Last Updated on: 19th September 2024, 12:56 pm

Market Analysis

Market

In this part, we discuss about Market Analysis and related topics like:

• Market Forms
• Competition
• Monopoly
• Equilibrium of Firm
• Price

Market

In general terms, Market means a specified place where buyers and sellers meet each other to buy and sell commodities. In economics, Market denotes the entire area were buyers and sellers of commodities are in such a close contact with each other, that the price of a commodity tend to be uniform throughout the area, and price in one area affects the price is another area. 

The market for a product may be local (e.g. bricks), national (e.g. sugar) or international (e.g. gold).

Market Forms

Depending on competitive situation, there are different market forms, like : Pure Competions, Perfect competition, Imperfect competition, Monopolistic competition, Monopoly competition, Duopoly competition, Oligopoly competition, etc.

Pure Competition

Pure competition exists where there are many sellers (so that one cannot influence the market), items are similar and there is free entry and exit.

Perfect Competition

The Perfect Competition is a form of market situation like Pure Competition, in which there is a large number of buyers and sellers, free entry of all the firms in the market of product. Moreover, both the buyers and sellers have perfect knowledge about the market situation.

Features of Perfectly Competitive Market : Large number of buyers & sellers. Product is homogeneous in nature. Firm is a price taker. Free entry & exit. Knowledgable buyers & sellers. Perfect mobility of factors. Absence of transport & selling cost

Characteristics of Perfect Competition

• There is perfect mobility of commodities, transport cost is negligible, and there is close communication between buyer and seller.  
• In perfect competition, there are large number of firms. Naturally any individual firm cannot influence the market price of commodity. Firm has to accept the price available in the market. So, under perfect competition, firms are price taker.
• Under perfect competition, as the firm is price taker, marginal revenue per unit is fixed for the firm because price is fixed. So, marginal revenue curve under perfect competition is straight line
• In perfect competition market situation, demand curve is linear and parallel to X axis. MR Curve = AR = Demand Curve is a feature of Perfect Competition  market
• In perfect competition the firms earn normal profits in long run (not the supernormal profits as the entry of outside firms are free). If average revenue (AR) is more than average cost (AC), the firm earns super normal profit.

Monopolistic Competition

Monopolistic Competition exists when there is a large group of firms producing commodities similar to one another, but not identical.

Monopolistic competition is a variety of imperfect competition and conceptually it is nearer to the Perfect competition, than the other varieties of imperfect competition.

Under Monopolistic competition, the cross elasticity of demand for the product of a  single firm would be zero

• Pure Monopoly : Pure Monopoly exists if there is only one seller with closed entry, producing goods for which there is no ideal substitute. It implies complete control over supply and leads to super profits.
• Duopoly : Duopoly means control over supply by two firms. Duopoly is generally regarded as a special case of oligopoly.
• Oligopoly: Oligopoly existswhere only a few firms control the supply. In an Oligopoly situation, each firm has to consider carefully the price and output policies of the other firms (rivals) and plan its price and output policies accordingly. OPEC, an organisation of a few petroleum selling countries, is an example of oligopoly
• Monopsony : Monopsony is monopoly of buyer. It exists when there are many sellers but only one buyer. Monopsony is rarely found.
• Duopsony : Duopsony is a situation where there are only two buyers but many sellers. Where there are only a few buyers but many sellers, it is referred as Oligopoly.
• Bilateral Monopoly : It is a situation where there is only one seller and only one buyer (e.g. in labour market). The workers in an industry may be members of a single Trade Union, which fixes the terms under which labour is supplied. There may, on the other side, be a single employer, or all the employers may be organized in a single association, which fixes the terms under which labour is employed. Wages (the price of labour) is, determined by negotiation between the two monopolists (employer’s Association and the Trade Union) through Collective Bargaining.

Equilibrium of Firm under Perfect competition

A firm is in equilibrium when it has no tendency to change its level of output. It needs neither expansion nor contraction. A firm will be in equilibrium when it is earning maximum profits.

Equilibrium of the firm can be analysed in both short-run and long-run periods. In the short run, a firm may earn the maximum profits or may incur the minimum loss. But in the long run, it can earn only normal profit

• Short Run: Under perfect competition, the marginal revenue is equal to price. The individual firm, under perfect competition, maximizes its net revenue by fixing output at the point where the marginal cost is equal to the price. So the formula MR (marginal revenue) = MC (marginal Cost) becomes p = mc. If the marginal cost is less than the price, the firm gains by expanding output. If the marginal cost is higher than the price, the firm incurs losses and must reduce its marginal cost by reducing output. If it cannot do so, it must abandon production.

