MEANING AND DEFINITION OF MARKET

Market generally means a place or a geographical area, where buyers with money and
sellers with their goods meet to exchange goods for money. In Economics market refers to a
group of buyers and sellers who involve in the transaction of commodities and services.

Characteristics of a market:

1. Existence of buyers and sellers of the commodity.

2. The establishment of contact between the buyers and sellers. Distance is of no

consideration if buyers and sellers could contact each other through the available
communication system like telephone, agents, letter correspondence and Internet.

3. Buyers and sellers deal with the same commodity or variety. Since the market in
economics is identified on the basis of the commodity, similarity of the product is very
essential.

4. There should be a price for the commodity bought and sold in the market..

Classification of Markets

Markets classified into three main categories according to Area, time, and competition. Each
category has subdivisions as we will see.

1. Market according to Area

2. Market according to time

3. Market according to competition

Market according to Area

Based on the extent of the market for any product, markets can be classified into local
regional, national and international markets.

Local Market

A local market for a product exists when buyers and sellers of commodity carry on business
in a particular locality or village or area where the demand and supply conditions are
influenced by local conditions only. E.g. Perishable goods like milk and vegetables and bulky
articles like bricks and stones.

National Market
When commodities are demanded and supplied throughout the country, there is national
market e.g. wheat, rice or cotton

Regional Market

Commodities that are demanded and supplied over a region have regional market.

Global Market

When demand and supply conditions are influenced at the global level, we have
international market. e.g. gold, silver, cell phone etc. On the basis of demand and supply,
this geographical classification is made. With improved transport facilities and
communications, even goods of local markets can become international goods.

Market according to time

Marshall classified market based on the time element. In economics “time” does not mean
clock time. It means only the division of time based on extent of adjustability of supply of a
commodity for a given change in its demand. The major divisions are very short period, short
period and long period.

Very Short Period

Very short period refers to the type of competitive market in which the supply of
commodities cannot be changed at all. So in a very short period, the market supply is
perfectly inelastic. The price of the commodity depends on the demand for the product
alone. The perishable commodities like flowers are the best example.

Short-period

Short period refers to that period in which supply can be adjusted to a limited extent by
varying the variable factors alone. The short period supply curve is relatively elastic.

The short period price is determined by the interaction of the short-run supply and demand
curves

Long Period

Long period is the time period during which the supply conditions are fully able to meet the
new demand conditions. In the long run, all (both fixed as well as variable) factors are
variable. Thus the supply curve in the long run is perfectly elastic. Therefore, it is the demand
that influences price in the long period.
Conditions for the equilibrium of a firm

To attain an equilibrium position, a firm must satisfy the following two conditions:

i) They must ensure that the marginal revenue is equal to the marginal cost (MR =
MC).
ii) If MR > MC, the firm has an incentive to expand its production and sell additional
units.

If MR < MC, the firm must reduce the output since additional units add more cost than
revenue.

The firm gets maximum profits only when MR = MC

Market according to competition

These markets are classified according to the number of sellers in the market and the nature
of the commodity. The classification of market according to competition is as follows
Perfect Competition.

Perfect competition is a market situation where there are infinite numbers of sellers that no
one is big enough to have any appreciable influence over market price. The price is
determined by the market forces as shown below.

Features and Conditions of perfect competition

1.Large number of buyers and sellers: There are a large number of buyers and sellers in a
perfect competitive market that neither a single buyer nor a single seller can influence the
price. The price is determined by market forces namely the demand for and the supply of the
product. There will be uniform price in the market. Sellers accept this price and adjust the
quantity produced to maximize their profit. Thus the sellers in the perfect competitive
market are price- takers and quantity adjusters.

2. Homogeneous Product: The products produced by all the firms in the perfectly
competitive market must be homogeneous and identical in all respects i.e. the products in
the market are the same in quantity, size, taste, etc. The products of different firms are
perfect substitutes and the cross elasticity is infinite.

3. Perfect knowledge about market conditions: Both buyers and sellers are fully aware of the
current price in the market. Therefore the buyer will not offer high price and the sellers will
not accept a price less than the one prevailing in the market.

