Market
7.1 Market
Ordinarily ‘market’ means a
specified place where buyers and sellers meet each other to buy and sell
commodities. In economics, it denotes the entire area were buyers and sellers
of commodities are in such a close contact with each other, that the price of a
commodity tend to be uniform throughout the area, and price in one area affects
the price is another area.
The market for a product
may be local (e.g. bricks), national (e.g. sugar) or international (e.g. gold).
7.2 Market Forms
Depending on competitive
situation, there are different types of market forms of market as follows:
-
Pure competition
-
Perfect competition
-
Imperfect competition
-
Monopolistic competition
-
Monopoly competition
-
Duopoly competition
-
Oligopoly competition
7.2.1 Pure Competition
It exists where there are
many sellers (that one cannot influence the market), items are similar and
there is free entry and exit. It is wider than pure competition.
7.2.2 Perfect Competition
(i)
The Perfect Competition is a form of market situation in which there is
a large number of buyers and sellers, free entry of all the firms in the market
of product. Moreover, both the buyers and sellers have perfect knowledge about
the market situation.
(ii)
There is perfect mobility of commodities, transport
cost is negligible, and there is close communication between buyer and seller.
(iii)
In case of perfect competition, there are large number of firms.
Naturally any individual firm cannot influence the market price of commodity.
Firm has to accept the price available in the market. So, under perfect
competition firms are price taker.
(iv) In short run under perfect
competition, firm can earn abnormal profit, normal profit, or a loss.
(v)
Under perfect competition as firm is price taker, marginal revenue per
unit is fixed for the firm because price is fixed. So, marginal revenue curve
under perfect competition is straight line.
(vi) A perfectly competitive
firm in the short run, can earn normal profit, incur loss & earn supernormal
profit.
(vii)
In perfect competition market situation demand curve is linear and
parallel to X axis
(viii) MR Curve = AR = Demand
Curve is a feature of Perfect Competition
market
(ix)
In perfect competition the firms earn normal profits in long run (not
the supernormal profits as the entry of outside firms are free).
(x)
If average revenue (AR) is more than average cost (AC), the firm earns
super normal profit.
Features of Perfectly
Competitive Market
(i)
Large number of buyers & sellers.
(ii)
Product is homogeneous in nature.
(iii)
Firm is a price taker.
(iv)
Free entry & exit.
(v)
Knowledgable buyers & sellers
(vi)
Perfect mobility of factors.
(vii)
Absence of transport & selling cost.
7.2.3 Monopolistic Competition
This is a situation
intermediate between Pure Competition and Pure Monopoly. Monopolistic
Competition exists when there is a large group of firms producing commodities
similar to one another but not identical.
Monopolistic competition is
variety of imperfect competition and conceptually it is nearer to the Perfect
competition, than the other varieties of imperfect competition.
Under Monopolistic
competition, the cross elasticity of demand for the product of a single firm would be zero
7.2.4 Pure Monopoly
Pure Monopoly exists if
there is only one seller with closed entry, producing goods for which there is
no ideal substitute. It implies complete control over supply and leads to super
profits.
7.2.5 Duopoly
Duopoly means control over
supply by two firms. Duopoly is generally regarded as a special case of
oligopoly.
7.2.6 Oligopoly
Oligopoly
exists where
only a few firms control the supply. In an Oligopoly situation, each firm has
to consider carefully the price and output policies of the other firms (rivals)
and plan its price and output policies accordingly.
OPEC is a organisation of a
few petroleum selling countries. It is an example of oligopoly
7.2.7 Monopsony
Monopsony is monopoly of
buyer. It exists when there are many sellers but only one buyer. Monopsony is rarely
found.
7.2.8 Duopsony
Duopsony is a situation where there
are only two buyers but many sellers. Where there are only a few buyers but
many sellers, it is referred as Oligopoly.
7.2.9 Bilateral Monopoly
It is a situation where
there is only one seller and only one buyer (e.g. in labour market). The
workers in an industry may be members of a single Trade Union, which fixes the
terms under which labour is supplied. There may, on the other side, be a single
employer, or all the employers may be organized in a single association, which fixes
the terms under which labour is employed. Wages (the price of labour) is,
determined by negotiation between the two monopolists (employer’s Association
and the Trade Union) through Collective Bargaining.
7.2.10 Unilateral monopoly
Unilateral monopoly market
is characterized by single buyer.
