Markets

• Components of Market
sellers
buyers
product
price
exchange

• Market is set of conditions in which buyers and sellers contact

each other and conduct exchange transactions.
Classification of Market
• Based on
• Area (Local, Regional, National,…)
• Volume of business (Wholesale & Retail)
• Time (short period, long period,…)
• Status of sellers (Producers, Wholesalers, Retailers,…)
• Regulations (Regulated and Un-regulated)
• Competition (Perfect,…..,Monopoly)
• Market structure
• Competitive behaviour
Different market structures
– Perfect competition
– Imperfect competition
• Monopoly
• Duopoly
• Monopolistic competition
• Oligopoly
– With product differentiation
– Without product differentiation
Classifying markets (by degree of competition)
– number of firms
– freedom of entry to industry
• free, restricted or blocked?
– nature of product
• homogeneous or differentiated?
– nature of demand curve
• degree of control the firm has over price
 Features of the four market structures

Type of Number Freedom of Nature of examples Nature of

Market of firms entry product demand
curve
Perfect very free/unrestri homogeneous horizontal
competition large cted
Monopolistic many unrestricted/ differentiated restaurants/ downward
competition relatively builders sloping,
easy relatively
elastic
Oligopoly few restricted undifferentiated cement/cars downward
/ sloping,
differentiated relatively
inelastic
Monopoly one completely unique downward
blocked sloping,
more
inelastic
than
oligopoly
Perfect Competition
Monopolistic Competition
Oligopoly (undifferentiated)
Oligopoly (differentiated)
Monopoly
 Perfectly Competitive Market
Assumptions
• Large number of buyers and sellers
– Seller is a price taker

• Homogeneous product
– Identical, perfect substitutes

• Free entry and exit

– Profit-firms will enter the market and vice-versa

• Perfect knowledge of the market

– Buyers & sellers are completely aware of prices

• Existence of a single and uniform price

– Both buyers and sellers cannot influence the price
Short-run equilibrium of industry and firm under perfect competition
P
S

Pe

D
O
Q

Industry
 Perfect Competition: Price & Revenue

Output Price Total Average Marginal

Revenue Revenue Revenue

1 6 6 6
2 6 12 6 6
3 6 18 6 6
4 6 24 6 6
5 6 30 6 6
6 6 36 6 6
7 6 42 6 6

Hence we say under perfect competition, Price=AR=MR

 P=AR=MR

P S P

P = AR = MR

Qe Q Q
(a) Industry (b) Firm
 Perfect Competition

• Short-run equilibrium of the firm

– Price
• given by market demand and supply

– Output
• Where MC=MR and MC cuts MR from below

– Profit
= TR-TC
• (AR – AC) × Q
• possible supernormal profits
 Equilibrium of industry and firm under perfect competition

P P
S

Pe D = AR
AR
= MR

Equilibrium Point
-MC=MR=Price
- MCDcut MR from below &
O MC must be raisingO after Qe
Q Q
Equilibrium Point

(a) Industry (b) Firm

 Profit maximisation under perfect competition

Super Normal
P Rs
Profit
S (AC < Price) MC AC

Pe D = AR
AR
AC = MR

D
O O Qe
Q Q

(a) Industry (b) Firm

 Loss minimisation under perfect competition
Loss (AC > Price)

P P AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Normal Profit

Normal Profit
MC = MR
P P AC = AR
S MC
AC

D2 = AR2
P2 AR2
= MR2
D2
O O
Q Q

(a) Industry (b) Firm

 Short-run shut-down point

P P AC
S MC
AVC

D2 = AR2
P2 AR2
= MR2
D2
O Q O
Q

(a) Industry (b) Firm

 Perfect Competition

• Short-run equilibrium of the firm

• short-run supply curve of firm

• the MC curve

• Short-run supply curve of industry

• sum of supply curves of firms

 Perfect Competition

• The long run

• long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
 Long-run equilibrium under perfect competition

Profits return
Supernormal
New firms enter to normalprofits
P P
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Long-run equilibrium of the firm under perfect competition
Cost,
Revenue
(SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

O output
• Firm is in equilibrium when MC=MR and MC cuts MR from
below(or MC must be rising).
• Firm maximizes the profit when the price(AR) exceeds the AC.
• Firm minimizes the loss when AC exceeds AR.
• In the short run firms earn either supernormal profits(when AR
exceeds AC), incurs loss (when AC exceeds the AR) and
normal profits (AR equals AC) or will be forced to shut
down(when price or AR falls short of minimum of AVC).
 Long Run Equilibrium under perfect competition

• Long run shows the entry and exit of the firms into the
industry. If firms in the industry make supernormal profits in
the short run, new firms will enter the industry till the excess
profits get wiped out.

• Similarly, If firms in the industry incurs loss, existing firms

will quit the industry so that the remaining ones will be able to
make at least normal profits.

• Thus, under long run, firm and industry under perfectly

competitive market will earn only normal profits.