4. Free entry and Free exit: There must be complete freedom for the entry of new firms or
the exit of the existing firms from the industry. When the existing firms are earning super-
normal profits, new firms enter into the market. When there is loss in the industry, some
firms leave the industry. The free entry and free exit are possible only in the long run. That is
because the size of the plant cannot be changed in the short run.

5. Perfect mobility of factors of production: The factors of productions should be free to

move from one use to another or from one industry to another easily to get better
remuneration. The assumption of perfect mobility of factors is essential to fulfill the first
condition namely large number of producers in the market.

6. Absence of transport cost: In a perfectly competitive market, it is assumed that there are
no transport costs. Under perfect competition, a commodity is sold at uniform price
throughout the market. If transport cost is incurred, the firms nearer to the market will
charge a low price than the firms far away. Hence it is assumed that there is no transport
cost.

7. Absence of Government or artificial restrictions or collusions: There are no government

controls or restrictions on supply, pricing etc. There is also no collusion among buyers or
sellers. The price in the perfectly competitive market is free to change in response to
changes in demand and supply conditions.

Nature of Revenue curves

Under perfect competition, the market price is determined by the market forces namely the
demand for and the supply of the products. Hence there is uniform price in the market and
all the units of the output are sold at the same price. As a result the average revenue is
perfectly elastic. The average revenue curve is horizontally parallel to X-axis. Since the
Average Revenue is constant, Marginal Revenue is also constant and coincides with Average
Revenue. AR curve of a firm represents the demand curve for the product produced by that
firm.

Short run equilibrium price and output determination under perfect competition

1. Since a firm in the perfectly competitive market is a price-taker, it has to adjust its level of
output to maximize its profit. The aim of any producer is to maximize his profit.

2. The short run is a period in which the number and plant size of the firms are fixed. In this
period, the firm can produce more only by increasing the variable inputs.

3. As the entry of new firms or exits of the existing firms are not possible in the shortrun, the
firm in the perfectly competitive market can either earn super-normal profit or normal profit
or incur loss in the short period.

Super-normal Profit
When the average revenue of the firm is greater than its average cost, the firm is earning
super-normal profit.

Short-run equilibrium with super-normal profits

In figure below, output is measured along the x-axis and price, revenue and cost along the
y-axis. OP is the prevailing price in the market. PL Line is the demand curve or average and
the marginal revenue curve. SAC and SMC are the short run average and marginal cost
curves. The firm is in equilibrium at point (E) where MR = MC and MC curve cuts MR curve
from below at the point of equilibrium. Therefore the firm will be producing OM level of
output. At the OM level of output ME is the AR and MF is the average cost. The profit per
unit of output is EF (the difference between ME and MF). The total profits earned by the
firm will be equal to EF (profit per unit) multiplied by OM or HF (total output). Thus the total
profits will be equal to the area HFEP. HFEP is the supernormal profits earned by the firm.

Long run equilibrium, price and output determination

In the long run, all factors are variable. The firms can increase their output by increasing the
number and plant size of the firms. Moreover, new firms can enter the industry and the
existing firms can leave the industry. As a result, all the existing firms will earn only normal
profit in the long run. If the existing firms earn supernormal profit, the new firms will enter
the industry to compete with the existing firms. As a result, the output produced will
increase. When the total output increases, the demand for factors of production will
increase leading to increase in prices of the factors. This will result in increase in average
cost.

On the other side, when the output produced increases, the supply of the product increases.
The demand remaining the same, when the supply of the product increases, the price of the
product comes down. Hence the average revenue will come down. A fall in average revenue
and the rise in average cost will continue till both become equal. (AR = AC). Thus, all the
perfectly competitive firms will earn normal profit in the long run.

Figure below represents long run equilibrium of firm under perfect competition. The firm is
in equilibrium at point S where LMC = MR = AR = LAC. The long run equilibrium output is ON.
The firm is earning just the normal profit. The equilibrium price is OP. If the price rises above
OP, the firm will earn abnormal profit, which will attract new firms into the industry. If the
price is less than OP, there will be loss and the tendency will be to exit. So in the long run
equilibrium, OP will be the price and marginal cost will be equal to average cost and average
revenue. Thus the firm in the long run will earn only normal profit.

