Concept of Market
For an individual it would mean a shopping complex or a place where he/she can buy things. But, in economics, the concept of market is very different from this. It doesn’t refers to any geographical area where goods are sold and purchased. Instead, it refers to all such systems that bring the buyers and sellers in contact with each other to settle the sale and purchase of goods. The system could be an electronic mail or an online order for a product.
Types of Markets
Mainly there are four types of market
1. Monopoly
2. Oligopoly
3. Monopolistic Competition
4. Perfect Competition
Explanation
1. Monopoly – It is a form of market in which there is a single seller of a product with no close substitutes. For example Railways in India are a monopoly industry of the government of India.
An Industry is a Group of Firms producing a particular product.
Features of Monopoly
1. One seller and large number of buyers
2. Sells Homogeneous or Differentiated product
3. Price is not uniform because of Price Discrimination
4. Restrictions on the entry of the new firms
5. Imperfect Knowledge
6. Imperfect Mobility
7. Slopes Downward with Low Elasticity (AR>MR)
8. No Advertising Costs
9. Full control over price
10. Earns Extra-Normal Profits or Abnormal Profits in the Long Run. (AR>AC)
11. No close Substitutes
Price Discrimination – Price Discrimination refers to the practice of charging different prices for different buyers for the same good or product.
Conclusions
1. A Firm under Monopoly is a Price Maker.
2. Demand Curve in case of a Monopoly Firm Slopes Downward.
3. A Monopoly Firm earns Abnormal Profits or Extra Normal Profits, both in the short run and the long run.
2. Oligopoly – Oligopoly is a form of market in which there are a few big firms and a large number of buyers of a commodity (product). Each firm has a significant share of the market. Price and output decision of one firm significantly impacts the price and output of decisions of the rival firms in the market. There is a high degree of interdependence among the competing firms, Price and output policy of one firm depends on the price and output policy of the other’s.
Features of Oligopoly
1. Small Number of Big Firms or Sellers and a large number of Buyers
2. Sells Homogeneous or Differentiated Products
3. Price is Not Uniform because of product differentiation
4. Entry Barriers
5. Imperfect Knowledge
6. Imperfect Mobility
7. Firms Demand Curve can’t be Specified , because there is no specific relationship b/w price and quantity demanded
8. Advertising Costs
9. Partial control over Price
10. High Degree of Interdependency in Decision Making
11. Non-Price Competition
12. Earns Extra-Normal Profits or Abnormal Profits in the Long Run. (AR>AC)
3. Monopolistic Competition – It is a form of market in which there are many buyers and sellers of the product, but the product of each seller is different from that of the other. So there are many sellers, selling a differentiated product. Product differentiation is generally promoted through trademark or brand name. For example firms producing different brands of toothpastes, like Colgate, Close-up, Pepsodent etc.
Monopolistic Competition includes the features of monopoly and perfect competition. Trademark or Brand Name gives some monopoly power to the firms.
Features of Monopolistic Competition
1. Large number of buyers and sellers
2. Product Differentiation
3. Price is Not Uniform, because of product differentiation
4. Freedom of entry and exit
5. Lack of perfect knowledge
6. Lack of perfect mobility
7. Downward Sloping Demand Curve, high elasticity of demand, (AR>MR)
8. Advertisement Cost
9. Partial control over price
10. Non-Price Competition
11. Normal Profits in long run (AR = AC)
4. Perfect Competition – Perfect Competition is said to be exist when there is a large number of sellers and buyers of a commodity (product), and no individual buyer or seller has any control over its price. Product is homogeneous and its price is determined by the forces of market supply and market demand.
Feature of Perfect Competition
1. Large number of small Buyers and Sellers of a Commodity (Product)
2. Sells Homogeneous Product
3. Uniform Price of Product
4. Freedom of Entry and Exit
5. Perfect Knowledge
6. Perfect Mobility
7. Perfectly Elastic Demand
8. Slope of the Demand Curve is Horizontal Straight Line (AR = MR)
9. No Advertising Costs
10. No Control over Price
11. Normal Profits in long run (AR = AC)
12. No Extra Transport Cost
13. Independent Decision Making (related to price and output)
Conclusions
1. A Firm under perfect competition is a Price Taker, not a Price Maker
2. Demand Curve of the form under perfect competition is Perfectly Elastic
3. A Firm under perfect competition earns only Normal Profits in the long run.
Monopoly – The Power Player
The term monopoly has been derived from a Greek word Monopolian, which means a single seller.
