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Economics Notes Unit 5

- Perfect competition is characterized by many small firms, homogeneous products, free entry and exit, and price-taking behavior where firms have no control over prices. - Features of perfect competition include a large number of buyers and sellers, product homogeneity, free entry and exit, profit maximization, no government intervention, and perfect factor mobility and knowledge. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly. Monopoly is characterized by a single seller, while oligopoly has a few dominant firms.

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89 views5 pages

Economics Notes Unit 5

- Perfect competition is characterized by many small firms, homogeneous products, free entry and exit, and price-taking behavior where firms have no control over prices. - Features of perfect competition include a large number of buyers and sellers, product homogeneity, free entry and exit, profit maximization, no government intervention, and perfect factor mobility and knowledge. - Market structures include perfect competition, monopoly, monopolistic competition, and oligopoly. Monopoly is characterized by a single seller, while oligopoly has a few dominant firms.

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ECONOMICS NOTES

$$ UNIT 5: Theory of firm and Markets

 Perfect Competition
 Perfect Competition is a market structure characterised by a complete absence
of rivalry among the individual firms.
 Perfect Competition is the world of price-takers. A perfectly competitive firm sells
a homogenous product (one identical to the product sold by others in the
industry.)
 The firm is so small relative to its market that it cannot affect the market price; it
simply takes the price as given.
 Features of Perfect Competition
i. Large number of sellers and buyers: The industry in Perfect Competition includes
a large number of sellers and buyers. Each individual firm produces only a small
part of the total quantity offered in the market.
ii. Product Homogeneity: Competition is between same product of the same firm.
iii. Free entry and exit of firm: There is no barrier to entry or exit from the industry.
Entry or exit may take time but firms have freedom of movement in and out of the
industry.
iv. Profit Maximisation: The goal of all firms is profit maximisation. No other goals
are pursued.
v. No government regulation: There is no intervention of government in terms of
tariffs, subsidy, rationing of production or demand.
vi. Perfect mobility of factors of production: The Factors of production i.e. Capital and
Labour (K, L) are free to move from one firm to another throughout the economy.
vii. Perfect Knowledge: All the sellers and buyers have complete knowledge about
the conditions of the market. This knowledge refers not only to the prevailing
conditions in the current period but in all future periods as well.
Note: There are four components of market:
I. Sellers
II. Buyers
III. Goods/Services
IV. Price
 Linkage between Cost, Revenue and Output through Optimisation

1. Total Revenue = Price × quantity {Total Revenue is the total money received from
the sale of any given quantity of output.}
Profit Maximisation (π) = TR - TC

2. Average Revenue (AR) = TR / quantity {Average Revenue is the revenue received


for selling a good per unit of output sold.}
AR = Price × quantity
quantity

AR = Price
 Marginal Revenue (MR) = Change in TR
Change in quantity
 Marginal revenue is the change in total revenue resulting from a change in the
quantity of output sold.

Large No. of
sellers and buyers

 Market is of three types: Competitive

There is only Non-Competitive


one seller. Perfect Competition
Eg:- Monopoly
 Price Taker
 It does not exist, it is
hypothetical.
 It does not follow law of
demand.
 Monopoly
 Monopoly is a non-competitive market and price-maker.
 There is no rival in the market.
 Monopoly is said to exist when one firm is the sole producer or seller of a product
which has no close substitutes.

 In monopoly, the firms demand is the demand of the industry and the monopolist
decides its price and output on the basis of the market demand which is
downward sloping, obeying the general law of demand.

TR

D= AR (Demand
Curve is average
revenue)

 Monopolistic Competition
 Price differentiation arises when substitutes of any product introduced.
 Large no. of sellers and producers are present.
 They are supplying the products that are little bit differentiated but are not perfect
substitutes. i.e. The products are sold under different brand names.
 Goal is profit maximisation. Prices of factors/technology are given.
 The long run consists of a number of identical short run periods which are
assumed to be independent on one another.
 Chamberlin (economist) makes a heroic assumption, the both demand and cost
curves for all products are uniform throughout the group.
 When there is a large no. of competition among monopoly, then it is known as
monopolistic competition.
 Free entry and exit.
 In monopolistic competition, the demand of the individual firm is downward
sloping, as is the market demand. As a consequence of product differentiation,
the firm has some freedom in setting its own price.

 Oligopoly
 Oligopoly is a state of market where the industry has a few types of products or
a few firms that dominate the market or industry.
 If the market of a particular commodity consists of more than one seller but the
no. of sellers is few, the market structure is termed as ‘oligopoly.’
Note: The special case of oligopoly where there are exactly two sellers is termed as
‘Duopoly.’ we assume that the product sold by the two firms is homogenous (same
good) and there is no substitute for the product produced by any other firm.
Eg:- Coca Cola & Pepsi
Two sellers working together
No. of Sellers Duopoly Monopoly

 There are two types of Oligopoly:


1. Collusive Oligopoly- It is a market situation where a firm cooperate with each
other in determining the price of output or both.
 There are mainly two types of collusion:
i. Cartels- Oligopolist come together to decide about the output and the prices in
the market, share and division of profit, territory, etc.
o Acting as a single producer.
o Cartels are generally illegal and there is a lack of transparency.
o {Output prices, price fixing, market share i.e. location specified, lack of
competition, Terms of delievery, Billing and interest, output and production.}
Eg:- OPEC (Organisation of petroleum-exporting countries
ii. Price Leadership- There is an agreement to assign the leader in terms of price.
i.e. one act as a leader and others are following ; No any formal restrictions.
Eg:- Airline industries.

o Types of Price Leadership-


a) Dominant Price Leadership {Partial monopoly}
b) Barometric Price Leadership {Short-lived}
c) Aggressive Price Leadership {Coercely making leader.}
d) Quantity Leadership {One firm makes a choice for other.}
2. Non-Collusive Oligopoly- It refers to a market situation where the firms compete
with each other rather than cooperating.
Homogenous (Nearly similar products)
Heterogenous (Slightly different products)

 Characteristics of Oligopoly
 Few no. of firms or only two.
 The firms are interdependent to each other.
 They do much advertisements to attract the consumers or customers. The more
the company advertises, the more that company go ahead in the competition in
the market.
 Exit is easy but entry is very difficult in the oligopoly market. Other firms create
barriers for entry of the newly firms. Barriers such as government policies,
patents, licences etc.
 Lack of uniformity i.e. It is not necessary for all firms to be same size. Some firms
may be small or some firms may be large.
 Intense competition; Since there are very few no. of firms in oligopoly.
 Group behaviour; It means that as a company changes its features or product
prices, others will follow.

In oligopoly competition, the demand curve of an oligopolist will depend upon nature
of its product and his distribution channels. The demand function is multi-variant.
Thus, if prices are sticky.
Advertisements, Taste, income etc. There are
other factors that influence the demand of the
firm.

 Price Discrimination in Monopoly


 A practice of charging different prices for the same product.
 It may also allow business to earn higher profits at the expense of some
consumers.
 Monopolist use this strategy to sell the same products at different prices to
different consumers.
 Deadweight Loss under competition
 Deadweight Loss is caused because of under-valued prices.
 Where there will be over-valued prices, demand will be less, and surplus will be
more. Resulting therein, Deadweight Loss will be caused.
 Purchasing power of a consumer depends upon his income.
Note: Wages should not be less than subsistence wages, i.e. (survival wages).

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