Competitive firms are in equilibrium at the minimum point of LAC curve. Operating at the
minimum point of LAC curve signifies that the firm is of optimum size i.e. producing output
at the lowest possible average cost
Advantages of perfect competition

1. There is consumer sovereignty in a perfect competitive market. The consumer is rational

and he has perfect knowledge about the market conditions. Therefore, he will not purchase
the products at a higher price.

2. In the perfectly competitive market, the price is equal to the minimum average cost. It is
beneficial to the consumer.

3. The perfectly competitive firms are price-takers and the products are homogeneous.
Therefore it is not necessary for the producers to incur expenditure on advertisement to
promote sales. This reduces the wastage of resources.

4. In the long run, the perfectly competitive firm is functioning at the optimum level. This
means that maximum economic efficiency in production is achieved. As the actual output
produced by the firm is equal to the optimum output, there is no idle or unused or excess
capacity.

Monopoly

Monopoly is a market structure in which there is a single seller, there are no close
substitutes for the commodity it produces and there are barriers to entry.

Characteristics of Monopoly

1. Single Seller: There is only one seller; he can control either price or supply of his product.
But he cannot control demand for the product, as there are many buyers.

2. No close Substitutes: There are no close substitutes for the product produced by
monopoly. The buyers have no alternatives or choice. Either they have to buy the product or
go without it.

3. Price: The monopolist has control over the supply so as to increase the price. Sometimes
he may adopt price discrimination. He may fix different prices for different sets of
consumers. A monopolist can either fix the price or quantity of output; but he cannot do
both, at the same time.

4. No Entry: There is no freedom to other producers to enter the market as the monopolist is
enjoying monopoly power. There are strong barriers for new firms to enter. There are legal,
technological, economic and natural obstacles, which may block the entry of new producers.
5. Firm and Industry: Under monopoly, there is no difference between a firm and an
industry. As there is only one firm, that single firm constitutes the whole industry.
Sources / Causes for Monopoly

1. Natural: A monopoly may arise on account of some natural causes. Some minerals are
available only in certain regions. For example, South Africa has the monopoly of diamonds;
nickel in the world is mostly available in Canada and oil in Middle East. This is natural
monopoly.

2. Technical: Monopoly power may be enjoyed due to technical reasons. A firm may have
control over raw materials, technical knowledge, special know-how, scientific secrets and
formula that enable a monopolist to produce a commodity. e.g., Coco Cola.

3. Legal: Monopoly power is achieved through patent rights, copyright and trade marks by
the producers. This is called legal monopoly.

4. Large Amount of Capital: The manufacture of some goods requires a large amount of
capital or lumpiness of capital. All firms cannot enter the field because they cannot afford to
invest such a large amount of capital. This may give rise to monopoly. For example, iron and
steel industry, railways, etc.

5. State: Government will have the sole right of producing and selling some goods. They are
State monopolies. For example, we have public utilities like electricity and railways. These
public utilities are undertaken by the State.

Price and Output Determination

A monopolist like a perfectly competitive firm tries to maximize his profits. A monopoly firm
faces a downward sloping demand curve, that is, its average revenue curve. The downward
sloping demand curve implies that larger output can be sold only by reducing the price. Its
marginal revenue curve will be below the average revenue curve. The average cost curve is
‘U„ shaped. The monopolist will be in equilibrium when MC = MR and the MC curve cuts the
MR curve from below.

In figure below, AR is the Average Revenue Curve and MR is the Marginal revenue curve. AR
curve is falling and MR curve lies below AR. The monopolist is in equilibrium at E where MR =
MC. He produces OM units of output and fixes price at OP. At OM output, the average
revenue is MS and average cost MT. Therefore the profit per unit is MS-MT = TS. Total profit
is average profit (TS) multiplied by output (OM), which is equal to HTSP. The monopolist is in
equilibrium at point E and produces OM output at which he is earning maximum profit. The
monopoly price is higher than the marginal revenue and marginal cost.
Advantages

1. Monopoly firms have large-scale production possibilities and also can enjoy both internal
and external economies. This will result in the reduction of costs of production. Output can
be sold at low prices. This is beneficial to the consumers.

2. Monopoly firms have vast financial resources which could be used for research and
development. This will enable the firms to innovate quickly.

3. There are a number of weak firms in an industry. These firms can combine together in the
form of monopoly to meet competition. In such a case, market can be expanded. Although
there are some advantages, there is a danger that monopoly power might be misused for
exploiting the consumers.
Disadvantages

1. A monopolist always charges a high price, which is higher than the competitive price. Thus
a monopolist exploits the consumers.

