Study Note - 2

FORMS OF MARKET

This Study Note includes

2.1 Various Forms of Market
2.2 Concepts of Total Revenue, Average Revenue & Marginal Revenue
2.3 Pricing in Perfect Competition
2.4 Pricing in Imperfect Competition

2.1 VARIOUS FORMS OF MARKET

Market
• In economics, market means a social system through which the sellers and purchasers of a
commodity or a service (or a group of commodities and services) can interact with each other.
• They can participate in sale and purchase.
• Market does not refer to a particular place or location.
• It refers to an institutional relationship between purchasers and sellers.
• Market is an arrangement which links buyers and sellers.
• A market can be of different types.
• The market differ from one another due to differences in the number of buyers, number of sellers,
nature of the product, influence over price, availability of information, conditions of supply etc.
Economists discuss four broad categories of market structures:
1. Perfect Competion
2. Monopoly
3. Monopolistic Competition
4. Oligopoly
2.1.1 Perfect Competition
A market is said to be Perfectly Competitive if it satisfies the following features:-
(i) Large number of buyers and sellers : Under perfect competition, there exists a large number of
sellers and the share of an individual seller is too small in the total market output. As a result a single
firm cannot influence the market price so that a firm under perfect competition is a price taker
and not a price maker. Similarly, there are a large number of buyers and an individual buyer buys
only a small portion of the total output available.
(ii) Homogenous goods : Under perfect competition all firms sell homogenous goods which are
identical in quantity, shape, size, colour, packaging etc. So the products are perfect substitutes of
each other.

FUNDAMENTALS OF ECONOMICS AND MANAGEMENT I 2.1

Forms of Market

(iii) Free entry and free exit : Any firm can enter or leave the industry whenever it wishes. The condition
of free entry and free exit ensures that all the firms under perfect competition will earn normal
profits in the long run. If the existing firms are earning supernormal profits, new firms would be
attracted to enter the industry and increases the total supply. This will reduce the market price and
the supernormal profit will not sustain. On the other hand if the existing firm incur supernormal loss
then firms would leave the industry, thus reducing the supply. As a result, price will again rise and
the loss will be wiped out.
(iv) Profit maximization :- The goal of all firms is maximization of profit.
(v) No Government regulation :- There is no Government intervention in the market.
(vi) Perfect mobility of factors :- Resources can move freely from one firm to another without any
restriction. The labours are not unionized and they can move between jobs and skills.
(vii) Perfect knowledge :- Individual buyer and seller have perfect knowledge about market and
information is given free of cost. Each firm knows the price prevailing in the market and would not
sell the commodity which is higher or lower than the market price. Similarly, each buyer knows the
prevailing market price and he is not allowed to pay a higher price than that. The firm also has a
perfect knowledge about the techniques of productions. Each firm is able to make use of the best
techniques of production.
2.1.2 Imperfect Competition
Imperfectly competitive markets may be classified as : (i) Monopoly, (ii) Monopolistic Competition,
(iii) Oligopoly and (iv) Duopoly
(1) Monopoly
Monopoly refers to the market situation where there is one seller and there is no close substitute
to the commodities sold by the seller. The seller has full control over the supply of that commodity.
Since there is only one seller, so a monopoly firm and an industry are the same.
Features :
(i) Single seller and large number of buyers : Under monopoly there is one seller and therefore
a firm faces no competition from other firms. Though there are large numbers of buyers, no
single buyer can influence the monopoly price by his action.
(ii) No close substitute : Under monopoly there is no close substitute for the product sold by the
monopolist. According to Prof. Boulding, a pure monopolist is therefore a firm producing a
product which has no substitute among the products of any other firms.
(iii) Restriction on the entry of new firms : Under monopoly new firms cannot enter the industry.
(iv) Price maker :- A monopoly firm has full control over the supply of its products and hence it
has full control over its price also. A monopoly firm can influence the market price by varying
it supply, for eg., It can make the price of its product by supplying less of it.
(v) Possibility of Price Discrimination : Price discrimination is defined as that market situation where
a single seller sell the same commodity at two different prices in two different markets at the
same time, depending upon the elasticity of demand on the two goods in their respective
market. Under such circumstances a monopolist can incur supernormal loss then firms would
leave the industry, thus reducing the supply. As a result, price will again rise and the loss will
wiped out.
(2) Monopolistic Competition
It is that form of market in which there are large numbers of sellers selling differentiated products
which are similar in nature but not homogenous, for eg., the different brands of soap. This are
closely related goods with a little difference in odour, size and shape. We separate them from

