Name of the Programme: B.Com.

Name of the Course: Business Economics

Course Code:

Unit: 3

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 Meaning, Definitions of Market and its Features

 Ordinarily, the term “market” refers to a particular place where goods are
purchased and sold.
 A market is an arrangement between buyers and sellers to exchange goods or
services for money.
 Definitions of Market:
 1. Cournot’s definition – the French economist Cournot defined a market thus
“Economists understand by the ‘Market’ not any particular market place in which
things are bought and sold but the whole of any region in which buyers and
sellers are in such free intercourse with one another that the prices of the same
goods tend to equality, easily and quickly.”
 According to Prof. Behham – “We must therefore, define a market as any area
over which buyers and sellers are in such close touch with one another either
directly or through dealers that the prices obtainable in one part of the market
affect the prices in other parts.”

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 Features of Market:
 Essential characteristics of a market are as follows:
 1. One commodity:
 In practical life, a market is understood as a place where commodities are bought and sold
at retail or wholesale price, but in economics “Market” does not refer to a particular place as
such but it refers to a market for a commodity or commodities i.e., a wheat market, a tea
market or a gold market and so on.
 2. Area:
 In economics, market does not refer only to a fixed location. It refers to the whole area or
region of operation of demand and supply
 3. Buyers and Sellers:
 To create a market for a commodity what we need is only a group of potential sellers and
potential buyers. They must be present in the market of course at different places.
 4. Perfect Competition:
 In the market there must be the existence of perfect competition between buyers and
sellers. But the opinion of modern economist is that in the market the situation of imperfect
competition also exists, therefore, the existence of both is found.

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 Business relationship between Buyers and Sellers:
 For a market, there must exist perfect business relationship
between buyers and sellers. They may not be physically present
in the market, but the business relationship must be carried on.
 6. Perfect Knowledge of the Market:
 Buyers and sellers must have perfect knowledge of the market
regarding the demand of the customers, regarding their habits,
tastes, fashions etc.
 7. One Price:
 One and only one price be in existence in the market which is
possible only through perfect competition and not otherwise.

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 Market Structure
 Meaning:
 Market structure refers to the nature and degree of competition in
the market for goods and services. The structures of market both
for goods market and service (factor) market are determined by the
nature of competition prevailing in a particular market.
 Definition: A market structure can be understood as a system for
categorising the products and services offered by the firms,
according to the nature and level of competition in the market. A
‘market’ in economics is an actual or virtual area where sellers and
buyers communicate to carry out trade activities is known as a
market in economic terms.

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Determinants of Market Structure

There are a number of determinants of market structure for a

particular good.
They are:
(1) The number and nature of sellers.
(2) The number and nature of buyers.
(3) The nature of the product.
(4) The conditions of entry into and exit from the market.
(5) Economies of scale.

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 Number and Nature of Sellers:
 The market structures are influenced by the number and nature of sellers in the
market. They range from large number of sellers in perfect competition to a
single seller in pure monopoly, to two sellers in duopoly, to a few sellers in
oligopoly, and to many sellers of differentiated products.
 Number and Nature of Buyers:
 The market structures are also influenced by the number and nature of buyers in
the market. If there is a single buyer in the market, this is buyer’s monopoly and is
called monopsony market. Such markets exist for local labour employed by one
large employer. There may be two buyers who act jointly in the market. This is
called duopsony market. They may also be a few organised buyers of a product
 Nature of Product:
 It is the nature of product that determines the market structure. If there is
product differentiation, products are close substitutes and the market is
characterised by monopolistic competition. On the other hand, in case of no
product differentiation, the market is characterised by perfect competition.
 . 7
 Entry and Exit Conditions:
 The conditions for entry and exit of firms in a market depend upon
profitability or loss in a particular market. Profits in a market will
attract the entry of new firms and losses lead to the exit of weak
firms from the market. In a perfect competition market, there is
freedom of entry or exit of firms.
 Economies of Scale:
 Firms that achieve large economies of scale in production grow
large in comparison to others in an industry. They tend to weed out
the other firms with the result that a few firms are left to compete
with each other. This leads to the emergency of oligopoly

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 Forms of Market Structure:
 On the basis of competition, a market can be classified in the
following ways:
 1. Perfect Competition
 2. Monopoly
 3. Duopoly
 4. Oligopoly
 5. Monopolistic Competition

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Forms of Market Structure with examples