Monopoly market is the extreme opposite of Perfect Competition.
According to Prof. Thomas, “Broadly, the term monopoly is used to cover any effective price control, whether of supply or demand of services or goods; narrowly it is used to mean a combination of manufacturers or merchants to control the supply price of commodities or services.”
Monopoly is a form of market in which there is only one seller of a product with no close substitutes and a large number of buyers. For example – Railway is a monopoly industry in India.
Features of Monopoly
1. One seller and a large number of buyers
There is only one seller and a large number of buyers and there are no close substitutes of the product, So there exists Price Discrimination and Full Control Over Price, this makes the Monopolist a Price Maker.
2. No Substitutes of the Product.
3. Price Discrimination
When a producer or seller charges different prices to different buyers for the the same product, it is called price discrimination.
Full Control over Price
Monopoly firm is a Price Maker
4. Independent Decision Making
There is only one firm in the industry and has no competitor, so it can increase or decrease price of its product, it has full control over price, so it has Independent Decision Making Power.
5. Earns Extra normal profits (AR>AC)
Monopolist can fix any price he wants, This gives Extra-Normal Profits or Abnormal Profits to the monopolist in Long Run as well as in the Short Run.
6. Imperfect Knowledge
Information is restricted to the organization and people working within the organization. This information is not available to others, so the other firms and buyers have no perfect Knowledge about it.
7. Monopoly firm lacks the Mobility of factors of production
8. Barriers to the Entry of new firms
There are some barriers to the entry of the new firms in the industry. Mostly monopoly firm has exclusive control over the production or over the raw material needed for production, There can be patent rights secured by the monopoly firm, to prevent new firms from entering in the industry.
There can be other barriers like technical, legal, natural, very high initial investment etc.
9. No Advertisement Cost
There is only one firm or producer so there is no need to advertise product, so there is no advertising cost.
10. Downward sloping demand curve (AR>MR)
There is an inverse relationship between the the price and quantity sold by the monopoly firm, so that demand curve of the monopoly firm slopes downward.
11. Low Elasticity of Demand
There is only one seller of the product and buyers have to have the product, so they will buy it, maybe in a less quantity if the price is increased, which results in the low elasticity of demand.
Oligopoly – It Takes Large Resources To Enter In
The term oligopoly has been derived from two Greek words, oligoi means few and poly means control.
According to Prof. George J. Stigler, “Oligopoly is a market situation in which a firm determines its marketing policies on the basis of expected behavior of close competitors.”
Oligopoly refers to a market form in which there are few sellers selling either in homogeneous or differentiated products and there is a large number of buyers. For example – Aviation and Telecommunication industries in India.
Each firm has a significant share of the market. Price and output decision of one firm significantly impacts the price and output of decisions of the rival firms in the market. There is a high degree of interdependence among the competing firms, Price and output policy of one firm depends on the price and output policy of the other’s.
Features of Oligopoly
1. Small Number of Big Firms or Sellers and a large number of Buyers
In oligopoly, there is a few firms which are producing either homogeneous or differentiated products.
If firms produce homogeneous products, for example – cement, concrete, and bricks, the industry is said to be pure or perfect oligopoly.
In case of differentiated products, for example – automobile, the industry is known as differentiated or imperfect oligopoly.
2. Sells Homogeneous or Differentiated Products
3. Price is Not Uniform
Because of the product differentiation, firms can fix higher prices for their products, this gives the firms partial control over price, it also helps firms to create brand loyalty. Brand loyalty can be achieved by advertising and providing better products than their competitors.
4. Advertising Costs
Under oligopoly firms have other competitors, producing nearly substitutes, so the firms have to do a lot of advertising to increase their market share and brand loyalty, this increases the prices of the products.
5. Partial control over Price
6. Entry Barriers
There are barriers to entry of the new firms. These barriers can be of different types such as patent rights, very high initial capital investment, full control over raw material resources of existing firms etc.
7. Imperfect Knowledge – No one in the industry knows all about the firms and the quality of their products.
8. Factors of production are not perfectly Mobile
9. Firms Demand Curve can’t be Specified , because there is no specific relationship b/w price and quantity demanded.
10. High Degree of interdependency in Decision Making
The market share of each firm is so significant that it affect the price and output policy of the other firms significantly, so there is a very high degree of interdependence among the competing firms.