2.2 I FUNDAMENTALS OF ECONOMICS AND MANAGEMENT

 each other. The concept of monopolistic competition was developed by an American economist
“Chamberline”. It is a combination of perfect competition and monopoly.
Features :
(i) Large number of sellers and buyers : In monopolistic competition the number of sellers is large
and each other act independently without any mutual dependence. Here the action of an
individual firm regarding change in price has no effect on the market price. The firms under
monopolistic competition are not price takers.
(ii) Product Differentiation : Most of the firms under monopolistic sale products which are not
homogenous in nature but are close substitutes. Products are differentiated from each other
in the following ways:
(a) Real Differentiation : These types of product differentiation arises due to differences in the
quality of inputs used in making these products, differences in location of firms and their
sales service.
(b) Artificial Differentiation : It is made by the sellers in the minds of the buyers of those
products through advertisements, attractive packing, etc.
(iii) Non-price competition : In this case, different firms may compete with each other by spending
a huge sum of money on advertisements keeping the product prices unchanged.
(iv) Selling Cost : Expenditure incurred on advertisements and sales promotion by a firm to promote
the sale of its product is called selling cost. They are made to persuade a particular product
in preference to other products. Some advertisements have become so popular that people
use a brand name to describe the product, for eg., brand name is used to describe all types
of washing powder.
(v) Free entry and free exit : There are no restrictions on the entry of new firms and the firms
decide to leave the industry. Every firm under monopolistic competition earns only normal
profits in the long run and there arises no supernormal profit nor loss.
(vi) Independent price policy : A firm under monopolistic competition can influence the price of
the commodity to some extent and hence they face an inverse relationship between price
and quantity. In this case the price elasticity of demand would be relatively elastic because
of the existence of many substitutes.
(3) Oligopoly
Oligopoly is a market situation in which there are few firms producing either differential goods
or closely differential goods. The number of firms is so small that every seller is affected by the
activities of the others.
Features :
(i) Few Sellers : There are few sellers in oligopoly market, such that number of sellers is small that
each and every seller is affected by the activities of the others.
(ii) Interdependence : Interdependence among firms is the most important characteristic under
Oligopoly. The number of sellers is so less in the market that each of these firms contribute
a significant portion of the total output. As a result, when any one of them undertakes any
measure to promote sales, it directly affect other firms and they also immediately react.
Hence every firm decides its policy after taking into consideration the possible reaction of
the rival firm. Thus every firm is affected by the activities of the other firms and this is called
interdependence of firm.
(iii) Nature of Product : A firm under oligopoly may produce homogenous goods which is called
oligopoly without product differentiation for eg. Cooking gas supplied by Indian Oil & HP.

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Forms of Market

Oligopoly may also produce differential products which is called oligopoly with product
differentiation for eg. Automobile Industry.
(iv) Barrier to Entry : The existence of oligopoly in the long run requires the existence of barrier to
the entry of the new firms. Several factors such as unlimited size of the market, requirement of
huge initial investment etc. creates such barrier upon the entry of new firms.
(4) Duopoly
It is a specific type of oligopoly where only two producers exist in one market. In reality, this definition
is generally used where only two firms have dominant control over a market. Duopoly provides
a simplified model for showing the main principles of the theory of oligopoly: the conclusions
drawn from analysing the problem of two sellers can be extended to cover situations in which
there are three or more sellers. If there are only two sellers producing a commodity a change in
the price or output of one will affect the other; and his reactions in turn will affect the first. In other
words, in duopolies there are two variables of interest: the prices set by each firm and the quantity
produced by each firm.

2.2 CONCEPTS OF TOTAL REVENUE, AVERAGE REVENUE AND MARGINAL REVENUE

The term revenue refers to the receipts obtained by a firm from the sale of certain quantities of a
commodity at various prices. The revenue concept relates to total revenue, average revenue and
marginal revenue.
2.2.1 Total Revenue (TR)- Total revenue is the total sale proceeds of a firm by selling certain units of a
commodity at a given price.
If a firm sell 10 units of a commodity at ` 20 each, Them TR = 20 x 10 = ` 200.00
Thus total revenue its price per unit multiplied by the number of units sold.
TR = P x Q where P - Price per unit Q - Quantity sold.
2.2.2 Average Revenue (AR) - Average Revenue is the revenue earned per unit of output. Average
Revenue is found out by dividing the total revenue by the number of units sold.
AR = TR/Q
TR = P.Q
Thus AR = P.Q/Q = P
2.2.3 Marginal Revenue - Marginal Revenue is the change in total revenue resulting from sale of an
additional unit of the commodity.
e.g If a seller realises ` 200.00 after selling 10 units and `225 by selling 11 units, we say MR = (225.00 -
200.00) = ` 25.00
Mathematically it can be expressed as MR = dTR/ dQ
Where d is the rate of change.

2.3 PRICING IN PERFECT COMPETITION

2.3.1 Firm’s Equilibrium under Perfect Competition

• A firm is a small producing unit.
• It supplies too small portion of the total product to influence price.
• By increasing or decreasing its contribution, it can hardly influence total supply and hence price.

2.4 I FUNDAMENTALS OF ECONOMICS AND MANAGEMENT