MEANING OF MARKET
There are two aspects of every market: demand and supply. We have discussed both the concepts in the previous units. In this chapter, we will put the two components together to examine the behaviour of 'Market' as a whole.
Market is like the nervous system of modern economic life. Producers and consumers carry out their transactions of sale and purchase through the medium of market. In the layman's language, market refers to a place where goods are purchased and sold. But, in economics, the term 'market' has a wider meaning.
In economics, market has no reference to a specific place. It is not necessary for buyers and sellers to assemble at a particular place for sale or purchase of goods. The only condition is that they should be in contact with each other through any means of communication, like internet, telephones, letters, etc.
Market refers to the whole region where buyers and sellers of a commodity are in contact with each other to effect purchase and sale of the commodity.
From the above discussion, the essential constituents of a market can be summarized as:
Area:
Concept
Forms of Market Structure
On the basis of main factors, which determine the market structure, the main forms of market structure are shown in the following chart:
Concept
PERFECT COMPETITION
Perfect Competition refers to a market situation where there are very large number of buyers & sellers dealing in a homogeneous product at a price fixed by the market.
In the perfectly competitive market, sellers sell a homogeneous product at a single uniform price.
The price is not determined by a particular firm but by the industry.
Example of Perfect Competition
In reality, perfect competition has never existed. The closest example we may have for such kind of market can be market for agricultural goods (like wheat and rice).
In case of wheat, there are numerous buyers and sellers (farmers). As a result, no single buyer and seller can significantly affect the market price of wheat.
Concept
Features of Perfect Competition
The various features of Perfect Competition are:
1. Very Large number of Buyers and Sellers:
In a perfectly competitive market, there are very large number of buyers and sellers.
Implication of Very large number of buyers and sellers' is that the number of sellers is so large that the share of each seller is insignificant in the total supply. Hence, an individual seller cannot influence the market price. Similarly, a single buyer's share in total purchase is sO insignificant because of their large numbers that an individual buyer cannot influence the market price.
Under such conditions, price of a commodity is determined by the market forces of demand and supply and each buyer and seller has to accept the same price. a As a result, uniform price prevails in the market.
2. Homogeneous Product:
The products offered for sale in the market are homogeneous, i.e., the product sold is identical in all respects like size, shape, quality, colour, etc. Since each firm produces 100% identical products, their products can be readily substituted for each other. So, the buyer has no specific preference to buy from a particular seller only.
Implication of 'Homogeneous Product' is that buyers treat the products as identical. Therefore, the buyers are willing to pay only the same price for the products of all the firms in the industry. It also implies that no individual firm is in a position to charge a higher price for its product. This ensures uniform price in the market.
Due to the homogeneity of goods, purchase of a commodity is a matter of chance and not of choice.
3. Freedom of Entry and Exit:
Every seller has the freedom to enter or exit the industry. There are no artificial and natural barriers for entry of new firms and exit of existing firms.
It ensures absence of abnormal profits and abnormal losses in the long run.
Implication of 'Freedom of Entry and Exit': 'Freedom of Entry' signifies that there are no barriers to the entry of new firms into industry. When the existing firms are earning abnormal profits, the new firms, attracted by the prospects of profit, enter the industry.
This raises market supply, which in turn, leads to fall in market price and consequently profits. The entry continues till each firm is earning just the normal profits.
Freedom to Exit' signifies that there are no barriers which restrict the existing firms from leaving the industry. The firms try to leave when they are facing losses. As the firms start leaving, market supply falls, leading to rise in market price and consequently reduction in losses. The firms continue to leave till the losses are wiped out and each existing firm is earning just the normal profits.
4. Perfect Knowledge among Buyers and Sellers:
Perfect knowledge means that both buyers and sellers are fully informed about the market price. Its implication is that no firm is in a position to charge a different price and no buyer will pay higher price. As a result a uniform price prevails in the market.
Both buyers and sellers have perfect knowledge about the product market. Sellers also have perfect knowledge about the input markets, i.e. each firm has an equal access to the technology and the inputs used in the production. As a result, all the firms have a uniform cost structure. Since, there is uniform price and uniform cost in case of all firms, all the firms earn uniform profits.
5. Perfect Mobility of Factors of Production:
The factors of production (land, labour, capital and entrepreneurship) are perfectly mobile. There is no geographical or occupational restriction on their movement. The factors are free to move to the industry in which they get the best price.
6. Absence of Transportation Costs:
In order to ensure uniform price in the market, it is assumed that transportation costs are zero. A producer can sell his product at any place and a buyer can buy it from the place he likes.
7. Absence of Selling Costs:
Selling cost refers to cost of advertisement of the product. In perfect competition, there are no selling costs because of perfect knowledge amongst buyers and sellers.
Concept - Perfect Competition and Pure Competition
Perfect Competition is used in wider sense as compared to Pure Competition. The competition is said to be 'Pure Competition' when the following 3 fundamental conditions exist:
1. Very Large number of buyers and sellers;
2. Homogeneous product;
3. Freedom of entry and exit.
Perfect competition is a wider concept. For the market to be perfectly competitive, in addition to three fundamental conditions, four additional conditions must be satisfied:
1. Perfect Knowledge among buyers and sellers;
2. Perfect mobility of factors of production;
3. Absence of transportation costs;
4. Absence of selling costs.
Concept - Firm is a Price-taker
Price taker means that an individual firm has no option but to sell at a price determined by the industry. Under perfect competition, an individual firm cannot influence the price on its own as its share in total market supply is negligible.
Therefore, a firm plays no role in price determination. It can affect neither the supply nor the demand in the market. So, 'Firm is a price-taker and Industry is the Price-maker'. Each firm has to accept the price as determined by market forces of demand and supply. Price is determined at the point where market demand curve intersects market supply curve.
In Fig , the market demand curve DD and market supply curve SS intersects at point E, at which OP price is determined. The price of OP is adopted by the price-taker firm and firm is free is to sell any quantity (0Q, 0Q1 or any other quantity), at this price. This makes the AR curve perfectly elastic and thus parallel to the X-axis. According to AR and MR relationship, when AR is constant, MR = AR. So, AR curve is also the MR curve of the firm.
For your Reference: In the long run, every perfectly competitive firm aims to produce that level of output at which there is minimum average cost.
Concept
Demand Curve under Perfect Competition
In case of perfect competition, there are very large number of buyers and sellers selling a homogeneous product at a price fixed by the market. Therefore, each firm is a price-taker and faces a perfectly elastic demand curve.
In Fig:, output is represented along the X-axis and price and revenue along the Y-axis. Firm's demand urve is indicated by the horizontal straight line parallel to the X-axis. As each firm has to accept the price fixed by the industry, the price is determined at OP. At OP price, a seller can sell 0Q1, OQ2 or any other quantity. However, a firm is not in a position to change the price.
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It must be noted that AR curve and demand curve are one and the the same thing as discussed in chapter 'Revenue',
Concept - MR = AR under Perfect Competition
In the perfectly competitive market, each firm is a price-taker. All the firms have to accept the same price as determined by market forces of demand and supply. As a result, uniform price prevails in the market. It means, revenue from every additional unit (known as MR) is equal to price (AR) of the product. So, MR = AR.
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