This chapter covers the concept and classification of markets, and total, average and marginal revenue curves under perfect competition and monopoly.
Concept of Market
A firm has to play a dual role as a producer and a seller. As a producer, it purchases raw materials, machinery, equipment, etc and as a seller, it sells finished goods which are purchased by the consumers. Similarly, services and money are also traded among people. To carry out these transactions, there is the need of the market. In general sense, market refers to a particular place where commodities and services are traded. In economics, market refers to a mechanism by which buyers and sellers are brought together for the purchase and sale of the commodity.
According to P.A Samuelson,” a market is a mechanism by which buyer and seller interact to determine the price and quantity of a good or service. “ According to N.G.Mankiw,” a market is a group of buyers and sellers of a particular commodity or service. The buyers as a group determine the demand for the product and sellers as a group determines the supply of the product. “A market can be local, regional ,national, international, competitive, noncompetitive ,organized or unorganized etc.
Features/characteristics of the market:
- Availability of commodity
There should be a commodity in the market which is being demanded and supplied.
- Availability of buyers and sellers
There must be buyers and sellers of the commodity in the market. Without buyers and sellers, there is no trading and no market.
- Communication
There must be communication between buyer and seller in the market. Without interaction between buyer and seller, there is no transaction.
- Place
There must be a place or an area where buyers and sellers interact with each other. It may be local, national or global.
- Medium of exchange
There must be a medium of exchange in order to trade in a market. Such a medium may be money, cheques, swipe cards, and other near money items.
Perfect Competition
Perfect competition is defined as the market structure where there is a large number of buyers and sellers within the homogeneous products, selling at a uniform price. In this market, both buyers and sellers have perfect knowledge regarding price. Firms can not change prices according to different situations. The price of the product is determined by the industry and all firms under the industry have to accept the price determined by the industry. Therefore, the industry is called price maker and the firm is called price taker. In a perfect competition market, the seller can sell any amount of the commodity at the ruling price or existing price.
Mrs. Joan Robinson has said, ”Perfect Competition prevails when the demand for the output of each producer is perfectly elastic.” According to K. E. Boulding, ”A Perfect Competition market may be defined as a large number of buyers and sellers all engaged in the purchase and sale of identically similar commodities, who are in close contact with one another and who buy and sell freely among themselves.”
Features of perfect competition:
1. Large Number of Buyers and Sellers: In a perfectly competitive market, there are numerous buyers and sellers. This large number ensures that no single buyer or seller can control the market price. 2. Homogeneous Goods: All firms in a perfectly competitive market produce goods that are identical or homogeneous. This means that consumers view products from different firms as perfect substitutes. 3. Free Entry and Exit: Firms in a perfectly competitive market can enter or leave the industry freely. There are no barriers to entry or exit, which means that new firms can join the market when they see a profit opportunity, and existing firms can leave the market if they are incurring losses. 4. No Government Intervention: In a perfect competition scenario, there is an absence of government intervention. Prices are determined purely by the forces of supply and demand. 5. Perfect Mobility of Factors of Production: Factors of production, such as labor and capital, can move freely in and out of the industry. There are no restrictions or barriers to the movement of resources, which allows firms to adjust their production levels in response to market conditions easily. 6. Perfect Knowledge of the Market: Buyers and sellers have complete and perfect knowledge about the market. This includes information about the prices of goods and services, availability of products, and the cost structures of the firms. 7. Profit Maximization Objective: The primary goal of all firms in a perfectly competitive market is to maximize their profits. Firms aim to produce at a level where their marginal cost equals marginal revenue, ensuring that they are operating efficiently.
Imperfect Competition
The concept of imperfect competition was brought by Mrs. Joan Robbinson in England and by E.H. Chamberlin in America in 1993. It is an important market segment where the individual firms maintain their control over the price to a smaller or higher degree.
Under imperfect competition, there is a large number of buyers and few sellers. Each seller can follow it’s own price-output policy. Each producer produces a differentiated product which is a close substitute for each other. Thus, the demand curve under monopolistic competition is highly elastic.
