only two players, it is a special case of oligopoly which termed as
Duopoly.
 In the oligopoly each seller enjoys a defined market share in the total demand.
 Where the power of only one player enjoying huge market share, is termed as market
leader.

Characteristics of Oligopoly Market

 Number of firms: "Few" – a "handful" of sellers. There are so few firms that the
actions of one firm can influence the actions of the other firms.
 Interdependence: The distinctive feature of an oligopoly is interdependence.
Oligopolies are typically composed of a few large firms. Each firm is so large that its
actions affect market conditions. Therefore the competing firms will be aware of a
firm's market actions and will respond appropriately. This means that in
contemplating a market action, a firm must take into consideration the possible
reactions of all competing firms and the firm's countermoves.
 Profit maximization conditions: An oligopoly maximizes profits.
 Ability to set price: Oligopolies are price setters rather than price takers.
 Entry and exit: Barriers to entry are high. The most important barriers are
government licenses, economies of scale, patents, access to expensive and complex
technology, and strategic actions by current firms designed to discourage or destroy
emerging firms. Additional sources of barriers to entry often result from government
regulation favoring existing firms making it difficult for new firms to enter the
market.
 Long run profits: Oligopolies can retain long run abnormal profits. High barriers of
entry prevent sideline firms from entering market to capture excess profits.

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 Product differentiation: Product may be homogeneous (steel) or differentiated

(automobiles).
 Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge
of various economic factors can be generally described as selective. Oligopolies have
perfect knowledge of their own cost and demand functions but their inter-firm
information may be incomplete. Buyers have only imperfect knowledge as to price,
cost and product quality.
 Non-Price Competition: Oligopolies tend to compete on terms other than price.
Loyalty schemes, advertisement, and product differentiation are all examples of non-
price competition.

3.2 Meaning of National Income

Some important definition of national income given by different thinkers is as follows:

Alfred Marshall: The labour and capital of country acting on its national resources
produce annually a certain net aggregate of commodities, material and immaterial
including services of all kind. This is the true national income or revenue of the country.

A. C. Pigou: The national dividend is that part of the objective income of the public,
including income received from abroad, which can be measured in money.

C. Rangarajan & Bakul Dholakia: National income is the aggregate income value of the
annual flow of final goods and services in the national economy.

The above definitions make it clear that national income is the monetary measure of –

 The net value of all products and services.

 In an economy during a year.
 Counted without duplication.
 After allowing for depression.
 Both in the public and private sector of products and services.
 In consumption and capital goods sector.
 The net gains from international transactions.

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3.2.1 Stock and Flow Concept of National Income

 There are two basic kinds of quantities.

 A flow is any quantity that must be measured over a period of time.
 Income is a flow.
 A stock is any quantity that is measured at a single instant in time.
 At any point of time the abstract liabilities are always equated with stock of liquid
assets (cash) or illiquid assets (land, buildings, machines, and materials etc.).
 The amount of orange juice I drink in a month is a flow.
 The amount of orange juice I have right now in my refrigerator is a stock.
 The amount of water that passes over Niagara Falls in an hour is a flow.
 The amount of water in all the world's oceans is a stock.
 Income is a flow, whether for an individual, or with all the individuals added up to
get national income.
 Everything that is done with income is also a flow: paying taxes, saving, consuming.
 The entire framework that we are putting together is a system of flows.

Relationship between stock of wealth and flow of income:

1. The stock concept represents the holding of wealth at a particular point of time
which is useable for the generation of the flow of income.
2. The stock of wealth is always presented at a particular point of time.
3. The change in the stock of wealth during the holding period occurs due to following
reasons:
 Generation of flow income will add up as stock of wealth for the next period of
time.
 Depreciation on fixed assets will reduce value of stock of wealth
4. It should be noted that period-end increase in the stock of wealth arise from the
following two sources:
 Periodic recurring operating income.
 One time capital gains between two points of time. Example: price of land is
increased by two lacs.

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3.2.2 National Income at Current Price

 In this method NI is calculated by using current market price for measurement of

factor cost.
 As it is considered current market price it is inclusion of fluctuation (variation) due
to inflation (price rise).

 It is also describe as monetary (financial) income.

 It does not give true picture of economic growth of a country.

 In India national income data compilation is done by Central Statistical Organization

(CSO).
 Year to year growth rate is calculated as follows:

Monetary value at the end of year

Growth Rate at current price in % = × 100
Monetary value at the beginning of year

 Causes of the changes in the NI at current price are:

- Due to inflation.
- Due to real change in the final value of goods and services.

3.2.3 National Income at Constant Price

 In this method NI is calculated by using some base year’s market price for
measurement of factor cost.
 As it is consider base year’s market price it is not affected due to inflation.
 Base year is some past year selected by experts. In India current base year is 2017-
2018. And before this 2011-2012 and before that 2004-2005 was considered as base
year.
 There is a need to change base year for GDP
 It is also describe as real income.
 It gives true picture of economic growth of a country.
 Growth rate in relation to base year is calculated as follows:

Monetary value at the end of year

Growth Rate at constant price in % = × 100
Monetary value at the base year

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 Causes of the changes in the NI at current price are only Due to real change in the
final value of goods and services.

3.2.4 GNP – Gross National Product

Gross national product (GNP) is a broad measure of a nation's total economic activity.
GNP is the value of all finished goods and services produced in a country in one year by
its nationals.