2. A monopolist is interested in getting maximum profit. He may restrict the output and raise
prices. Thus, he creates artificial scarcity for his product.

3. A monopolist often charges different prices for the same product from different
consumers. He extracts maximum price according to the ability to pay of different
consumers.

4. A monopolist uses large-scale production and huge resources to promote his own selfish
interest. He may adopt wrong practices to establish absolute monopoly power.

5. In a country dominated by monopolies, wealth is concentrated in the hands of a few. It

will lead to inequality of incomes. This is against the principle of the socialistic pattern of
society.

Methods of Controlling Monopoly

1. Legislative Method: Government can control monopolies by legal actions. Antimonopoly

legislation has been enacted to check the growth of monopoly. In India, the Monopolies and
Restrictive Trade Practices Act was passed in 1969. The objective of this Act is to prevent the
unwanted growth of private monopolies and concentration of economic power in the hands
of a small number of individuals and families.

2. Controlling Price and Output: This method can be applied in the case of natural
monopolies. Government would fix either price or output or both.

3. Taxation: Taxation is another method by which the monopolistic power can be prevented
or restricted. Government can impose a lump-sum tax on a monopoly firm, irrespective of its
level of output. Consequently, its total profit will fall.

4. Nationalization: Nationalizing big companies is one of the solutions. Government may

take over such monopolistic companies, which are exploiting the consumers.

5. Consumer’s Association: The growth of monopoly power can also be controlled by

encouraging the formation of consumers associations to improve the bargaining power of
consumers
Comparison between Perfect Competition and Monopoly

The main aim of firms both under monopoly and perfect competition is to maximize profit.
In both the market forms, the firms are in equilibrium at the output level where MC = MR.
The differences are as follows:
Price discrimination in monopoly:

Price discrimination is the practice of charging different prices from different consumers for
the same good or service at the same time.

The other words for price discrimination are ‘selective pricing’ or ‘pricing by market
segmentation’ or ‘charging what the traffic will bear’.

Price discrimination may be (a) personal, (b) local, or (c) according to trade or use:

(a) Personal: It is personal when different prices are charged for different persons.

(b) Local: It is local when the price varies according to locality.

(c) According to Trade or Use: It is according to trade or use when different prices are
charged for different uses to which the commodity is put, for example, electricity is supplied
at cheaper rates for domestic than for commercial purposes. Some monopolists used
product differentiation for price discrimination by means of special labels, wrappers,
packing, etc. For example, the perfume manufacturers discriminate prices of the same
fragrance by packing it with different labels or brands.

Conditions of Price-Discrimination

There are three main types of situation:

(a) When consumers have certain preferences or prejudices. Certain consumers usually have
the irrational feeling that they are paying higher prices for a good because it is of a better
quality, although actually it may be of the same quality. Sometimes, the price differences
may be so small that consumers do not consider it worthwhile to bother about such
differences.

(b) When the nature of the good is such as makes it possible for the monopolist to charge
different prices. This happens particularly when the good in question is a direct service.

(c) When consumers are separated by distance or tariff barriers. Similarly, the monopolist
can charge higher prices in a city with greater distance or a country levying heavy import
duty.

Conditions making Price Discrimination Possible and Profitable:

The following conditions are essential to make price discrimination possible and profitable:

(a) The elasticities of demand in different markets must be different. The market is divided
into sub-markets. The sub-market will be arranged in ascending order of their elasticities, the
higher price being charged in the least elastic market and vice versa. If coefficient of price
elasticity of demand is same in all markets, then price discrimination cannot be
implemented.

(b) The costs incurred in dividing the market into sub-markets and keeping them separate
should not be so large as to neutralize the difference in demand elasticities.

(c) There should be complete agreement among the sellers otherwise the competitors will
gain by selling in the dear market.

(d) There should be no contact among buyers. The purchaser cannot know what is being
charged from others

The effects of price discrimination are:

1. The discriminating monopolist is able to extract a large part of consumer surplus.

2. The discriminating monopolist’s total revenue and total profit will be more.

3. Output sold in the market will increase.

Price discrimination is not desirable because

1. Problem of economic allocation of resources.

Price discrimination leads to destruction of competition from rival firms and strengthening
of its own power and hence, inefficient and uneconomic allocation of resources.