7.3 Equilibrium
of Firm under Perfect competition
(i) Short Run: Under perfect competition, the marginal revenue is equal to price. The
individual firm, under perfect competition, maximizes its net revenue by fixing
output at the point where the marginal cost is equal to the price. So the
formula mr = (marginal revenue) mc becomes p = mc. If the marginal cost is less
than the price, the firm gains by expanding output. If the marginal cost is
higher than the price, the firm incurs losses and must reduce its marginal cost
by reducing output. If it cannot do so, it must abandon production.
Under perfect competition, the individual firm cannot influence the
price. It takes the average revenue curve adjusting its output, according to
its marginal cost curve.
(ii)
Long Run: In the long run, the total revenue of the firm must equal its total cost
of production (“total cost” includes normal profits).
If the total revenue is
greater than the total cost, the firm is making excess profits. In such
situation, new firms will be attracted into the industry, the total output of
the industry will increase and the price will fall, excess profit is wiped away.
If the total revenue is
less than the total cost, the process will be reversed. Some firms, will exit
causing reduction in the total output, causing rise of prices. Finally at
equilibrium, the total revenue must equal total cost.
Under perfect competition, a firm attains
equilibrium in long run when price = Minimum average cost of production.
Distinction
between Pure and Perfect competition
|
Pure Competition
|
Perfect competition
|
|
Strict restrictions are
imposed on the entry or exit of firms
|
No restrictions are
imposed on the entry or exit of firms
|
|
Super profit is obtained
due to the difference between price and marginal cost
|
The firm earns a normal
profit in the long run.
|
|
Price is more than
average cost
|
Price is equal to
marginal cost at an equilibrium output.
|
|
Equilibrium can be achieved
whether marginal cost rises remains constant or falls
|
Equilibrium can be achieved
only when marginal cost is equal to marginal revenue (MC=MR).
|
7.4 Imperfect Competition
Imperfect
competition implies a market situation where one or more of the conditions of
perfect competition is not satisfied. Market is said to be imperfect, when some
of the buyers or sellers or both are not fully aware of the prices in the
market. Thus, imperfect competition is a broad term, which includes duopoly,
oligopoly and monopolistic competitive markets.
Under imperfect
competition, a firm maximize its profit when MR = MC.
Features
of Imperfect Competition
(i) There exist large number of
buyers and large number of small producers-cum-sellers in the market. The
sellers have no feeling of mutual interdependence among them.
(ii) Products are not identical
but close substitutes.
(iii) Unrestricted entry of new
firms in the market.
(iv) Each firm is a small monopolist
in its area of production of a particular substitute product.
(v) Each firm has its own
selling cost, particularly advertising in local area create monopoly situation its
substitute product in the market.
(vi) The
buyers have imperfect knowledge about market, which creates segmentation of
total market in which individual firms have monopolistic conditions.
7.6 Monopolistic Competition
The theory of monopolistic
competition is developed by H.E. Chamberlin.
Monopolistic
competition is a market situation where there are many producers, but each
offers a slightly differentiated product. Monopolistic market is dominated by a few. So,
firms can influence price determination. So, under monopolistic competition market firm can
be considered as price maker. They are not takers/givers/acceptors of price.
a.Characteristics of Monopolistic competition
i. Entry and exit: The firms has total freedom
to enter or exit the industry. No limitation are imposed on them.
ii. Large Number of buyers and
sellers:
There are large numbers of firms. The sellers are more than that of oligopoly,
but less than that of perfect competition market.
iii. Profit motive: Firm earns a surplus
profit due to selling price and product differentiation. Firms earn profit
through price discrimination.
iv. Nature
of product: Product of each seller differ from each other.
b.Equilibrium of Firm under
Monopolistic Competition and Oligopoly
i)
The individual firm under monopolistic competition and oligopoly face a
downward sloping average revenue curve, and the marginal revenue is always less
than the average revenue.
ii) The products of the
different firms in the group are not perfectly substitute of another. They differ
in quality, trade name, brand reputation, or just location.
iii) A firm wishing to increase
its sales, must either reduce the price or shift the demand curve by some form
of sales initiative (advertisement, special service or, even bribery or
coercion). If shifting the demand curve (or increasing consumers’ preference
for the product) is not practicable, price reduction is the ultimate recourse.