Calculation of GNP

 GNP includes income earned by citizens and companies abroad, but does not include
income earned by foreigners within the country.
 The figures used to assess GNP include the manufacturing of tangible goods (cars,
furniture and agricultural products) and the provision of services (education,
healthcare, and business services).
 GNP does not include the services used to produce manufactured goods because
their value is included in the price of the finished product.
 However, GNP does include depreciation (reduction) and indirect business taxes like
sales tax.

The formula for GNP is:

Gross National Product = Consumption + Government Expenditures + Investments +
Exports + Foreign Production by national Companies – Domestic Production by Foreign
Companies

GNP can be adjusted to make valid comparisons year-to-year or among countries. For
year-to-year comparisons, GNP needs to be adjusted for inflation. For country-to-
country comparisons, GNP needs to be stated on a per capita basis (i.e. GNP divided by
the population of the country).

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3.2.5 GDP – Gross Domestic Product

Gross Domestic Product (GDP) is the broadest quantitative measure of a nation's total
economic activity. More specifically, GDP represents the monetary (financial) value of
all goods and services produced within a nation's geographic borders over a specified
period of time.
Calculation of GDP
The formula for GDP is:

GDP = Consumption + Government Expenditures + Investment + Exports − Imports

 Consumption:
o Durable goods (items expected to last more than three years)

o Nondurable goods (food and clothing)

o Services
 Government Expenditures:
o Defence

o Roads

o Schools
 Investment Spending:
o Nonresidential (spending on plants and equipment), Residential (single-family
and multi-family homes)
o Business inventories
 Net Exports: Exports are added to GDP
 Net Imports: Imports are deducted from GDP

Importance of GDP
 Gross Domestic Product (GDP) is the monetary value of all finished goods and
services made within a country during a specific period.
 GDP provides an economic snapshot of a country, used to estimate the size of an
economy and growth rate.
 GDP can be calculated in three ways, using expenditures, production, or incomes. It
can be adjusted for inflation and population to provide deeper insights.

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 Though it has limitations, GDP is a key tool to guide policymakers, investors, and
businesses in strategic decision
The Basics of GDP:
GDP includes all private and public consumption, government outlays, investments,
additions to private inventories, paid-in construction costs, and the foreign balance of
trade (exports are added, imports are subtracted).

There are several types of GDP measurements:

 Nominal GDP is the measurement of the raw data.

 Real GDP takes into account the impact of inflation and allows comparisons of
economic output from one year to the next and other comparisons over periods of
time.
 GDP growth rate is the increase in GDP from quarter to quarter.
 GDP per capita measures GDP per person in the national populace; it is a useful
way to compare GDP data between various countries.

The balance of trade is one of the key components of a country's (GDP) formula. GDP
increases when the total value of goods and services that domestic producers sell to
foreigners exceeds the total value of foreign goods and services that domestic
consumers buy.

3.2.6 NNP – Net National Product

The Net National Product (NNP) is the monetary value of finished goods and services
produced by a country's citizens, whether overseas or resident, in the time period being
measured (i.e., the gross national product, or GNP) minus the amount of GNP required
to purchase new goods to maintain existing stock (i.e., depreciation).

The formula for NNP is:

NNP = GNP − Depreciation on Gross Capital Investment

 NNP is often examined on an annual basis as a way to measure a nation's success

in continuing minimum production standards.

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 Gross Domestic Product (GDP) is the most popular method to measure national
income and economic prosperity, although NNP is prominently used in
environmental economics.

3.2.7 NDP – Net Domestic Product



The Net Domestic Product (NDP) is an annual measure of the economic output of a
nation that is adjusted to account for depreciation, calculated by subtracting
depreciation from the gross domestic product (GDP).

The formula for NDP is:

NDP = GDP − Depreciation on Gross Capital Investment

Importance of NDP:

 The net domestic product (NDP) is an annual measure of the economic output of a
nation that is adjusted to account for depreciation and is calculated by subtracting
depreciation from the gross domestic product (GDP).
 Net domestic product, along with GDP, gross national income (GNI), disposable
income, and personal income, is one of the key gauges of economic growth that is
reported on a quarterly basis by the bureau of economic analysis (BEA).
 An increase in NDP would indicate growing economic stagnation, while a decrease
would indicate ongoing economic health.

3.2.8 Personal Income

Definition:
Personal income is the gross earnings received by an individual or a household
including all the sources of compensation such as wages, salaries, investments, and
bonuses.

Personal income is used in calculating adjusted gross income (AGI) -- which is

important to individuals for income-tax purposes.

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It is also an essential measure to investors because it serves as an indicator of future

demand for both goods and services in the market. If personal income is high, there
could be more money spent in the economy, indicating a future business boom.

National personal income levels are very closely linked to the Gross Domestic Product
(GDP), and they serve as a key indicator on consumer spending, inflationary pressures,
the overall economy and markets.

3.2.9 Disposal/Disposable Income or Disposable Personal Income

Disposable income, also known as disposable personal income (DPI), is the amount of
money that households have available for spending and saving after income taxes have
been accounted for.

𝐷𝑃𝐼 = 𝑃𝐼 − 𝐼𝑛𝑐𝑜𝑚𝑒 𝑡a𝑥 𝑝𝑎𝑖𝑑

 Disposable income is the net income available to invest, save, or spend after income
taxes.
 Disposable income is calculated by subtracting income taxes from income.

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