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Types of Markets in Economics; Based on competition

Updated on October 15, 2014

Market

A market is a place where goods and services are bought and sold. In other words it is a medium that allows buyers and sellers of a specific good or service to interact in order to facilitate an exchange.

In Economics market refers to the exchange place for a commodity. Based on compatition we can devide markets into four type, they are:

1) Perfect Competition Markets

2) Monopoly

3) Oligopoly

4) Monopolistic Competition or Imperfect Competition

1) Market Under Perfect Competition

A perfect competition market is one were there is a large number of buyers and sellers. Whose products are homogeneous and price is uniform.

Features:

a) Large number of buyers and sellers

Under perfect competition there are a large number of buyers and sellers. So any buyer can buy from any seller and any seller can sell to any buyer. So a single buyer or seller can’t influence the market. The buyers and sellers are ‘price takers’ and not ‘price makers’. The price of a commodity is determined by the market demand and market supply. Hence the demand curve is parallel to the horizontal axis.

b) Homogeneous products

Under perfect competition the products are similar or identical in color, size, packing, quality etc. Hence they are perfect substitutes.

c) Free entry and exit

Here producers are free to ender or leave out the market at any time. As a result profit will be always normal. Normal profit is the profit that is essential for continuing the business. There is neither lose or gain.

If profit is more than normal some new producers may enter the market, their by profit decreases and becomes normal on the other hand if it is less than normal some of the existing producers may leave out. Hence profit increases and become normal.

d) Absence of transportation cost

Here transportation charges are absent. If transportation cost is there price will not be uniform.

e) Uniform price

Under perfect competition price throughout the market will be uniform. Because transportation cost is absence, products are homogenous and perfect substitutes and the factors are freely mobile.

f) Perfect knowledge about the market\

It is assumed that both buyers and sellers should have perfect knowledge about the market conditions. In other words they should have information about the availability of the product, the prevailing price, market conditions etc. That this essential for avoiding exploitation. “According to Marshell; Though every one acts for himself, his knowledge of what others are doing is supposed to be generally sufficient to prevent him from taking a lower or paying a higher price than others are doing”

g) Perfect mobility of the factors of product.

The factors of production are free to move from one firm to another. Hence we can adjust there demand and supply.

h) No government interference

Under perfect competition government interference is absent . As a result there is no tariff, subsidies,etc.

Price and output determination under perfect competition

In Short run

Short run is a period were much changes will not occur. That is new firms may not enter or the existing firms may not leave out.

A competitive firm is in equilibrium in the point were MC=MR. MC is the additional cost for producing an additional unit. MR is the additional revenue obtained from an additional unit. The equilibrium can be explained with the help of the following diagram.

In this diagram output is taken on the OX axis and cost and revenue on the OY axis. MC is the marginal cost curve, AC is the average cost curve, MR is marginal revenue curve.

Here. MC equal MR at point Q, at this point output is OM. Average revenue (AR) is MQ.

Total revenue (TR) = Output x Average revenue

That is; TR = OM x MQ = OMQP

AC is MR

Total cost (TC) = Output x Average cost.

That is; TC = OM x MR = OMRS

Profit = OMQP - OMRS = PQRS ( the shaded area in graph )

In Long run

Long run is a period were much changes will occur. That is new firms may enter or the existing firms may leave out. Hence profit is normal.

If profit is more than normal some new firms may enter. There by profit falls and becomes normal. Similarly if it is less than normal some of the existing firms may leave out. Then profit increases and becomes normal.

In the long run for attaining equilibrium the following two conditions should be satisfied.

1. LMC ( Long run marginal cost ) = MR (Marginal Revenue)

2. LAC ( Long run average cost ) = AR (Average Revenue)

At this point price is equal to each.

Price = LMC = MR = LAC = AR.

MC is the additional cost for producing an additional unit. MR is the additional revenue obtained from an additional unit. AC refers to the cost per unit , and AR is the revenue per unit. This can be explained the help of the following diagram

In this diagram output is taken on the OX axis and cost and revenue on the OY axis. LMC is the long run marginal cost curve, LAC is the long run average cost curve. MR is the marginal revenue curve and AR is the average revenue curve. Here LMC is equal to MR (LMC=MR) at point Q. At this point LAC is equal to AR (LAC=AR). Hence profit is normal. Thus at the equilibrium point Q, (Price=LMC=MR=LAC=AR).

