Lecture Note#3 Market Structure and Pricing Dr. Mahmoud ...

Lecture Note#3 Market Structure and Pricing Dr. Mahmoud Arafa

E-mail: Mahmoud.arafa@agr.cu.edu.eg Page:

3 Meaning and Definition of Market 3.1 Characteristics of a market: 3.2 Classification of Markets 3.2.1 Market according to Area 3.2.2 Market according to time 3.2.3 Market according to competition 3.2.3.1 Perfect Competition 3.2.3.2 Monopoly 3.2.3.3 Monopolistic Competition 3.2.3.4 Oligopoly 3.3 Summary 3.4 Questions and Problems 3. Meaning and Definition of Market:

Market generally means a place or a geographical area, where buyers with money and sellers with their goods meet to exchange goods for money. In Economics market refers to a group of buyers and sellers who involve in the transaction of commodities and services. 3.1. Characteristics of a market: 1. Existence of buyers and sellers of the commodity. 2. The establishment of contact between the buyers and sellers. Distance is of no

consideration if buyers and sellers could contact each other through the available communication system like telephone, agents, letter correspondence and Internet. 3. Buyers and sellers deal with the same commodity or variety. Since the market in economics is identified on the basis of the commodity, similarity of the product is very essential. 4. There should be a price for the commodity bought and sold in the market.. 3.2. Classification of Markets

Markets classified into three main categories according to Area, time, and competition. Each category has subdivisions as we will see. 1. Market according to Area

2. Market according to time 3. Market according to competition 3.2.1 Market according to Area Based on the extent of the market for any product, markets can be classified into local regional, national and international markets. Local Market A local market for a product exists when buyers and sellers of commodity carry on business in a particular locality or village or area where the demand and supply conditions are influenced by local conditions only. E.g. Perishable goods like milk and vegetables and bulky articles like bricks and stones. National Market When commodities are demanded and supplied throughout the country, there is national market e.g. wheat, rice or cotton Regional Market Commodities that are demanded and supplied over a region have regional market. Global Market When demand and supply conditions are influenced at the global level, we have international market. e.g. gold, silver, cell phone etc. On the basis of demand and supply, this geographical classification is made. With improved transport facilities and communications, even goods of local markets can become international goods. 3.2.2. Market according to time Marshall classified market based on the time element. In economics "time" does not mean clock time. It means only the division of time based on extent of adjustability of supply of a commodity for a given change in its demand. The major divisions are very short period, short period and long period. Very Short Period Very short period refers to the type of competitive market in which the supply of commodities cannot be changed at all. So in a very short period, the market supply is perfectly inelastic. The price of the commodity depends on the demand for the product alone. The perishable commodities like flowers are the best example. Short-period Short period refers to that period in which supply can be adjusted to a limited extent by varying the variable factors alone. The short period supply curve is relatively elastic. The short period price is determined by the interaction of the short-run supply and demand curves.

Long Period Long period is the time period during which the supply conditions are fully able to meet the new demand conditions. In the long run, all (both fixed as well as variable) factors are variable. Thus the supply curve in the long run is perfectly elastic. Therefore, it is the demand that influences price in the long period. 3.2.3. Market according to competition These markets are classified according to the number of sellers in the market and the nature of the commodity. The classification of market according to competition is as follows.

Market

Perfect Competition

(Large number of sellers selling homogeneous products

Imperfect competition

Monopoly (Single Seller)

Duopoly (2 Sellers

Oligop oly (A few sellers selling hom ogeneous or differentiated

products)

Monopolistic

competition

(Large number of

sellers selling differentiatd products)

3.2.3.1. Perfect Competition Perfect competition is a market situation where there are infinite numbers of sellers that no one is big enough to have any appreciable influence over market price. Features and Conditions of perfect competition 1. Large number of buyers and sellers: There are a large number of buyers and sellers in a perfect competitive market that neither a single buyer nor a single seller can influence the price. The price is determined by market forces namely the demand for and the supply of the product. There will be uniform price in the market. Sellers accept this price and adjust the quantity produced to maximize their profit. Thus the sellers in the perfect competitive market are price- takers and quantity adjusters.

2. Homogeneous Product: The products produced by all the firms in the perfectly competitive market must be homogeneous and identical in all respects i.e. the products in the market are the same in quantity, size, taste, etc. The products of different firms are perfect substitutes and the cross elasticity is infinite.

3. Perfect knowledge about market conditions: Both buyers and sellers are fully aware of the current price in the market. Therefore the buyer will not offer high price and the sellers will not accept a price less than the one prevailing in the market.

4. Free entry and Free exit: There must be complete freedom for the entry of new firms or the exit of the existing firms from the industry. When the existing firms are earning super-normal profits, new firms enter into the market. When there is loss in the industry, some firms leave the industry. The free entry and free exit are possible only in the long run. That is because the size of the plant cannot be changed in the short run.

5. Perfect mobility of factors of production: The factors of productions should be free to move from one use to another or from one industry to another easily to get better remuneration. The assumption of perfect mobility of factors is essential to fulfill the first condition namely large number of producers in the market.

6. Absence of transport cost: In a perfectly competitive market, it is assumed that there are no transport costs. Under perfect competition, a commodity is sold at uniform price throughout the market. If transport cost is incurred, the firms nearer to the market will charge a low price than the firms far away. Hence it is assumed that there is no transport cost.

7. Absence of Government or artificial restrictions or collusions: There are no government controls or restrictions on supply, pricing etc. There is also no collusion among buyers or sellers. The price in the perfectly competitive market is free to change in response to changes in demand and supply conditions.

Nature of Revenue curves Under perfect competition, the market price is determined by the market forces namely the demand for and the supply of the products. Hence there is uniform price in the market and all the units of the output are sold at the same price. As a result the average revenue is perfectly elastic. The average revenue curve is horizontally parallel to X-axis. Since the Average Revenue is constant, Marginal Revenue is also constant and coincides with Average Revenue. AR curve of a firm represents the demand curve for the product produced by that firm. Short run equilibrium price and output determination under perfect competition

1. Since a firm in the perfectly competitive market is a price-taker, it has to adjust its level of output to maximize its profit. The aim of any producer is to maximize his profit.

2. The short run is a period in which the number and plant size of the firms are fixed. In this period, the firm can produce more only by increasing the variable inputs.

3. As the entry of new firms or exits of the existing firms are not possible in the shortrun, the firm in the perfectly competitive market can either earn super-normal profit or normal profit or incur loss in the short period.

Super-normal Profit When the average revenue of the firm is greater than its average cost, the firm is earning super-normal profit. Short-run equilibrium with super-normal profits In figure 2, output is measured along the x-axis and price, revenue and cost along the yaxis. OP is the prevailing price in the market. PL Line is the demand curve or average and the marginal revenue curve. SAC and SMC are the short run average and marginal cost curves. The firm is in equilibrium at point (E) where MR = MC and MC curve cuts MR curve from below at the point of equilibrium. Therefore the firm will be producing OM level of output. At the OM level of output ME is the AR and MF is the average cost. The profit per unit of output is EF (the difference between ME and MF). The total profits earned by the firm will be equal to EF (profit per unit) multiplied by OM or HF (total output). Thus the total profits will be equal to the area HFEP. HFEP is the supernormal profits earned by the firm.

Pr ice

Revenue

MC

Costs

P AR MR E

ATC

P

L

Profits

H

F

O

Y

M

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