According to Mrs. Joan Robbinson, "Imperfect competition is the market structure where buyers and sellers have imperfect knowledge of market situation regarding prices and commodities, and producers adopt the policy of product differentiation." According to P. A. Samuelson and W. D. Nordhaus, " Imperfect competition prevails in the industry whenever individual sellers can affect the price of their output."
Features/ Characteristics of imperfect competition:
A. A large number of buyers and few sellers There are a large number of buyers and few sellers in this market. These firms are small in size. Every firm acts independently without concern about the reaction of its competitors.
B. Product differentiation The product of each seller in this market may be similar but not identical to the product of other sellers in the industry. For example; a firm may be producing Horlicks which may be similar to another kind of product like Boost, Complan, etc.
C. Selling cost There is product differentiation in this type of market. So, selling costs are important to convince the buyer to change their preferences as the products are the substitute for each other.
D. Free entry and exit of the firm Firms under imperfect competition are free to join and leave the industry at any time they like to. If any individual finds potential profit then he/she can enter into the industry and if they are suffering the loss they may exit. However in the case of Duopoly and Oligopoly market there are entry barriers.
E. Price maker Under this market, every firm is a price maker. It can determine the price of its own brand and product itself.
F. Blend of perfect competition and monopoly In this market, every firm has monopoly power over its product. At the same time, there is competition because the consumer assumes different firms' products as a close substitute.
Types of imperfect competition:
1. Oligopoly market: Oligopoly is a market situation in which there are few firms selling a homogeneous or differentiated product. It is not too difficult to point out the number of firms in the market. There may be 2 or 3 or 4 or 5 firms in the market. The firms are mutually interdependent. The entry and exit of a firm are difficult in an Oligopoly market. There are heavy expenditures and advertisements in the market.
2. Duopoly market: Duopoly means that type of market in which there are two sellers, selling homogeneous or differentiated products. These two sellers exercise monopoly among themselves in the sale of the product produced by them. Both the sellers are completely dependent and there is no agreement between them although they are dependent.
3. Monopolistic competition: Monopolistic competition refers to the market structure in which there are many sellers producing differentiated products. Differentiated products have different characteristics. Eg; Laptops have different characteristics in their size, storage, RAM, Battery capacity, Processors, Speed, etc. As these products have different characteristics, sellers can sell them at different prices. 4. Monopoly: A monopoly market is a type of market structure where a single firm or entity is the sole producer and supplier of a particular product or service, with no close substitutes available. This firm dominates the entire market, giving it significant control over the price and output of its product. High barriers to entry, such as large capital requirements, legal restrictions, or control over essential resources, prevent other firms from entering the market and competing.
Monopoly Market
Monopoly is defined as the market structure where there is a single seller of a product having no close substitutes. Thus, the monopoly market has full control over the price of the product. There are a large number of buyers and no competitors. The firm or seller can determine the price of its product. So, it can reduce the price of its products in order to increase sales or can even earn more profit by selling fewer products at a high price.
According to Anna Koutsoyiannis, “Monopoly is a market situation in which there is a single seller. There are no close substitutes of the commodity it produces, there are barriers to entry.”
Features of monopoly:
1. Single seller and a large number of buyers A monopoly firm is the only firm and industry of a monopolist. But there are a large number of buyers. 2. No close substitutes There are no substitutes which are close to the product and services sold by a monopolist. 3. Entry barriers There is a difficulty for new firms to enter into the monopoly industry. There are either natural or artificial restrictions on the entry of firms into the industry. 4. It is also an industry Under monopoly, there is only one firm which is included in the industry. So, there is no distinction between industry and firm under monopoly. 5. Price maker A monopolist has absolute control over the supply of the commodity. As monopolist is a single supplier of a product, the buyer has to pay the price fixed by the monopolist. So, he/she is the price maker.
Monopolistic Competition
Monopolistic Competition
Monopolistic competition is a type of market structure where many firms compete against each other, but each firm sells a slightly differentiated product. This differentiation allows firms to have some degree of market power, enabling them to set prices above marginal cost. Unlike perfect competition, where products are identical, firms in monopolistic competition focus on product differentiation to attract customers.
According to Edward Chamberlin, "Monopolistic competition is a market structure in which a large number of sellers produce similar, but not identical products."