This kind of interdependence makes it very difficult to specify the any relationship between the price and quantity demanded. So it is not possible to draw a specific demand curve for an oligopoly firm.
11. Non-Price Competition
Firms under oligopoly tends to avoid price competition. Non-price competition helps firms to establish brand loyalty, Greater the the brand loyalty, higher the market share, higher the control over the price.
12. Firms under oligopoly Earns Extra-Normal Profits or Abnormal Profits in the Long Run (AR>AC) mostly by forming groups and fixing high prices for their products.
Perfect Competition
According to 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.” But, just in case, for those who haven’t read that, Here we will discuss this in details.
According to Mrs. Joan Robinson —”Perfect Competition prevails when the demand for the output of each producer is perfectly elastic.”
A Perfect Competition market is that market in which there is a number of buyers and sellers, all are engaged in buying and selling a homogeneous product, and individual buyer or seller has any control over its price and the price is determined by the forces of market supply and market demand.
Features of Perfect Competition
1. Large Number of Buyers and Sellers of a Product
The number of buyers are so large that the demand of an individual buyer is only a small fraction of the market demand and the number of sellers are so large that supply of an individual seller is only a small fraction of the market supply. So the demand and supply remains unaffected.
Because of this the Demand Curve of becomes a Horizontal Straight Line.
2. Selling Homogeneous Product means No Product Differentiation
Under Perfect Competition each firm sells a Homogeneous product.
A product is Homogeneous when each unit of it is identical in shape, size, colour, weight and in every way or manner.
3. No Control over Price
When the product is homogeneous, a firm has no control over price, just a little bit increase in price will shift its buyers to other firms identical product.
4. No Advertising Cost
When there is identical or Homogeneous products, there is no need to do advertising.
5. Uniform Price of the Product
Because the products are Homogeneous and firm’s have no control over its price, the price of the products is decided by the market forces of supply and demand, So there is Uniform price in all over the market.
Perfectly Elastic Demand (Ed = infinite) shows firm has no control over price.
Slope of Demand Curve is Horizontal Straight Line (AR = MR), a firm can sell any quantity of its product at the prevailing market price.
6. Freedom of Entry and Exit
Any new firm can enter in the industry and any old firm can exit from the industry. There are no restrictions or barriers to it.
7. Perfect Knowledge
This is also a feature of perfect competition, buyers and sellers have the complete knowledge that the products are homogeneous and other important information related to price, quality etc.
8. Perfect Mobility of Factors Of Production
In perfect competition, factors of production are perfectly mobile, factors of production can be shifted easily
9. No Transportation Cost
Buying a product from one seller or the other doesn’t involve any extra transportation cost. This means no producer or seller is able to charge higher price for the product. There is only one price in the market.
10. Independent Decision Making
There is no agreement between any firms regarding quality or price.
Under Perfect Competition there is Maximum Output and Minimum Cost.
11. Firms under Perfect Competition Earns Normal Profits in the Long Run (AR=MR)
This is due to the fact that there is freedom of entry and exit. In times of extra normal profits, new firms will enter in the industry, which will increase the supply and decrease the price, extra normal profits will be gone in such case. In times of extra normal losses, some firms will leave the industry, which will cause fall in supply and increase in price, extra normal losses will be gone in this type of cases.
Monopolistic Competition – Real Life Applications
According to William Baumol, “The term monopolistic competition refers to the market structure in which the sellers do have a monopoly (they are the only sellers) of their own product, but they are also subject to substantial competitive pressures from sellers of substitute products.”
In Monopolistic Competition sellers sells the products which have close substitutes, but not the perfect substitutes, which is a characteristic of monopoly & there is a large number of sellers and buyers of products, which is a characteristic of perfect competition, So it has the characteristics of both monopoly and perfect competition.
The product of each seller is different from the other in one way or the other, such as difference in brand, shape, color, style, trademarks, durability, and quality. Therefore, buyers can easily differentiate among the available products in more than one way, (this is a feature of monopoly) this difference in products is called Product Differentiation, it also helps firm’s to create Brand Loyalty.
Examples – Car Companies produces cars, all cars are different from each other in some way. Similarly Clothing Brands or Companies, Shoe Companies, Bike Companies and so much more which you can find around you with a brand name.