Equilibrium of an industry

Under perfect competition an industry is in equilibrium were the total demand for the product is equal to its total supply in other words equilibrium is attained at the point were the demand curve interests the supply curve. The price so determined is called the equilibrium price. It is the price at which demand equates supply. This can be explained to the help of the following diagram.

In this diagram OX axis shows demand and supply and OY axis shows price. DD is the demand curve and SS is the supply curve. Here E is equilibrium point, were demand is equal to supply. Here the equilibrium price is OP and equilibrium quantity is OM.

The equilibrium price is not constant. It changes when demand and supply changes.

Let us assume that demand increases then the demand d curve shifts forward. Here the new demand curve is D1 D1, Equilibrium point is E1 and equilibrium price is OP1. Thus an industry is in equilibrium at the point were market demand is equal to market supply.

2) Monopoly

The word monopoly has been derived from two Greek words, ‘monos’ meaning single ‘polity’ means seller. Monopoly is a market situation where there is a single seller. Whose products are heterogeneous and free entry and exit is absent.

Features

  1. Existence of a single seller
  2. Products are heterogeneous, that is they are different, quality, size, color, packing, etc. Hence they are not perfect substitutes.
  3. Free entry and exit is absent.
  4. There is no difference between firm and industry, because there is only a single seller.
  5. Price will be high: whether price is high or low is depends on the conditions

a) Cost condition

b) Nature of elasticity

The monopoly facing increasing cost price will be high. On the other hand it there is diminishing cost price will be high. On the other hand it there is diminishing cost price will be low.

If the commodity has elastic demand. The monopolistic will change high price. If it has elastic demand he will charge low price.

Types of monopoly

1) Natural Monopoly : It is created by nature, eg ; in all protection the Arab countries are enjoying monopoly right.

2) Legal Monopoly : It is created by law, eg ; railway is an owner managed by government


3) Financial Monopoly : For producing certain goods huge finance is needed those who process such finance is given monopoly right in producing such goods, eg : Tata and Birla are enjoying monopoly rights in iron and steel products.

4) Patent Monopoly : Unit give patent rights to a firm for the production of good or to use a particular technique, eg : patent right for Maruthi is given for Suzuki.

In this diagram out put is taken on the OX axis and cost and revenue on the OY axis, AR is the Average Revenue curve, MR is the Marginal Revenue curve, AC is the Average Cost curve, and MC is the Marginal Cost curve. In this diagram MC equals MR at point R. Here output is OM.

AR is MQ

There for TR = OM x AR

That is OM x MQ = OMQP

Here Average Cost is Marginal Revenue (AC is MR).

Total Cost (TC) = Output x AC

That is OM x MR = OMRS

Profit = Total Revenue (TR) – Total Cost (TC)

= OMQP – OMRS = PQRS (The Shaded Area)

Here profit is high or low depends on two conditions. Cost and elasticity of demand. If there is increasing cost, price and profit will be high and vice verse Similarly if there is elastic demand price and profit will be low and vice verse.

In Long run

Long run is a period were much changes will occur. That is new firms may enter or the existing firms may leave out.

In the long run a monopolist firm is in equilibrium were LMC = MR.

In this diagram, output is taken on the OX axis and cost and revenue on the OY axis. LAC is the long run average cost curve, LMC is the long run marginal cost curve, AR is the average revenue curve and MR is the marginal revenue curve.

Diagram shows LMC equals MR (LMC = MR) at point R. Here output is OM.

AR is MQ

TR = Output x AR

That is OM x MQ = OMQP

AC = MR

TC = Output x AC

That is OM x MR = OMRS

Profit = TR – TC

= OMQP – OMRS = PQRS ( The shaded area )

Whether profit is high or low depends on the cost condition and nature of elasticity of demand.

Price Discrimination or Discriminatory Monopoly.

Price discrimination is the act of selling the same commodity to different buyers at different price. Discriminating monopoly is that type of monopoly were the same product is sold to different buyers at different price.

Price discrimination is of the following types.

1) Local

If different price is charged for the same products in different localities, discrimination is local, for eg: prices of goods are higher in city shops than in rural shops.

2) Personal.

When different prices are charged from different persons discrimination is personal, for eg: a doctor may charge more fees from rich patients and less fees from poor patients.

3) According to use

Here different prices are charged for the different use of the product, for eg: electricity rates are higher for industrial purpose.

Causes of Price Discrimination.

1) Geographical Distance.

If there exists much geographical distance between two submarkets, price discrimination is possible.