Under monopolistic
competition, the firm earn normal profits in the long run a because LAR = LAC,
as there is excess capacity with them.
c.Marginal Cost & marginal Revenue: Reduction of price reduces
the marginal revenue. However, as long as the marginal revenue is greater than
the marginal cost, it is profitable to expand production. The total revenue is
maximum at the level of output where the marginal revenue is equal to the
marginal cost. At this
point, there is no difference between a firm under monopolistic competition and
firms under any kind of imperfect competition or under perfect competition, as
every firm tries to maximize its net revenue.
Selling Expenses: But in monopolistic competition and oligopoly, price reduction is not
the only method of increasing sales. Advertisement, propaganda and salesmanship
play an important part and forms a substantial part of the total expenditure of
the firm. Under monopolistic competition, therefore, the net revenue, which the
firm seeks to maximize, is :
[Price x Output]
–[Production Costs + Selling Costs]
The
firm will extend its selling expenditure up to the point at which the marginal
revenue from the sales expenditure is equal to the marginal increment of such
expenditure. Taking production costs and selling costs together, the marginal
cost must also be equal to the marginal revenue.
7.7 Monopoly
If
in the market, there is one single seller of a product and there is no
competition at all, the situation will be of pure or perfect or absolute
monopoly. In monopoly, there is only one single seller or producer of the
commodity which has no close substitute.
a.Characteristics of Monopoly
-
Monopoly firm has a dominating power to price determination. To check
price increase, government impose restrictions on monopoly. Price fixation save
consumers from increase of price to unwanted level.
-
Monopoly market is dominated by single seller. So, under long run,
monopoly can earn abnormal profit.
-
At the time of price fixation, monopoly firm consider marginal cost of
production as well as price elasticity of demand.
-
By setting a lower price than any new entrant, a monopolist try to
increase its production to large scale and he can drive the new entrant out of
business. Large scale provides economics of scale by reducing production cost.
b.Types of Monopoly
i. Absolute Monopoly: It is a market situation where there is one seller of a product, having
no substitute.
ii. Relative Monopoly: It is a market situation where single firm constitutes the whole
industry. The firm and industry become synonymous.
c.Features of Monopoly
(i)
‘Mono’ means single, ‘poly’ means seller i.e., single seller with large
number of buyers.
(ii)
No close substitutes.
(iii)
Firm is price maker.
(iv)
Restrictions to entry.
(v)
Firm itself is an industry.
(vi) Sole objective is to
maximize profit.
(vii) Monopoly competition has
opposite characteristics to the characteristics of perfect competition.
d.Demerits of Monopoly
(i) When a monopolist exercise
the market power by limiting supplies, he will become richer at the expense of
those who consume his product.
(ii) In absence of competition,
there will be no pressure on the monopolist firms to be economical to keep down
costs.
(iii) In the interest of the
consumers, the state may intervene and fix a maximum selling price.
7.7.1Equilibrium of a Monopoly Firm
In monopoly, a single firm
controls the entire output or a commodity. The monopolist regulates output to
get the highest possible profit.
The Condition of Equilibrium. The net revenue is maximum at the level of
output where marginal cost is equal to the marginal revenue.
Assume that a
monopolist can sell 20 units of a commodity' at Rs.5 each. The total revenue is
Rs.100. Assume that he can sell 21 units at Rs.4.90 each. The total revenue now
is Rs.102.90. The marginal revenue is Rs.2.90. If the marginal cost, i.e., the
cost of producing the 10th. unit is less than Rs.2.90, the monopolist will gain
by manufacturing the 10th unit. As long as marginal revenue is more than
marginal cost, the monopolist will go' on increasing his output to increase his
profit. He will stop production when marginal revenue is equal to marginal
cost. Beyond this point, marginal cost is greater than marginal revenue and
further production involves a loss. Hence total revenue is maximum at the level of output where
marginal revenue is equal to marginal cost.
Diagrammatic
Illustration. Monopoly equilibrium can be diagrammatically illustrated as shown
below.
