Micro economics

Unit-4
Market
General meaning:
A market is any place where the sellers of a
particular good or service can meet with
the buyers of that goods and service and
where there is a potential for a transaction
to take place. The buyers must have
something they can offer in exchange for
there to be a potential transaction.
Features:
1. a commodity or a set of commodities that
can be bought or sold.
2. buyers and sellers of commodities.
3. price determination by means of bargaining
4. a region or regions whereby the commodity
will be traded.
In economics market is the trading of a
commodity or commodities at a particular
price reached at after bargaining between
buyer and seller.
Classification of market
1.On the basis of area or scope:
a. Local market: a market of commodities
which is confined to a particular region
Example: Fish , Vegetables ,Milk.
b. National market: a market of commodities
that covers a whole country.
Example: Cosmetics , Cloths.
c. International market: a market of
commodities which is not confined to the
geographical boundary of a country.
Example: Tea , Jute, Cotton, Gold.
On the basis of time:
Very short period market: a market that lasts few hours
or few days
Example: fish , vegetables , milk
Short period market: a market whereby supply can be
changed to a limited extent in response to the change in
demand. Example : cloths
Long period market: a market whereby supply can be
fully adjusted to the changes in demand. A firm can
change its production capacity
Very long period market: a market whereby the tastes,
habits of buyers can be changed and the supplier is in a
position to change his production s and procedures to
cope with the ever changing demand.
Market on the basis of competition
1.Perfect competitive market
2.Imperfect competitive market
a. Monopoly
b. Duopoly
c. Oligopoly
d. Monoposony
e. Monopolistic competition
Perfect competitive market:
Perfect competitive market is characterized
by many buyers and sellers, many products
that are similar in nature and, as a result,
many substitutes.
 Perfect competition means there are few, if
any, barriers to entry for new companies,
and prices are determined by supply and
demand.
Characteristics of perfect competition
Large Number of Small Firms
A perfectly competitive market or industry contains a large
number of small firms, each of which is relatively small
compared to the overall size of the market. This ensures that no
single firm can exert market control over price or quantity.
Identical Goods
Each firm in a perfectly competitive market sells an identical
product, which is also commonly termed "homogeneous
goods." The essential feature of this characteristic is not so
much that the goods themselves are exactly, perfectly the same,
but that buyers are unable to discern any difference.
Perfect Resource Mobility
Perfectly competitive firms are free to enter and exit an
industry. They are not restricted by government rules and
regulations, start-up cost, or other barriers to entry. While
some firms incur high start-up cost or need government
permits to enter an industry, this is not the case for perfectly
competitive firms.
Perfect Knowledge
In perfect competition, buyers are completely aware of sellers'
prices, such that one firm cannot sell its good at a higher price
than other firms. Each seller also has complete information
about the prices charged by other sellers so they do not
inadvertently charge less than the going market price.
 Imperfect competitive market
a. Monopoly: when there is only one buyer in a market it is called
monopoly.
A monopoly is a market structure in which there is only one
producer/seller for a product. In other words, the single business
is the industry.
Entry into such a market is restricted due to high costs or other
impediments, which may be economic, social or political.
For instance, a government can create a monopoly over an
industry that it wants to control, such as electricity. Another
reason for the barriers against entry into a monopolistic industry
is that oftentimes, one entity has the exclusive rights to a natural
resource. For example, in Saudi Arabia the government has sole
control over the oil industry.
Characteristics of monopoly
Single Supplier
The essence of a monopoly is a market controlled
by a single seller. The "mono" part of monopoly
means single. The single seller, of course, is a
direct contrast to perfect competition, which has
a large number of sellers.
Unique Product
To be the only seller of a product, however, a
monopoly must have a unique product.
Barriers to Entry and Exit
A monopoly is generally assured of being the
ONLY firm in a market because of assorted
barriers to entry. Some of the key barriers to entry
are: (1) government license or franchise, (2)
resource ownership, (3) patents and copyrights, (4)
high start-up cost, and (5) decreasing average total
cost.
Specialized Information
Monopoly is commonly characterized by control
of information or production technology not
available to others. This specialized information
often comes in the form of legally-established
patents, copyrights.
Other characteristics:
There are many buyers in the market.
The firm enjoys abnormal profits.
The seller controls the prices in that
particular product or service and is the
price maker.
The product does not have close
substitutes.
 Why might Monopolies arise?
1. State monopoly: A government may create a
statutory or legal monopoly giving a certain
body the sole right to supply a particular good
or provide a certain service. The Act which
creates the monopoly places a legal restriction
on competition.