Let us assume that a commodity has two submarkets Delhi and Berlin. The customers in Delhi will not go to Berlin for knowing the price conditions and vice versa. As a result price discrimination is possible.

2) Nature of the product.

If a commodity purchased from one market can’t be purchased from some other markets, price discrimination is possible.

3) Nature of the consumer

If the consumer are lazy and illiterate, price discrimination is possible.

Degrease of Price Discrimination

According to AC Pigou, price discrimination is to three degrease.

1) 1st degree discrimination

Here the aim of the monopolist is to take whole of the consumer surplus.

2) 2nd degree discrimination

Here the aim is the monopolist is to take a major part of the consumer surplus.

3) 3rd degree discrimination

Here the monopolist will discriminate price in such a way as to take a least part of the consumer surplus.

Price and Output Determination Under Discriminative Monopoly

For studying price and output determination under discriminating monopoly we have to assume two things.

a) There exists two submarkets, A and B.

b) Elastic demand is existing in one submarket and inelastic demand in other.

The following two conditions are essential for attaining the equilibrium price and output.

TMC = MR

MR (A) = MR (B) = TMC

This can be explained with the help of the following diagram.

In this diagram the first figure shows the position of the total market. Output is taken on the X axis and cost and revenue on the Y axis. AR is the Average Revenue curve and TMC is the Total Marginal cost curve.

TMC is equal to MR (TMC = MR) at point E, here output is OM. TMC is ME and Marginal Revenue (MR) is also ME.

This output is distributed in between the two submarkets A and B. The second diagram shows the position os market A. AR1 is the Average Revenue curve and MR1 is the Marginal Revenue curve. OM1 is the equilibrium output. Marginal Revenue (MR) is E1M1, Price is P1M1.

The third figure shows the position of market B. Here AR2 is the Average Revenue curve. MR2 is the Marginal Revenue curve. The output is OM2. Marginal revenue (MR) is E2M2, price is P2M2. Thus it is clear that price is higher in market A. So inelastic demand it is there in market A, and elastic demand in market B.

MR(A) = MR(B) = TMC

M1E1 = M2E2

Thus the two conditions are satisfied.

3) Oligopoly

Oligopoly is a market situation were there exist few sellers, selling either homogeneous or heterogeneous products. It is pictured as competition among few.

Types

1) Pure oligopoly (non differentiated)

If the products produced are homogenious or similar that market is known as pure (homogenious or non differentiated) oligopoly.

2) Differentiated oligopoly

If the products produced are hetrogenious or different, that market is known as differentiated oligopoly or oligopoly with product differenciation.

3) Collusiee oligopoly

It I that type of oligopoly were price is fixed after consultation discussion and agreement by the oligopolist.

4) Non collusiee oligopoly

Here firms act indipendantly there will not be any consultation or

discussion among the oligopolist.

Cartel

It is a combination of firms, whose aim is to reduce uncertainty in business. The objective of cartel is to reduce the compatative forces in the market and there my create a monopoly condition. OPEC is an example of international cartel. Thus cartel is a collusive agreement.

Price Leadership

Price leadership is an important feature of oligopoly. There exist price war. In this price war, those firm whose cost of production is minimum will came out victorius. Thus the firm having low cost of production will act as price leader and others will follow the leader.

Let us assume that there exist only two firms, A and B. Price leadership can be explain with the help of the following diagram.

In this diagram, output is taken on the OX axis and cost and revenue on the OY axis. AR is the Average Revenue curve, MR is the marginal revenue curve, MC(A) is the marginal cost curve of market A (firm A) and MC(B) is the marginal cost curve of market B (firm B). Firm A is in equilibrium at point R, here output is OM and price is QM. Firm B is in equilibrium at point S, here output is ON and price is PN.

SN < RM, thus here B will act us the leader. And firm A will follow (obey) the leader.

KIMKY demand curve hypothesis (Kinked)

Under oligopoly price is always stable or rigid. It is neither responsive to demand or supply, for example a particular firm will not raise the price, fearing that others may also raise the price. Similarly he will not lower the price. Hence price I always stable or rigid.

For explaining the price stability or price rigidity Paul.M.Sweezy developed kinky demand curve hypothesis. According to this hypothesis there is kink upon the prevailing price, On the demand curve. The demand curve above the kink is highly elastic and below is in elastic.

In this diagram DD1 is the demand curve the prevailing price is OM, were demand is ON. The demand curve DP is highly elastic and PD1 inelastic. The kinky demand curve analysis has been criticized on the ground that it is neither theoretically sound nor empirically supported.