In Fig. DD1 is the demand curve for a
monopolist's product or the average revenue curve and MC is the curve of
marginal costs. AC shows the average cost. Under monopoly, the marginal revenue
is always less than price. So the marginal revenue at each level of output will
be shown by a downward sloping line lying below the average revenue curve. Let
MR shows marginal revenue. MR and MC intersect at K. Therefore marginal cost
and marginal revenue are equal when output is OA. The average revenue curve
shows that when output is OA, the price is OP or AB. The monopolist will secure
maximum net revenue when he produces OA units. The monopoly price is AB.
|
The net monopoly revenue
|
= total revenue – total
cost
|
|
|
= (OA x AB) – (OA x AE)
|
|
|
= OABP – OAEG = PBEG
|
Monopoly Equilibrium
7.8 Price Discrimination
Price
discrimination means charging different prices from different buyers of the
same commodity or service. This can be done under monopoly but cannot be done
under perfect competition.
7.8.1 Types
of price discrimination
There are three
possible types of price-discrimination:
-
Personal Discrimination
-
Local Discrimination
-
Trade or Use Discrimination
(i)
Personal
Discrimination: The
monopolist can charge higher price from buyers whose is intense or whose financial
ability to pay is greater. Normally such discrimination is made in a veiled
manner. The new book of a famous writer may first be issued as de luxe edition
with a very high price. Only the richer classes will purchase this. Finally a
low priced (e.g., a paper back) edition is published for common people.
The de luxe edition has a prestige value, so those who are able may be induced
to pay more. Similarly, people travelling in the upper
classes, pay more than the cost of providing
extra benefits.
(ii)
Local
Discrimination: Different prices may be charged from different
localities. Prices in fashionable shops, where the richer buyers go, are often higher than in ordinary market shops.
Sometimes the monopolist charges lower prices in
a foreign market than in the home market (known as Dumping).
(iii)
Trade
or Use Discrimination: Different prices may be changed for different uses.
Thus commercial rate of electricity is higher than for domestic consumption. Price
of LPG for commercial use is higher than for domestic use.
7.8.2 Conditions of Price-discrimination
Price discrimination can occur only in following situations
(i) The demand is
not transferable from the high priced market to the low priced
market. If rich people do not buy de luxe editions
but wait for cheap ones, personal discrimination in books is not possible.
(ii) The buyers of
low priced articles cannot resell them in the high priced
market. If domestic buyers of cheap LPG are allowed to resell it for commercial
use, there can never be two prices for LPG.
Situations where price
discrimination may occur
i.
Where some consumers are ignorant of prices being charged
from others, the monopolist finds it easy to charge different prices.
ii.
When some consumers can be induced to believe that they are
getting something different from others, they can be charged at a higher rate. This is frequently done by slightly varying
the product (e.g. using different kinds of
packages).
iii.
In case of direct services, which cannot be resold by the buyer
(e.g., medical advice or a haircut), discrimination is easy.
iv.
Different prices can be charged from .consumers situated in different
countries or at a distance from one another.
v.
Price-discrimination is possible only if
there is no legal restriction bar. In some cases (e.g., in public utility
services) the monopolist may be compelled by law to charge uniform prices.
Conditions for profitable price discrimination
Profitable situations of price-discrimination for monopolist
i. The demand for
the monopoly product can be split up into different markets.
ii. The elasticity
of demand in different markets are different.
iii. The cost of keeping
the various markets separate is not large relative to the
differences in the demand elasticities.
7.8.4 Benefits of price discrimination
(i) Beneficial to society. Price-discrimination may
sometimes be beneficial to society. For example, if a doctor charges low fees
from poor patients and high fees from rich ones.
(ii) Beneficial to the poor. First class passengers pay
comparatively more, so that second class passengers pays less. Therefore the system of charging discriminatory fares is
beneficial to the poorer classes.
7.8.5 Evils of
price discrimination
The Evils of price
discrimination are:
(i) The price
charged in price discrimination is based on the principle,
"as the traffic will bear". This means that every consumer is charged the maximum price he can pay, Therefore price
discrimination leads to exploitation of consumers.
(ii) Consumers’
surplus is wholly extracted or much reduced.
(iii) All the evils
of the monopoly are found in the price discrimination in an increased manner.
(iv) Marshall was first to
compare the problem of price determination with a pair of scissors.
7.8.6 Dumping
-
Dumping is a technique of international price discrimination.
-
Dumping is not possible when price elasticity of demand in the
international market is higher than that of domestic market.
7.9 Oligopoly
Oligopoly means there are only a few producer. The
products of the oligopolists may be identical or may be differentiated.
Pure
oligopoly is a market condition in which a few industries produce a homogeneous
products.