Due to the product differentiation sellers can sell their products at different prices, to maximize their profits. But there is a limit to it because their products have close substitutes, if sellers charge high price than their competitors for their products, consumers can shift to the close substitutes of their products, & if sellers charge less than their competitors for their products, consumers can get suspicious about their products and the intentions of sellers. So the sellers in the monopolistic competition have to fix the prices in a range, so they can partially control the prices of their products & earn profits.
Firms earns Normal Profits under Monopolistic Competition in the Long Run & has Partial Control over price, which leads to Partial Monopoly Power.
Average Revenue is equal to the Average Cost in the Long Run, (AR=AC), in Monopolistic Competition.
Due to a large number of close substitutes of a product in the market, Elasticity of Demand of the firm’s product tends to be high, means a little bit of change in price of product causes a large change in its Demand, ( If the price is increased the by one unit then decrease in demand will be more than a unit and if the price is decreased by one unit then demand will increase by more than a unit or percentage change in quantity demanded is greater than percentage change in price of the product, Ed>1 ).
Now comes the Advertising Cost,
Advertisement is the most important constituent of the selling cost which affects demand as well as price of the product, it also helps the monopolists to increase their market share and Brand Loyalty. And there is more reason to advertise because they are selling products which have close substitutes, so advertisement is a must.
Lack of Perfect Knowledge
The buyers and sellers do not have the perfect knowledge of the products in the market. There is a large number of products each being a close substitutes of the other.So this is nearly impossible for the buyers to know all about these products and their qualities and their prices. Similarly, sellers does not know the the exact preference of buyers.
Lack of Perfect Mobility of Factors of Production
This is because if an firm is willing to move its factors of production or goods and services, it has to pay heavy transportation cost and other charges depending on the policy of the government in that locality or state or country & there can be other unforeseen expenses too. This leads to difference in the prices of products of firm.
Free Entry and Exit of Firms
There are no restrictions of the firms to enter in or exit from the industry. However there may be products of some firms which are legally patented, so the new firms entering in this industry can’t produce and sell identical products. Example – No rival firm can produce or sell a patented item like Woodland brand of shoes.
Slope of the Demand Curve
Partial control over price leads to Downward Sloping Demand Curve of the firm, quantity sold increases when price is reduced and decreases when price is increased.
Average Revenue is greater than Marginal Revenue. (AR>MR) under monopolistic competition.
Non-Price Competition
Non-Price Competition is a marketing strategy adopted by the a firm to increase its market share by promoting its product through advertisement or publicity. In this strategy firms avoid getting into price war.
Examples – A firm offers better service, after sale of the durable goods, like the service facility for AC, TV, Refrigerate when required, even when the price is not lowered or increased.
There is a difference between Producer & Seller, all Producers are seller because they sell their products to other seller or to consumers, But all sellers are not producers, because they may be selling the products manufactured by other producers.
Real Life Applications
Suppose you are entering in an industry as a Producer, Then you must know about the markets.
And Ask Yourself some Questions –
Q 1. Is this the Industry I want to enter and Produce a ABC Product ?
Q 2. What is my Product ?
Q 3. How much Knowledge Do I have about the industry and the product ?
Q 4. What resources Do I have ?
Q 5. What is my current Financial Situation ?
Q 6. How much budget Do I have ? And Is it sufficient to get to the other side or to succeed in this field or Industry ?
Q 7. What is the difference in my Product and my Competitor’s ?
Q 8. How much competition I’m going to face ?
Q 9. Is this a cyclic industry or ever growing ?
Q 10. How long I wish to be in this industry ? And what will be exit plan ?
Q 11. What will be my strategy to survive in the long run as well as in the short run ?
Q 12. What will be Advertising Strategy, budget, medium of advertisement ?
Q 13. At What price it will be sold and what are the prices of its close substitutes ?
Q 14. How much time Do I have to give to this Business ?
Q 15. How am I going to cover the unforeseen expenses ?
Q 16 What is that you’re expecting from this Venture ?
Q 17. How can I create a brand name for my product ?
Q 18. What will be the expected profit in starting, in midway, in Long Run ?
Q 19. Can I afford to lose what I am going to invest in this venture, if it didn’t go well ?
Q 20. And Then Most IMPORTANT QUESTION, IF THIS DIDN’T GO THE WAY IT SHOULD BE , WHAT AM I GOING TO DO THEN ?
Aim Institute of Economics 