Under perfect competition, the individual firm cannot influence the price. It takes the average revenue curve adjusting its output, according to its marginal cost curve.

• Long Run: In the long run, the total revenue of the firm must equal its total cost of production (“total cost” includes normal profits).

If the total revenue is greater than the total cost, the firm is making excess profits. In such situation, new firms will be attracted into the industry, the total output of the industry will increase and the price will fall, excess profit is wiped away.

If the total revenue is less than the total cost, the process will be reversed. Some firms, will exit causing reduction in the total output, causing rise of prices. Finally at equilibrium, the total revenue must equal total cost.

Under perfect competition, a firm attains equilibrium in long run when price = Minimum average cost of production. 

Imperfect Competition

Imperfect competition implies a market situation where one or more of the conditions of perfect competition is not satisfied. Market is said to be imperfect, when some of the buyers or sellers or both are not fully aware of the prices in the market. Thus, imperfect competition is a broad term, which includes duopoly, oligopoly and monopolistic competitive markets.

Under imperfect competition, a firm maximize its profit when MR = MC.

Features of Imperfect Competition

• Players: There exist large number of buyers and large number of small producers-cum-sellers in the market. The sellers have no feeling of mutual interdependence among them.
• Products: Products are not identical but close substitutes. Each firm is a small monopolist in its area of production of a particular substitute product.
• Entry : Unrestricted entry of new firms in the market.
• Marketing: Each firm has its own selling cost, particularly advertising in local area create monopoly situation for its substitute product in the market.
• Market Segmentation: The buyers have imperfect knowledge about market, which creates segmentation of total market in which individual firms have monopolistic conditions.  

Monopolistic Competition

The theory of monopolistic competition is developed by H.E. Chamberlin.

Monopolistic competition is a market situation where there are many producers, but each offers a slightly differentiated product. Monopolistic market is dominated by a few. So, firms can influence price determination. So, under monopolistic competition market firm can be considered as price maker. They are not takers/givers/acceptors of price.   

Characteristics of Monopolistic competition

• Entry and exit: The firms has total freedom to enter or exit the industry. No limitation are imposed on them.
• Large Number of buyers and sellers: There are large numbers of firms. The sellers are more than that of oligopoly, but less than that of perfect competition market.
• Profit motive: Firm earns a surplus profit due to selling price and product differentiation. Firms earn profit through price discrimination.
• Nature of product: Product of each seller differ from each other.

Equilibrium of Firm under Monopolistic Competition and Oligopoly

• The individual firm under monopolistic competition and oligopoly face a downward sloping average revenue curve, and the marginal revenue is always less than the average revenue.
• The products of the different firms in the group are not perfectly substitute of another. They differ in quality, trade name, brand reputation, or just location.
• A firm wishing to increase its sales, must either reduce the price or shift the demand curve by some form of sales initiative (advertisement, special service or, even bribery or coercion). If shifting the demand curve (or increasing consumers’ preference for the product) is not practicable, price reduction is the ultimate recourse.

Under monopolistic competition, the firm earn normal profits in the long run a because LAR = LAC, as there is excess capacity with them.

Marginal Cost & marginal Revenue: Reduction of price reduces the marginal revenue. However, as long as the marginal revenue is greater than the marginal cost, it is profitable to expand production. The total revenue is maximum at the level of output where the marginal revenue is equal to the marginal cost. Atthis point, there is no difference between a firm under monopolistic competition and firms under any kind of imperfect competition or under perfect competition, as every firm tries to maximize its net revenue.

Selling Expenses: In monopolistic competition and oligopoly, price reduction is not the only method of increasing sales. Advertisement, propaganda and salesmanship play an important part and forms a substantial part of the total expenditure of the firm.

Under monopolistic competition, firm seeks to maximize the Net Revenue:

[Price x Output] –[Production Costs + Selling Costs]

The firm will extend its selling expenditure up to the point at which the marginal revenue from the sales expenditure is equal to the marginal increment of such expenditure. Taking production costs and selling costs together, the marginal cost must also be equal to the marginal revenue.

Monopoly

Pure Monopoly (or perfect or absolute monopoly) is the situation when there is single seller of a product, with no close substitute, without any competitor.

Characteristics of Monopoly

• Monopoly firm has a dominating power to price determination. To check price increase, government impose restrictions on monopoly. Price fixation save consumers from increase of price to unwanted level.
• Monopoly market is dominated by single seller. So, under long run, monopoly can earn abnormal profit.
• At the time of price fixation, monopoly firm consider marginal cost of production as well as price elasticity of demand.
• By setting a lower price than any new entrant, a monopolist try to increase its production to large scale to drive the new entrant out of business. Large scale provides economics of scale by reducing production cost.