2. Maldistribution of goods between consumers.

Price discrimination causes discontent and dissatisfaction among those rich consumers who
have to pay higher prices and those poor consumers who have to do without the good
because they do not have the required money to buy it.

3. Dumping In case of dumping, higher price is charged in the home market and a lower price
in the world market

Good Effects of Price Discrimination

Price discrimination is desirable on the following grounds:

1. It promotes equity When price is raised for the rich section of the society and lowered for
the poor section, it has a redistributive effect. It reduces the inequalities of income. The poor
people can have access to certain essential goods and services, like those of a doctor.
2. It makes production feasible Certain commodities can be profitably produced only under
discriminating monopoly. Price discrimination helps to produce those goods which pure
monopolist will not produce.

Monopolistic Competition

Monopolistic competition, as the name itself implies, is a blending of monopoly and

competition. Monopolistic competition refers to the market situation in which a large
number of sellers produce goods which are close substitutes of one another. The products
are similar but not identical. The particular brand of product will have a group of loyal
consumers. In this respect, each firm will have some monopoly and at the same time the
firm has to compete in the market with the other firms as they produce a fair substitute. The
essential features of monopolistic competition are product differentiation and existence of
many sellers.

Characteristics of Monopolistic Competition

i)Existence of Large Number of firms:

Under monopolistic competition, the number of firms producing a commodity will be very
large. The term ‘very large„ denotes that contribution of each firm towards the total
demand of the product is small. Each firmwill act independently on the basis of product
differentiation and each firm determines its price-output policies. Any action of the
individual firm in increasing or decreasing the output will have little or no effect on other
firms.

(ii) Product differentiation:

Product differentiation is the essence of monopolistic competition. Product differentiation

is the process of altering goods that serve the same purpose so that they differ in minor
ways. Product differentiation can be brought about in various ways. Product differentiation
is attempted through

(a) Physical difference;

(b) Quality difference;

(c) Imaginary difference

(d) Purchase benefit difference.

It may be by using different quality of the raw material and different chemicals and mixtures
used in the product. Difference in workmanship, durability and strength will also make
product differentiation. Product differentiation may also be effected by offering customers
some benefits with the sale of the product. Facilities like free servicing, home delivery,
acceptance of returned goods, etc. would make the customers demand that particular
brand of product when such facilities are available. Product differentiation through
effective advertisement is another method. This is known as sales promotion.

By frequently advertising the brand of the product through press, film, radio, and TV, the
consumers are made to feel that the brand produced by the firm in question is superior to
that of other brands sold by other firms.

(iii) Selling Costs: From the discussion of ‘product differentiation„, we can infer that the
producer under monopolistic competition has to incur expenses to popularize his brand.
This expenditure involved in selling the product is called selling cost. According to Prof.
Chamberlin, selling cost is “the cost incurred in order to alter the position or shape of the
demand curve for a product”. Most important form of selling cost is advertisement. Sales
promotion by advertisement is called non-price competition.

(iv) Freedom of entry and exit of firms: Another important feature is the freedom of any
firm to enter into the field and produce the commodity under its own brand name and any
firm can go out of the field if so chosen. There are no barriers as in the case of monopoly
Monopolistic competition presupposes that customers have definite preferences for
particular varieties or brand of products. Hence pricing is not the problem but product
differentiation is the problem and competition is not on prices but on products. Thus in
monopolistic competition, the features of monopoly and perfect competition are partially
present.

Determination of Equilibrium price and output under monopolistic competition

The monopolistic competitive firm will come to equilibrium on the principle of equalizing
MR with MC. Each firm will choose that price and output where it will be maximizing its
profit. Figure below shows the equilibrium of the individual firm in the short period.
MC and AC are the short period marginal cost and average cost curves. The sloping down
average revenue and marginal revenue curves are shown as AR and MR. The equilibrium
point is E where MR = MC. The equilibrium output is OM and the price of the product is fixed
at OP. The difference between average cost and average revenue is SQ. The output is OM.
So, the supernormal profit for the firm is shown by the rectangle PQSR. The firm by
producing OM units of its commodity and selling it at a price of OP per unit realizes the
maximum profit in the short run.