Kinked
demand curve is found in oligopoly market. Horizontal demand curve is found in
perfect competition market
Reasons of Oligopoly. Nowadays pure
competition and pure monopoly are not found. We generally find oligopoly and
monopolistic competition.
The causes of oligopoly are.
i. The economies
of large scale production.
ii. Monopolistic
combinations, to eliminate competition.
iii. Product
differentiation which leads to consumer preferences.
iv. Tariff barriers
(elimination of foreign import leads to advantages to local
firms).
v. Some firms are
able to get cost advantages or institutional
Features of Oligopoly
The characteristics of
oligopoly are:
i. Number of sellers: There is a small number of sellers.
ii. Differentiation: The products of the oligopolists may be differential or perfectly
identical.
iii. Interdependence: Pricing under oligopoly is a more complicated than under perfect
competitions or monopolistic competition. As there are only a few producers in
an oligopoly, it is difficult to predict rival’s strategy. For example, a
price-out by one producer may not be followed by a price-cut by the others.
Therefore in an oligopoly, each depends on the others.
iv. Varying power: Oligopolists have different monopoly power.
v. Selling costs: The oligopolists have to employ various strategies to get a greater
share of market. Advertising is very important in this type of market.
7.10 Selling Cost
The term Selling Cost is
used to denote costs of advertisement, salesmanship and other expenses incurred
to influence the customers and consumer demand.
Advertisements are of' two types (a) .informative and
(b) competitive. The object of informative advertisement is to acquaint the people. with useful products. The object of
competitive advertisement is to promote the sale of the products of a particular firm against those of others.
Informative advertisement spreads knowledge and is therefore socially
advantageous for useful goods, while advertisements of harmful goods are
socially disadvantageous.
Competitive advertisements are not useful from the social
standpoint as they involve wastage of resources.
7.10.1 Selling Cost and Demand Curve
Selling costs affect the demand through imperfect
knowledge of buyers, which in turn, makes demand
less elastic. The role of selling costs becomes greater when there is product differentiation.
Selling costs are incurred to shift the demand curve to an
upper position. Though it is difficult to predict effect of selling costs
on demand curve, the normal tendency is to shift the
demand curve to upper position.
7.10.2 Selling
Costs and the Cost Curves
When selling costs are incurred, the average and marginal cost
curves firm lie above the original one. If selling costs are a
fixed sum, the marginal costs remain unaffected
and average costs will decrease.
7.10.3 Selling costs under pure competition
Selling costs are not necessary under pure competition.
As there are many buyers and sellers, it is presumed that every firm under pure competition can sell as much as
it wants at the current price. Hence there is
no need of selling costs.
7.10.4 Selling
costs under monopoly
Under monopoly, competitive advertisements are
not necessary as there are no competitors. But there may be informative advertisements intended to spread knowledge
of the products of the monopolist. Monopolists
often use advertisements as propaganda that they
change fair prices and that the goods are of high quality, to keep the public
pleased.
7.10.5 Selling
costs under monopolistic competition
Under monopolistic competition and oligopoly, competition is
usually very keen and the firms spend large sums of money to fight
one another. Selling costs in these cases may even exceed production costs.
7.10.6 Effect
of Selling Costs
Selling Costs increase total cost and make prices higher. But
sales expenditure usually increase demand and increase output, ultimately
resulting lower production costs and lower prices. In modern times, however,
competitive advertisement costs are so high that they amount to more than the
gains from lower production costs. Therefore, selling costs often increase
total costs and prices.
7.11 Price Mechanism
It is a self-adjusting and
self-correcting mechanism that regulates and controls the economic activities. Price
is determined by the interaction of demand and supply forces.
7.11.1 Role of Price Mechanism in a Free Market
Price mechanism plays an
important role in performing the following functions.
1. What to produce: In a free market economy, there are large number of buyers and sellers. Producer
has to decide the level of quantity to be produced. Similarly buyer has to
decide his level of consumption. The price trend indicate the relative
preferences of consumers motivating the producer to produce goods of high
prices to earn higher profit.
2. How to produce: The producer should decide the production techniques with lowest
production cost.
3. For whom to produce: In a free economy, price mechanism determines consumer’s selection,
taste and preferences and helps the producer to produce the goods according to
the consumers preferences.
7.11.2 Role of Price Mechanism in Socialistic Economy
In socialist economic
system (known as communist economic system) of all the production factors and
all consumers price mechanism has less applicability over the socialist economy.
Prices are determined by the state.