Demerits of Monopoly

• When a monopolist exercise the market power by limiting supplies, he will become richer at the expense of those who consume his product.
• In absence of competition, there will be no pressure on the monopolist firms to be economical to keep down costs.
• In the interest of consumers, the state may intervene and fix a maximum selling price.

Equilibrium of a Monopoly Firm

In Monopoly, a single firm controls the entire output or a commodity. The monopolist regulates output to get the highest possible profit.

The Condition of Equilibrium. The net revenue is maximum at the level of output where marginal cost is equal to the marginalrevenue.

Assume that a monopolist can sell 20 units of a commodity’ at Rs.5 each. The total revenue is Rs.100. Assume that he can sell 21 units at Rs.4.90 each. The total revenue now is Rs.102.90. The marginal revenue is Rs.2.90. If the marginal cost, i.e., the cost of producing the 21st unit is less than Rs.2.90, the monopolist will gain by manufacturing the 21st unit.

As long as marginal revenue is more than marginal cost, the monopolist will go on increasing his output to increase his profit. He will stop production when marginal revenue is equal to marginal cost. Beyond this point, marginal cost is greater than marginal revenue and further production involves a loss. Hence total revenue is maximum at the level of output where marginal revenue is equal to marginal cost.

Monopoly Equilibrium-dvidya.com

In the Monopoly Equilibrium graph as shown, DD^’ is the demand curve for a monopolist’s product or the average revenue curve and MC is the curve of marginal costs. AC shows the average cost. Under monopoly, the marginal revenue is less than price. So the marginal revenue at each level of output will be shown by a downward sloping line lying below the average revenue curve. MR shows marginal revenue. MR and MC intersect at K. Therefore marginal cost and marginal revenue are equal when output is OA. The average revenue curve shows that when output is OA, the price is OP or AB. The monopolist will secure maximum net revenue when he produces OA units.

The monopoly price is AB. The net monopoly revenue  = total revenue – total cost =(OA x AB) – (OA x AE) = OABP – OAEG = PBEG

Price Discrimination

Price Discrimination means charging different prices from different buyers of the same commodity or service. This can be done under monopoly but cannot be done under perfect competition.

Types of Price Discrimination

• Personal Discrimination: The monopolist can charge higher price from intent buyers having ability to pay. Normally such discrimination is made in a veiled manner.

For example, the new book of a famous writer may first be issued as de luxe edition with a very high price. Only the richer classes will purchase this. Finally a low priced (e.g., a paper back) edition is published for common people. The de luxe edition has a prestige value, so those who are able may be induced to pay more.

• Local Discrimination: Different prices may be charged from different localities. Prices in fashionable shops, where the richer buyers go, are often higher than in ordinary market shops. Sometimes the monopolist charges lower prices in a foreign market than in the home market (known as Dumping).
• Trade or Use Discrimination: Different prices may be changed, having regard to ability to pay. Thus commercial rate of electricity is higher than for domestic consumption. Rent for commercial space may be more than residential space. Price of LPG for commercial use is higher than for domestic use.

Conditions of Price-discrimination

• Restriction in Price discrimination
  • The demand is not transferable from the high priced market to the low priced market. If rich people do not buy de luxe editions but wait for cheap ones, personal discrimination in books is not possible.
  • The buyers of low priced articles cannot resell them in the high priced market. If domestic buyers of cheap LPG are allowed to resell it for commercial use, there can never be two prices for LPG.
  • Price-discrimination may not be possible if there is legal restriction. In some cases (e.g., in public utility services) the monopolist may be compelled by law to charge uniform prices
• Situations of price discrimination
  • Where consumers are ignorant of prices being charged from others, the monopolist finds it easy to charge different prices.
  • When consumers can be induced to believe that they are getting something different from others, they can be charged at a higher rate. This is frequently done by slightly varying the product (e.g. using different kinds of packages).
  • In case of direct services, which cannot be resold by the buyer (e.g., medical advice or a haircut), discrimination is easy.
  • Different prices can be charged from consumers situated in different localities

Profitable situations of price-discrimination for monopolist

• The demand for the monopoly product can be split up into different markets.
• The elasticity of demand in different markets are different.
• The cost of keeping the various markets separate is not large relative to the differences in the demand elasticities.

Benefits of price discrimination

• Beneficial to society. Price-discrimination may sometimes be beneficial to society. For example, if a doctor charges low fees from poor patients and high fees from rich ones.
• Beneficial to the poor. First class passengers pay comparatively more, so that second class passengers pays less. Therefore the system of charging discriminatory fares is beneficial to the poorer classes.