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Perfect Competition
 Perfect competition is a market structure where a large number of small firms compete
against one another with homogeneous products. Both buyers and sellers(firms) have
perfect information about market
 Perfect competition is a type of market where many firms offer a homogeneous product.
All firms are price taker and not price maker. Individual firm cannot influence market
price because market price is determined based on demand and supply conditions.
 A Perfect Competition market is that type of market in which the number of buyers and
sellers is very large, all are engaged in buying and selling a homogeneous product without
any artificial restrictions and possessing perfect knowledge of the market at a time.
 Examples of perfect competition
 In the real world, it is hard to find examples of industries which fit all the criteria of
‘perfect knowledge’ and ‘perfect information’. However, some industries are close.
 Foreign exchange markets. Here currency is all homogeneous. Also, traders will have
access to many different buyers and sellers. There will be good information about relative
prices. When buying currency it is easy to compare prices/exchanage rate
 Agricultural markets. In some cases, there are several farmers selling identical products
to the market, and many buyers. At the market, it is easy to compare prices. Therefore,
agricultural markets often get close to perfect competition. 11
Characteristics of Perfect Competition:
 The following characteristics are essential for the existence of Perfect Competition:
 1. Large Number of Buyers and Sellers:
 The first condition is that the number of buyers and sellers must be so large that none of
them individually is in a position to influence the price and output of the industry as a whole.
In the market the position of a purchaser or a seller is just like a drop of water in an ocean.
 Homogeneity of the Product:
 Each firm should produce and sell a homogeneous product so that no buyer has any
preference for the product of any individual seller over others. If goods will be homogeneous
then price will also be uniform everywhere.
 3. Free Entry and Exit of Firms:
 The firm should be free to enter or leave the firm. If there is hope of profit the firm will enter
in business and if there is profitability of loss, the firm will leave the business.
 4. Perfect Knowledge of the Market:
 Buyers and sellers must possess complete knowledge about the prices at which goods are
being bought and sold and of the prices at which others are prepared to buy and sell. This
will help in having uniformity in prices.

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 Perfect Mobility of the Factors of Production and Goods:
 There should be perfect mobility of goods and factors between industries. Goods
should be free to move to those places where they can fetch the highest price.
Absence of Transport Cost
 There must be absence of transport cost. In having less or negligible transport
cost will help complete market in maintaining uniformity in price.

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Short-run Equilibrium of a Competitive Firm
under perfect competition.
 In the short-run, there the following assumptions:
 The price of the product is given and the firm can sell any quantity at that
price
 The size of the plant of the firm is constant
 The firm faces given short-run cost curves
 We know that the necessary and sufficient conditions for the equilibrium of a
firm are:
 MC = MR
 MC curve cuts the MR curve from below
 In other words, the MC curve must intersect the MR curve from below and
after the intersection lie above the MR curve.
 A firm is in equilibrium when it has no tendency to change its level of output.
It needs neither expansion nor contraction. It wants to earn maximum profits
in by equating its marginal cost with its marginal revenue, i.e. MC = MR. it can
seen in table.
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Short-run Equilibrium of a Competitive Firm: Profit
Maximization.

Marginal Cost (MC

Price Total Cost Total Revenue Profit (?) Marginal Revenue (MR in Rs) MC MC=TCn-
put (Q) (units)
(P) (TC in Rs) (TR in Rs) (ARxQ) (TR-TC) in Rs) (P = MR)
TCn_1

1 24 26 24 -2 24 26

2 24 50 48 –2 24 24

3 24 72 72 0 24 22

4 24 92 96 4 24 20

5 24 115 120 5 24 23

6 24 139 144 5 24 24

7 24 165 168 3 24 26
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 Price- Output Determination in Short run

Four Possibilities in Short-run

In a perfectly competitive market, a firm can earn a normal profit, super-normal
profit, or it can bear a loss.
1.Normal Profit It is a situation in which P = AC or TR = TC. Or AR =AC It is also
referred as a no profit and no loss situation.
Break-even Point Break-even for a firm occurs when it is able to cover its all
costs of production. Under this situation, the firm earns only normal profit, i.e.
neither super normal profits nor super normal losses. This situation prevails at
the point where Total Cost is equal to Total Revenue
2. Super normal profit : It is a situation in which P > AC or TR > TC Or AR >AC
3. Losses It is a situation in which TR < AC or P < AC .
4. Shut Down Point It is defined as a situation when TR = TV C or AR = AV C. It
occurs when firm is just able to cover its variable costs, incurring the loss of
fixed cost of production