2. Control of critical resources: A particular firm

may have exclusive access to the only source of
supply of the raw materials necessary for the
production of a certain commodity. Mining
firms would be examples of this type of
monopoly.
3. Capital intensive monopoly: Certain industries
require such a large investment of capital in plant and
equipment that any form of competition from potential
rivals is completely discouraged e.g. aircraft
manufacturing, ship-building, steel firms etc.

4. Legal restriction: A firm which develops or invents

a new product or process can use the law of patents,
franchise, copyright etc. to obtain the sole right of
manufacture of the product or use of the process. In our
country production of arms and ammunitions is done
only by BOF(Bangladesh ordnance factory)

5. Trade Agreements: All the firms within a certain

industry, may by agreement, adopt completely uniform
policies on price and output. This type of agreement
effectively creates a monopoly. (OPEC on Oil
production).
Duopoly: a market controlled by only two sellers.
A true duopoly is a specific type of oligopoly where only
two producers exist in one market. In reality, this
definition is generally used where only two firms have
dominant control over a market.
A situation in which two companies own all or nearly all
of the market for a given product or service. A duopoly
is the most basic form of oligopoly, a market
dominated by a small number of companies. A
duopoly can have the same impact on the market as a
monopoly if the two players collude on prices or
output.
Oligopoly:
In an oligopoly, there are only a few firms that make
up an industry. This select group of firms has control
over the price and, like a monopoly, an oligopoly has
high barriers to entry.
The products that the oligopolistic firms produce are often nearly
identical and, therefore, the companies, which are competing
for market share, are interdependent as a result of market
forces.
Assume, for example, that an economy needs only 100
computers. Company X produces 50 computers and its
competitor, Company Y, produces the other 50.
The prices of the two brands will be interdependent and,
therefore, similar. So, if Company X starts selling the
computers at a lower price, it will get a greater market share,
thereby forcing Company Y to lower its prices as well.
Monoposony
When there is only one buyer in a market it is
termed as monoposony.
A market similar to a monopoly except that a large
buyer not seller controls a large proportion of the
market and drives the prices down. Sometimes
referred to as the buyer's monopoly.
Monopolistic competition
Monopolistic competition is a type of
imperfect competition whereby many
producers sell products that are
differentiated from one another (e.g. by
branding or quality) and hence are not
perfect substitutes.
In monopolistic competition, a firm takes the
prices charged by its rivals as given and
ignores the impact of its own prices on the
prices of other firms
Definition of ‘Monopolistic Competition'

A type of competition within an industry where:

1. All firms produce similar yet not perfectly

substitutable products.

2. All firms are able to enter the industry if the

profits are attractive.

3. All firms are profit maximizers.

4. All firms have some market power, which

means none are price takers.
Monopolistic competitive market is a
form of imperfect competitive market where many
competing producers sell products that are
differentiated from one another (that is, the
products are substitutes, but, with differences such
as branding, are not exactly alike).
In monopolistic competition firms can behave like
monopolies in the short-run, including using
market power to generate profit. In the long-run,
other firms enter the market and the benefits of
differentiation decrease with competition; the
market becomes more like perfect competition
where firms cannot gain economic profit
Profit maximization
Profit is the excess of revenue over expenses.
An assumption in classical economics is firms
seek to maximize profits.
Profit = total revenue – total costs
therefore, profit maximization occurs at
the biggest gap between total revenue and
total costs.
A Firm can maximize profits if it produces at an
output where marginal revenue (MR) =
marginal cost (MC)
Diagram of Profit Maximization
 
To understand this principle look at the above
diagram. If the firm produces less than Q1, MR
is greater than MC. Therefore, for this extra
output, the firm is gaining more revenue than
it is paying in costs. Total revenue will increase.
Close to Q1, MR is only just greater than MC,
therefore, there is only a small increase in
profit. But, profit is still rising.
However, after Q1, the marginal cost of the
output is greater than the marginal revenue.
This means the firm will see a fall in its profit
level.
Profit in monopoly
In this diagram, the monopoly maximises
profit where MR=MC – at y*. This enables
the firm to make supernormal profits (Blue
area). Note, the firm could produce more
and still make normal profit. But, to
maximize profit, it involves setting higher
price and lower quantity than a competitive
market.
Therefore, for a firm profit maximization
involves selling a lower quantity and at a
higher price.
Profit in perfect competition