Evils of price discrimination

• The price charged in price discrimination is based on the principle, “as the traffic will bear”. This means that every consumer is charged the maximum price he can pay, Therefore price discrimination leads to exploitation of consumers.
• Consumers’ surplus is wholly extracted or much reduced.
• All the evils of the monopoly are found in the price discrimination in an increased manner.

Dumping

• Dumping is a technique of international price discrimination.
• Dumping is not possible when price elasticity of demand in the international market is higher than that of domestic market.

Oligopoly

Oligopoly means there are only a few producer. The products of the oligopolists may be identical or may be differentiated.

Pure oligopoly is a market condition in which a few industries produce a homogeneous products. 

Kinked demand curve is found in oligopoly market. Horizontal demand curve is found in perfect competition market 

Reasons of Oligopoly. Pure competition and pure monopoly are not normally found. Instead, we normally generally find oligopoly and monopolistic competition, due to 1. Economies of large scale production. 2. Monopolistic combinations to eliminate competition. 3. Product differentiation which leads to consumer preferences. 4. Tariff barriers (elimination of foreign import leads to advantages to local firms), etc.

Features of Oligopoly

• Limited sellers: There are few number of sellers.
• Differentiation: The products of the oligopolists may be differential or perfectly identical.
• Interdependence: Pricing under oligopoly is more complicated than under perfect competitions or monopolistic competition. As there are only a few producers in an oligopoly, it is difficult to predict rival’s strategy. For example, a price-cut by one producer may not be followed by a price-cut by the others. Therefore in an oligopoly, each depends on the others.
• Varying power: Oligopolists have different monopoly power.
• Selling costs: The oligopolists have to employ various strategies to get a greater share of market. Advertising is very important in this type of market.

Selling Cost

The term Selling Cost is used to denote costs of advertisement, salesmanship and other expenses incurred to influence the customers and consumer demand.

Advertisements

• Informative advertisement :  The object of informative advertisement is to acquaint the people with useful products. Informative advertisement spreads knowledge and is therefore socially advantageous for useful goods, while advertisements of harmful goods are socially disadvantageous.
• Competitive Advertisement : The object of competitive advertisement is to promote the sale of the products of a particular firm against those of others. Competitive advertisements are not useful from the social standpoint as they involve wastage of resources.

Selling Cost and Demand Curve

Selling costs affect the demand through imperfect knowledge of buyers, which in turn, makes demand less elastic. The role of selling costs becomes greater when there is product differentiation.

Selling costs are incurred to shift the demand curve to an upper position. Though it is difficult to predict effect of selling costs on demand curve, the normal tendency is to shift the demand curve to upper position.

Effect of Selling Costs

Selling Costs increase total cost and make prices higher. But sales expenditure usually increase demand and increase output, ultimately resulting lower production costs and lower prices. In modern times, however, competitive advertisement costs are so high that they amount to more than the gains from lower production costs. Therefore, selling costs often increase total costs and prices.

• Selling Costs and the Cost Curves : When selling costs are incurred, the average and marginal cost curves firm lie above the original one. If selling costs are a fixed sum, the marginal costs remain unaffected and average costs will decrease.
• Selling costs under pure competition : Selling costs are not necessary under pure competition. As there are many buyers and sellers, it is presumed that every firm under pure competition can sell as much as it wants at the current price. Hence there is no need of selling costs.
• Selling costs under monopoly : Under monopoly, competitive advertisements are not necessary as there are no competitors. But there may be informative advertisements intended to spread knowledge of the products of the monopolist. Monopolists often use advertisements as propaganda that they charge fair prices and that the goods are of high quality, to keep the public pleased.
• Selling costs under monopolistic competition : Under monopolistic competition and oligopoly, competition is usually very keen and the firms spend large sums of money to fight one another. Selling costs in these cases may even exceed production costs.

Price Mechanism

Price Mechanism is a self-adjusting and self-correcting mechanism that regulates and controls the economic activities. Price is determined by the interaction of demand and supply forces.

Role of Price Mechanism in a Free Market

Price mechanism plays an important role in performing the following functions.

• Products: In a free market economy, there are large number of buyers and sellers. Producer has to decide the level of quantity to be produced. Similarly buyer has to decide his level of consumption. The price trend indicate the relative preferences of consumers motivating the producer to produce goods of high prices to earn higher profit.
• Production Methods: The producer should decide the production techniques with lowest production cost.
• Buyers: In a free economy, price mechanism determines consumer’s selection, taste and preferences and helps the producer to produce the goods according to the consumers preferences.   

Role of Price Mechanism in Socialistic Economy

In socialist economic system (known as communist economic system), production factors and all consumers price mechanism has less applicability. Prices are determined by the state.  

MCQ related to Micro Economics

MCQ related to Market

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