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 In case of Normal Profit

In the above figure, you can see that the costs and revenue are on the Y-axis and the
Quantity is on the X-axis. Further, marginal costs cut the marginal revenue curve from below
at point A. At point ‘A’, P is the equilibrium price and ‘Q’ is the equilibrium quantity of output.
Note firm produce OQ output and cost of producing OQ is OPAQ. After producing OQ output
and sold in market and receives sales total revenue is OPAQ the total cost is equal to the
total revenue. It also means that the firm is earning a normal profit.
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In Case of Super-normal Profit

In the figure above, the per unit revenue or average revenue is OP* while the per unit cost or average
cost is OP’. Therefore, the per unit receipts are high in comparison with the per unit cost. That’s why
the average revenue curve lies above the average cost curve corresponding to Q*. The firm is
earning super-normal profits.
or
Note firm produce OQ* output and cost of producing OQ* is OP’AQ*. After producing OQ* output and
sold in market and receives sales total revenue is OP*BQ* the total revenue is more than total
revenue. It also means that the firm is earning a super normal profit.
The per unit profit is P’P* and the total profit is for quantity OQ* is P’P*BA. 18
 In Case of Loss

In the figure above, the cost and revenue curves are on the Y-axis and the quantity demanded is on
the X-axis. Further, the marginal cost curve cuts the marginal revenue curve from below at point ‘A’,
the equilibrium point.
Corresponding to point ‘A’, P* and Q* are the equilibrium price and quantity respectively. Also,
corresponding to Q*, the average cost is more than the average revenue.
In this case, the per unit cost of OQ* (average cost) is more than the per unit revenue of OQ*
(average revenue). As per the figure, the per unit revenue is OP and the per unit cost is OP’. this
means that the per unit loss is PP’. Also, the total loss on quantity OQ* is P*P’BA.

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 Long-Run Equilibrium of the Firm

 Long-Run Equilibrium of the Firm:

 The long run is a period of time in which the firm can change its plant and scale of
operations. Thus in the long-run all costs are variable and there are no fixed costs.
The firm is in the long-run equilibrium under perfect competition when it does not
want to change its equilibrium output.
 It is earning normal profits. If some firms are earning supernormal profits, new
firms will enter the industry and supernormal profits will be competed away. The
number of firms will go up in market which will lead to increase output and supply..
When supply increases, price will decline which lead to revenue and profit decline.
If some firms are incurring losses, some of the firms will leave the industry till all
earn normal profits.
 Thus there is no tendency for firms to enter or leave the industry because every
firm must earn normal profits. “In the long-run, firms are in equilibrium when they
have adjusted their plant so as to produce at the minimum point of their long-run
AC curve, which is tangent (at this point) to the demand (AR) curve defined by the
market price” so that they earn normal profits.

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 Long-run Equilibrium Conditions

 Each firm of the industry will be in long-run equilibrium when it fulfils the
following two condition.
 1) In equilibrium, its short-run marginal cost (SMC) must equal to its long-run
marginal cost (LMC) as well as its short-run average cost (SAC) and its long-run
average cost (LAC) and both should equal MR=AR=P.
 Thus the first equilibrium condition is:
 SMC = LMC = MR = AR = P = SAC = LAC at its minimum point, and
 (2) LMC curve must cut MR curve from below: Both these conditions of
equilibrium are satisfied at point E in Figure. At point Firm maximize profit .

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 Since we assume equal costs of all the firms of industry, all firms will
be in equilibrium in the long-run. At OP price a firm will have neither a
tendency to neither leave nor enter the industry and all firms will earn
normal profits.

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 Monopolistic Competition
 Definition: Monopolistic Competition is type of market, in which there are a large
number of firms that produce differentiated products which are close substitutes
for each other. In other words, large sellers selling the products that are similar,
but not identical and compete with each other on other factors besides price.
 Examples of monopolistic competition
 Restaurants – restaurants compete on quality of food as much as price. Product
differentiation is a key element of the business. There are relatively low barriers to
entry in setting up a new restaurant.
 Hairdressers. A service which will give firms a reputation for the quality of their
hair-cutting.
 The Fast Food companies like the McDonald and Burger King who sells the burger
in the market are the most common type of example of monopolistic competition.
 Clothing. Designer label clothes are about the brand and product differentiation
 Different brand shops
 There are certainly a lot of bakeries in any town and each one of them sells a
slightly differentiated product to the consumer in the market.
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Features of Monopolistic
Competition

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 Product Differentiation: This is one of the major features of the firms operating
under the monopolistic competition, that produces the product which is not
identical but is slightly different from each other. The products being slightly
different from each other remain close substitutes of each other and hence
cannot be priced very differently from each other.
 Large number of firms: A large number of firms operate under the monopolistic
competition, and there is a stiff competition between the existing firms. Unlike
the perfect competition, the firms produce the differentiated products which are
substitutes for each other, thus make the competition among the firms a real and
a tough one.
 Free Entry and Exit: With an intense competition among the firms, the entity
incurring the loss can move out of the industry at any time it wants. Similarly, the
new firms can enter into the industry freely, provided it comes up with the unique
feature and different variety of products to outstand in the market and meet with
the competition already existing in the industry.