The different firms in monopolistic competition may be making either abnormal profits or
losses in the short period depending on their costs and revenue curves. In the long run, if
the existing firms earn super normal profit, the entry of new firms will reduce its share in
the market. The average revenue of the product will come down. The demand for factors of
production will increase the cost of production. Hence, the size of the profit will be
reduced. If the existing firms incur losses in the long-run, some of the firms will leave the
industry increasing the share of the existing firms in the market. As the demand for factors
becomes less, the price of factors will come down. This will reduce the cost of production,
which will increase the profit earned by the existing firm. Thus under monopolistic
competition, all the existing firms will earn normal profit in the long run.

Wastages of Monopolistic competition

1. Unemployment: Under monopolistic competition, the firms produce less than optimum
output. As a result, the productive capacity is not used to the fullest extent. This will lead to
unemployment of resources.

2. Excess capacity: Excess capacity is the difference between the optimum output that can
be produced and the actual output produced by the firm. In the long run, a monopolistic
firm produces an output which is less than the optimum output that is the output
corresponding to the minimum average cost. This leads to excess capacity which is
regarded as waste in monopolistic competition.

3. Advertisement: There is a lot of waste in competitive advertisements under monopolistic

competition. The wasteful and competitive advertisements lead to high cost to consumers.
4. Too Many Varieties of Goods: Introducing too many varieties of a good is another waste
of monopolistic competition. The goods differ in size, shape, style and colour. A reasonable
number of varieties would be desirable. Cost per unit can be reduced if only a few are
produced.

5. Inefficient Firms: Under monopolistic competition, inefficient firms charge prices higher
than their marginal cost. Such type of inefficient firms should be kept out of the industry.
But, the buyers„ preference for such products enables the inefficient firms to continue to
exist. Efficient firms cannot drive out the inefficient firms because the former may not be
able to attract the customers of the latter.

Monopolistic Competition vs. Monopoly

OLIGOPOLY

Oligopoly is a market situation in which an industry has only a few firms (or few large firms
producing most of its output) mutually dependent for taking decisions about price and
output.

Oligopolistic industries can be classified into various ways. Some are following:

1. Perfect or Imperfect Oligopoly

If in an oligopoly market, the firms produce homogeneous products, it is called perfect

oligopoly. If the firms produce differentiated products, it is called imperfect oligopoly.

2. Non-collusive or Collusive Oligopoly

If in an oligopoly market, the firms compete with each other, it is called a non-collusive or
non-cooperative oligopoly. If the firms cooperate with each other in determining price or
output or both, it is called collusive oligopoly, or cooperative oligopoly.

3. Duopoly

When there are only two firms producing a product, it is called duopoly. It is a special case
of oligopoly

Characteristics of Oligopoly

Features of Oligopoly

The major features of oligopoly are:

(a)Few Dominant Firms. Oligopolists are often large firms, each producing a significant
portion of total market output. There are only a few rival firms. Each big firm has
contributed a large proportion into total market supply of the product. Therefore, it can
influence the price of the product by its own action and that he can provoke rival firms to
react.

(b)Mutual Interdependence. Since the market is dominated by a few firms, the price and
output decisions of one firm affects the profitability of the remaining firms in the market.
Mutual interdependence is an incentive to develop alternatives to price competition in
pursuit of economic profit. Each firm carefully considers and watches how its actions will
affect its rivals and how its rivals are likely to react. This makes firms mutually
interdependent on each other.
(c) Barriers to Entry. Barriers to entry limits the threat of competition and facilitates the
ability of firms to earn long-run economic profits.

(d)Homogeneous or Differentiated Products. The output of an oligopolistic market may be

either homogeneous or differentiated.

(e) Demand Curve. In an oligopoly, due to high degree of interdependency amongst

oligopolistic firms, that we cannot define the demand curve faced by an oligopolist. Hence,
the solution is indeterminate.

(f)Price Rigidity. In oligopolistic firms, prices are administered. Rival firm takes time to react
to the changed price, due to which the price remains rigid in this market.

(g) Non-price competition. Firms try to avoid price competition for the fear of price war.
They use other methods like advertising, better services to customers, etc. to compete with
each other.
Summary of Comparison of the four markets