Economics Unit 4
Economics Unit 4
Economics Unit 4
1. Market
Basically, a market is a mechanism or an arrangement in which the buyers and the sellers
are involved. The buyers and the sellers of a commodity or service come into contact with one
another and complete the act of sale and/or purchase on mutual agreements by the exchange of
money.
Broadly categorizing, there are two forms of market;
Perfect competition
Imperfect competition
2. Perfect Competition
A perfectly competitive market is that type or form of market where there are a large
number of buyers and sellers who are selling and buying identical products at a uniform price.
There is free entry and exit of firms and the absence of government control. Since the price under
perfect competition remains constant, AR and MR curves coincide with each other and become equal and
parallel to the X-axis.
MC=MR
MC should cut MR from below
Some firms earn super-normal profits PCDE and some incur loss MPEN.
Short-run equilibrium of the industry
For full equilibrium of the industry in short run, all firms should earn normal profits.
Condition for equilibrium is SMC=MR=SAC=AR.
D=S; equilibrium price OP, equilibrium output OQ.
At OP price some firms are earning super-normal profits PAEB, some firms incur loss
TPRE.
Long-run equilibrium of the firm
AC=AR; Normal profits i.e., no profit; no loss.
Conditions for equilibrium
LMC=MR=LAC=AR=P.
LMC must cut MR from below.
3. Imperfect competition
Imperfect competition is a competitive market situation where there are many sellers, but they
are selling heterogeneous (dissimilar) goods as opposed to the perfect competitive market
scenario. The types of imperfect market are;
4. Monopoly Market
A monopoly market is that form of market structure where there is a single seller and a
large number of buyers for a product or service. There is an absence of close substitutes to the
products or service. A monopoly firm is regarded as an industry itself and hence can set price to
its maximum advantage.
Example: State Electricity Board (domestic and commercial charges differ)
Indian Railways (I class and II class fares are different)
Hindustan Aeronautics Limited (HAL) has monopoly over the production of aircrafts.
Under a monopoly market structure, the AR curve or the demand curve is downward
sloping from left to right and is less elastic than that of a monopolistic market structure. Hence,
in order to increase demand, the firm has to reduce the price.
Short-run equilibrium
In short-run, a monopolist may earn super-normal profits or they may incur loss.
Profit
In long-run, the firm has time to adjust its plant size to maximize profits.
Equilibrium output OM; equilibrium price OP where LMC=LMR.
Super-normal profit equal to PTSR.
6. Monopolistic Market
A monopolistic market structure is a form of market structure where there are a large
number of buyers and sellers and where the sellers sell differentiated products but not identical
or homogenous.
Under the monopolistic market structure, the AR (demand) curve is sloping downward
from left to right. Also, the AR curve is more elastic and flatter than that of the AR curve under
a monopoly market structure. Hence, when there is any change in price, the change in demand
will be relatively more under a monopolistic market structure.
Features of Monopolistic Market
A large number of buyers and sellers
Selling costs which include the cost of advertisement and sales promotion
Product differentiation which means that the products of different producers or sellers are
different on the basis of price, color, taste, packaging, size, shape and etc.
Free entry and exit of firms
Partial control over price
Lack of perfect knowledge
Imperfect mobility as factors of production and products are not perfectly mobile
An elastic and downward sloping demand curve
7. Oligopoly Market
An oligopoly market is that type of market structure in which there are a few large firms
or sellers who compete with each other or against each other and have interdependence in their
decision making.
Example: Cement, Aluminium and Automobile industry, Commercial air travel, Telecom service
providers etc.
On the basis of production, an oligopoly market structure can be categorised into two categories:
Collusive oligopoly: Where all the firms decide to avoid competition and determine the
price and quantity of output.
Non- collusive oligopoly: Where all firms determine the price and quantity of output on
the basis of the action and reaction of the competing and rival firms in the market.
On the basis of product differentiation, an oligopoly market structure can be further categorised
into two categories:
Perfect Oligopoly: It refers to a perfect or pure oligopoly when the firms deal with
homogeneous products.
Imperfect Oligopoly: Where the oligopoly is said to be imperfect because the firms deal
in heterogeneous products.
Features of Oligopoly Market
Few but large sellers
The firms produce homogeneous or differentiated products
Price rigidity
Demand cannot be determined under oligopoly as the demand curve is a kinked demand
curve
All the firms are interdependent with respect to price determination
If a firm increases the price, then it becomes more expensive than rivals and therefore,
consumers will switch to its rivals.
Therefore for a price rise, there is likely to be a significant fall in demand. Demand is,
therefore, price elastic.
In this case, of increasing price firms will lose revenue because the percentage fall in
demand is greater than the percentage rise in price.
Impact of price cut
If a firm cut its price, it is likely to lead to a different effect. In the short term, if a firm
cuts price it would cause a big increase in demand and therefore would lead to a rise in
revenue. The firm would gain market share.
However, other firms will not want to see this fall in market share and so they will
respond by also cutting price to follow the first firm. The net effect is that if all firms cut
price – the individual firm will only see a small increase in demand.
Because there is a ‘price war’ demand for a firm is price inelastic – there is a smaller
percentage rise in demand.
If demand is inelastic and price falls, then revenue will fall.
Prices stable
If the kinked demand curve is true, the firm has no incentive to raise price or to cut price.
8. Duopoly
A duopoly is a market situation that entails two competing companies that share the
market. In this market, two brands can collude to set prices or quantities and make customers pay
more money. A duopoly has a significant impact on how companies interact with each other.
Since there are only two players within the market, the actions of one will affect the other’s
response and activity. They also influence the way a company operates and how it produces and
promotes its products.
Example: PC processor: AMD and Intel, OS: iOS and Android, Electronic
payments: MasterCard and Visa and Soft drinks: Coca-Cola and Pepsi
Types of duopoly
Duopolies can be divided into two main groups:
Cournot duopoly. According to this duopoly, the output of produced goods and services
shapes the competition between players. Businesses in this market system manufacture a
certain amount of products to maximize their profits. Besides, firms have to negotiate to
divide the market. In the long run, companies establish stable prices and output. This type
also excludes the presence of collusion.
Bertrand duopoly. In this market situation, prices shape the nature of competition
between companies. Customers opting for the firms with the lowest price can cause price
war and high competition between players. Consequently, brands implement low-pricing
strategies and lose profit while consumers enjoy purchasing products or services for
incredibly low prices.
Features
Only two sellers in the market
Each seller is fully aware of his rival’s motive and actions.
Both sellers may collude (they agree on all matters regarding the sale of the commodity).
They may enter into cut-throat competition.
There is no product differentiation.
They fix the price for their product with a view to maximizing their profit.
Since costs are zero, the profit will be equal to ONPS. The price charged is equal to OP.
Now, suppose that the producer B enters into business and notices that producer A is producing
ON amount of output. The market which is unsupplied by A is the market open for B equal to
NB. B will produce output assuming that A will not change its price and output (as he is making
maximum profits).
From Figure, it can be seen that with the entry of producer B, price has fallen to P1,
which has decreased the profits of A to ONCP1. Thus, A would make adjustments in price and
output assuming that B would not change his output and price levels. He/she would produce ½ of
the (OB-NH) of the market.