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 Some control over price: Since, the products are close substitutes for each
other, if a firm lowers the price of its product, then the customers of other
products will switch over to it. Conversely, with the increase in the price of the
product, it will lose its customers to others. Thus, under the monopolistic
competition, an individual firm is not a price taker but has some influence
over the price of its product.
 Heavy expenditure on Advertisement and other Selling Costs: Under the
monopolistic competition, the firms incur a huge cost on advertisements and
other selling costs to promote the sale of their products. Since the products
are different and are close substitutes for each other; the firms need to
undertake the promotional activities to capture a larger market share.

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SHORT RUN EQUILIBRIUM OF FIRM

 We know that the necessary and sufficient conditions for the equilibrium of a firm
are:
 MC = MR
 MC curve cuts the MR curve from below
 In other words, the MC curve must intersect the MR curve from below and after
the intersection lie above the MR curve.
 A firm is in equilibrium when it has no tendency to change its level of output. It
needs neither expansion nor contraction. It wants to earn maximum profits in by
equating its marginal cost with its marginal revenue, i.e. MC = MR.
 Under monopolistic competition, the firm will be in equilibrium position when
marginal revenue is equal to marginal cost. So long the marginal revenue is
greater than marginal cost, the seller will find it profitable to expand his output,
and if the MR is less than MC, it is obvious he will reduce his output where the
MR is equal to MC. In short run, therefore, the firm will be in equilibrium when it is
maximising profits, i.e., when MR = MC.It can seen in table.

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

 Short run is the time period in which there are fixed as well as variable factors
of production. Monopolistic firm can increase its output by increasing variable
factor only up to existing production capacity. short-run time period is too
short that no new firm can enter and no existing firm can leave the market so
a firm can face three situations in short-run

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 Super Normal Profit

 A firm may get super normal profit in short period of a time. Super
normal profit is a situation when average revenue (AR) is greater
than average cost (AC) at the equilibrium output.

Figure shows the super normal profit. Equilibrium is at point e.

Firm will produce OQ level of output and OP price will be charged.
Here average cost is BQ and average revenue is AQ. Per unit
super normal profit is AB. Total super normal profit are PABP1. 29
 Normal Profit: A firm may earn normal profit under monopolistic
competition. It is the situation when average revenue (AR) is equal
to average cost (AC) at the equilibrium level of output..
Figure 4: Normal Profit

Figure shows the normal profit. Firm’s equilibrium is at point E.

Firm is producing OQ level of output and charging OP level of price.
Here average revenue and average costs are equal i.e. AQ. So form
is getting normal profit
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 Losses: A firm may incur minimum losses in short-run. It is a situation when
average cost (AC) is greater than average revenue (AR) but a firm covers its

average variable cost .

Figure shows the minimum losses. Equilibrium of firm is at point E. Firm is producing OQ
level of output and OP1 price will be charged. Here average cost is AQ and average
revenue is BQ. Average cost is greater than average revenue. Firm is incurring losses
PP1BA. But here firm is covering average variable cost i.e. BQ. So these losses are
minimum losses.

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LONG RUN EQUILIBRIUM OF FIRM

 Long run is the time period when all the factors of production are variable. The
firm can change the size of the plant and machinery. New firms can enter into the
market or existing can leave the market. A firm will produce that level of output
where long rum marginal cost is equal to marginal revenue curve. A firm will earn
normal profit in long run under monopolistic competition because
 If there is super normal profit, new firms will enter into the group so it will
increase the supply into the market and price will fall. Again there will be normal
profit.
 In the long run to increase the demand a firm will reduce the price of the product
following it other firms will also reduce the price, resulting normal profit to all the
firms in the group.
 If there are losses to the firm in the short run it will try to recover it in long run but
still it incur losses in the long run it will exit the group. AR = LAC.


So in monopolistic competition each firm earns normal profit in the long run.

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Figure is depicting long run equilibrium of firm. Here equilibrium is at point E. Firm is
producing OQ level of output and will charge OP price. Here firm is getting normal profit
as average revenue is equal to average cost i.e. AQ. If there is super normal profit, new
firms will enter in the market or if firms are incurring losses then they will leave the
group. So in long run each firm will get normal profit.

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