In perfect competition, the same rule for profit

maximization still applies. The firm maximizes profit
where MR=MC. Here the firm earns supernormal profit.
 Equilibrium of a firm in perfect competition
Equilibrium refers to a production level where the profit
is maximum.
In perfect competition a firm takes a price which was fixed
earlier. So in perfect competition a firm only determines the
amount of output and it has no bearing in price. In perfect
competition a firm can attain equilibrium under following
conditions-
a.MC=MR
b. Slope of MC curve > slope of MR curve
Equilibrium can be
a. Short-run equilibrium
b. Long-run equilibrium
Short run equilibrium
Short run does not indicate any time duration.
Short-run
Economists define the short run as situation when factors of
production can not be changed completely fixed. For
example, for a particular company this might mean that they
have reached full capacity in a warehouse or at a factory site.
These short-run costs consist of both fixed and variable costs.
In short run a firm can face three situations
A firm can earn -
1.super normal profit
2.Normal profit
3.or can attain equilibrium at loss.
Equilibrium with super normal profit

In short run a firm can earn super normal

profit. A firm can reduce average cost (AC)
by using its experience , efficiency or any
location benefits. Those can make a firm
able to earn super normal profit.
Conditions :
P=AR=MR=SMC>SAC
OX axis shows quantity of out put and OY axis shows
revenue and cost. AR = MR curve shows the average and
marginal revenue of the firm. SAC and SMC curve
denotes short run average cost and marginal cost. At the
point a SMC curve intersects MR line from below. So
point a is the equilibrium point.
Here , equilibrium output is OM and equilibrium price is
OP.
As per diagram total revenue of the firm is OPAM and
total cost is OP1BM.
Total profit is PABP1.
Here the firm attains equilibrium with super normal
profit. Super normal profit as per diagram is PABP1.It is
also known as economic profit.
Equilibrium with normal profit
In short run a firm can attain equilibrium
with normal profit
Normal profit is the profit that inspires a firm
to carry on its business.
Condition:
SMC=MR=AR=SAC
Equilibrium with losses
In short run a firm can attain equilibrium
while it is incurring losses. In this situation
average cost is higher than average revenue.
Condition:
SMC=MR=AR>SAC.
Long run equilibrium of a firm
Long-run
In contrast, economists define the long-run as
being the time period when all the factors of
production can be changed. So in the
example above, the company can now look
to expand its warehouse or factory capacity
without any problems.
 Equilibrium of a monopoly firm
A monopoly firm can control price and supply. So here
equilibrium means determining the price and quantity.
Equilibrium in monopoly can be classified into two types
a. Short run equilibrium
b. Long run equilibrium
In short run a firm can attain equilibrium in three
situation-
a. Equilibrium with super normal profit
b. Equilibrium with normal profit
c. Equilibrium with loss
In long run a firm can attain equilibrium in two
situation-
a. Equilibrium with super normal profit
b. Equilibrium with normal profit

To attain equilibrium in monopoly following two

conditions are to be fulfilled-
a.MC=MR
b.MC curve intersects MR curve from below.
Short run equilibrium in monopoly
Equilibrium with super normal profit: in short run a firm
can earn super normal profit. Here the condition of
equilibrium is SMC=MR<AR. And AR>SAC which
means average revenue or price will be higher
than the average revenue.
In above diagram OX(land) axis shows quantity of
supply and OY(vertical) axis shows price , revenue
and expense.
AR and MR curves show average revenue and
marginal revenue. SAC curve denotes short run
average cost .and SMC curve denotes short run
marginal cost.
as per diagram, the firm attains equilibrium at the
point a where SMC=MR. here equilibrium
production is OM and equilibrium price is OP. at
this price
total revenue=OPCM
Total cost =OP1BM
So super normal profit is PP1BC.
 Equilibrium with normal profit
or
zero profit

In monopoly a firm can attain equilibrium

with normal profit.
Condition:
SMC=MR<AR=SAC. That means a firm earns
normal profit where the average cost is equal
to average revenue.
Equilibrium of a firm with loss
In short run a firm can carry on its production
while it is making loss. Because in short run
a firm is to bear fixed cost. In this situation
if the firm sees that it can recover a portion
of fixed cost if it keeps its production going,
the firm will continue its production on loss.
Condition:
a. SMC=MR<AR
b. AVC<AR<SAC
Long run equilibrium in monopoly
In long run a firm will not continue its production
while it is making loss. In long run a firm can earn
super normal profit due to its nature. In monopoly
only one firm produces so there is no close
substitute of the product. No new firm can enter
the market. So in monopoly the only firm can
exercise sole control over market supply. So it can
fix any price for the product as it wishes. Thus it
can earn super normal profit.
Though the sole firm can earn super normal
profit in long run but a logical and deliberate
monopolist can earn nor mal profit in long run.
The reasons are as follows
1.New competitor firm can appear in the market
seeing the super normal profit.
2.Customers may be dissatisfied on super normal
profit.
3. The government can impose restrictions.
Normal profit in long run
Super normal profit in long run