Game Theory to Oligopolistic Stratagy

It is the situations in wich there are several participants and each of whom has a significant influence on others. This is called the game of strategy or a game.

Let us apply game theory to understand wether or not to increase adverticement ecpenditure. Let us assume that there are only two television companys, Sony and LG. In this contest the company need to inspect the following aspects.

a) What will be the attitude of the rival company, in response to the increace in adverticement expenditure by the company.

b) Pay of strategy, when the rival company does not react


c) When the rival company also decide to increace adverticement expenditure.

After collecting the information the company has to select the best possible strategy. There by it can maximize it’s sails. The best possible strategy is called the dominant strategy, that gives the optimum payoff.

4) Monopolistic Competition or Imperfect Competition

Perfect competition and monopoly are two extreme situation in the real world there exist a combination of competition and monopoly. Which is known as imperfect competition or monopolistic competition. The term monopolistic competition was developed by Prof. Chamberlain It is so called because it has the elements of both monopoly and perfect competition. This market situation was developed by Mr. John Robinson and Prof. Chamberlain John Robinson called it as imperfect competition.

Characteristics or Feature of Imperfect competition

1) Large number of buyers and sellers.

Under monopolistic competition there are a large number of buyers and sellers. So any buyer can buy any seller and any seller can sell to any buyer. So a single buyer or seller can’t influence the market. The buyers and sellers are ‘price takers’ and not ‘price makers’. The price of a commodity is determined by the market demand and market supply. Hence the demand curve is parallel to the horizontal axis.

2) Products are hydrogenous.

Under monopolistic competition products are different in quality, color, packing, but they are substitutes.

3) Freedom of entry and exit.

Here products are free to ender or leave out from the market any time. As a result profit will be always normal. Normal profit is the profit the profit that is assumption for continuing the business. There is neither lose or gain.

If profit is more than normal some new producers may enter the market their by profit decreases and becomes normal on the other hand if it is less than normal some of existing producers may leave out. Hence profit increases and becomes normal. Prof. Chemberline used the term “Group” rather than industry.

4) Selling Cost is existing.

This is an important feature of monopolistic competition. It is the cost for advertisement and propaganda.

Equation for finding selling cost: Selling cost = Total cost – Production cost

SC = TC - PC

Selling Cost

It is the cost for adverticement and propeganta. TC = PC + SC

There for SC = TC – PC

Here TC is Total Cost curve and PC is the Production Cost curve. At OM output, TC is MQ and production cost is MR.

Selling cost (SC) = TC – PC

That is = MQ – MR = QR

Price and Output Determination

In Short run

In the short run a monopolistic firm is in equilibrium were MC = MR. This output determination can be explained with the help of the following diagram

In this diagram output is taken on the OX axis and cost and revenue on the OY axis, MC is the marginal cost curve, AC is the Average Cost curve , MR is the Marginal revenue curve and AR is the Average revenue curve.

Here MC = MR at the point R at this point output is OM. Average Revenue (AR) MQ.

Total revenue (TR) = Output x AR

= OM x MQ = OMQP

Here AC is MR

Total cost (TC) = Output x AC

= OM x MR = OMRS

Profit = Total revenue – Total cost (TR – TC)

= OMQP – OMRS

= PQRS ( Shaded area)

In Long run

Long run is a period were much changes will occur. There is freedom of entry and exit. Hence profit will be normal.

In the long run a monopolist firm is in equilibrium here MC = AR.

AC =

Total cost (TC)

Output

AR =

Total revenue (TR)

Output

That is the revenue per unit. This can be explained with the help of the following diagram.

Here output is taken on the OX axis, cost and revenue on the OY axis. MC is the Marginal cost curve, AC is the average cost curve, AR is the Average revenue curve and MR is the Marginal revenue curve. Here MC = MR at the point R. The equilibrium output is OM, AC = AR at the OM output. Here AR is MQ and AC is also MQ. Here AR and AC is equal. So profit is normal.

Price and Output Determination In Monopoly.

In Short run

Short run is a period were much changes will not occur. That is new firms may not enter or the existing firms may not leave out.

Under monopoly, the monopolist is in equilibrium at the point were MC=MR. At this point price and profit will be high. The average revenue (AR) curve is downward sloping, showing that higher the price lower is the demand and vice versa. The following diagram shows the price and output determination in the short run.

These are the main types of markets, based on the competition.

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