Features of Monopolistic Competition
1. Large Number of Firms: Many firms operate in the market, each holding a small market share. This ensures that no single firm can control the entire market.
2. Product Differentiation: Firms sell products that are similar but not identical. Each firm tries to differentiate its product through branding, quality, features, or other attributes, creating a unique product identity.
3. Free Entry and Exit: Firms can freely enter or exit the market. This means that if firms are earning abnormal profits, new entrants will join the market, increasing competition and driving profits down. Conversely, if firms are incurring losses, they can leave the market.
4. Some Degree of Market Power: Due to product differentiation, each firm has some control over its pricing. Firms are price makers to a certain extent because consumers may prefer their product over others due to its unique features.
5. Non-Price Competition: Firms often compete using non-price factors such as advertising, branding, product features, customer service, and packaging to attract customers and gain market share.
6. Normal Profits in the Long Run: In the long run, firms in monopolistic competition tend to earn only normal profits. Any short-term abnormal profits attract new entrants, which increases supply and reduces prices and profits.
7. Downward Sloping Demand Curve: Each firm faces a downward-sloping demand curve, meaning that it can sell more only by reducing its price. This is different from perfect competition, where firms are price takers and face a perfectly elastic demand curve.
Total, Average and Marginal Revenue
The total amount of money received by a firm from the sale of the product is called revenue. The profit of a firm depends upon the cost and revenue. The profit earned by the firm is the difference between the revenue and the cost of production.
According to Dooley,” The revenue of a firm is its sales receipt from the sale of a product.” There are three types of revenue which can be explained as follows:
- Total revenue (TR)
Total revenue is the total amount of money received by a firm from the sales of a given quantity of product. Technically, total revenue is the sum of marginal revenues. Mathematically, total revenue is the product of price and quantity sold.
Symbolically;
TR=∑MRor TR=P×QWhere,
TR= Total Revenue∑MR= Sum of Marginal Revenues P=price per unitQ= Quantity sold
- Average revenue (AR)
Average revenue is the price per unit. Average revenue is obtained by dividing the total revenue by the total number of quantities sold.
Symbolically;
AR=TR/QWhere,
AR= Average RevenueTR= Total revenue Q= Quantity sold
- Marginal Revenue(MR)
Marginal revenue is the addition to the total revenue from the sales of an additional unit of a commodity. Marginal revenue is obtained by dividing change in total revenue by the change in quantity sold.
Symbolically,
MR= ∆TR / ∆QWhere, ∆TR =Change in TR ∆Q= Change in quantity sold OR
MR=TRn -TRn-1 Where, TRn = Current Total Revenue TRn-1 = Initial Total Revenue
Revenue Curves under Perfect Competition
Perfect competition is a market structure having a large number of buyer and sellers selling homogeneous products at a uniform price. The TR, AR, and MR under Perfect competition can be derived as follows:
In the above schedule, we can see that the value of TR is increasing at the same rate because every additional of the commodity is sold at Rs.10. Average revenue remains constant at all levels of output. AR, MR, and price are equal to each other. It can be graphically explained as follows:
In the above diagram, we can see that the TR curve is increasing at a constant rate. AR and MR curve are the same and they coincide with each other. They are the same at all levels of output. TR curve is positively sloped whereas AR and MR are a horizontal straight line parallel to the x-axis.
Revenue Curves under Monopoly
Monopoly is the market structure having a single seller selling the type of product which has no close substitute. They are the price makers. Under Monopoly, a monopolist can increase its revenue by selling few products at a high price and more products at a low price. The TR, AR, and MR can be derived with the help of the following schedule:
In the above table, we can see that when the quantity sold is increasing, the price is decreasing. Total revenue increases at first up to the fifth unit then becomes maximum and declines thereafter. AR and price are similar. Marginal revenue is declining, becomes zero and even negative. The TR, AR and MR Curve can be derived from the above schedule as follows:
In the above diagram TR, MR and AR are shown along y-axis and quantity sold is shown along x-axis respectively. We can observe that when total revenue is rising AR and MR are falling. When TR becomes maximum, marginal revenue becomes zero. When TR starts to fall, then marginal revenue declines to negative.