Market is an arrangement where buyers and sellers interact for buying and selling of a commodity/services and determine price. Market structure refers to the nature and degree of competition in a market, based on number of firms, product nature, entry conditions and control over price.
Perfect competition is a market structure where there are many buyers and sellers, the product is homogeneous, firms are price takers, and there is free entry and exit.
Industry price is determined by market demand and supply. A single firm accepts this price. Therefore, the firm’s demand curve is perfectly elastic (horizontal):
In short run, a competitive firm maximises profit where: Since MR = P, equilibrium is at:
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Market is an arrangement where buyers and sellers interact for buying and selling of a commodity/services and determine price. Market structure refers to the nature and degree of competition in a market, based on number of firms, product nature, entry conditions and control over price.
Perfect competition is a market structure where there are many buyers and sellers, the product is homogeneous, firms are price takers, and there is free entry and exit.
Industry price is determined by market demand and supply. A single firm accepts this price. Therefore, the firm’s demand curve is perfectly elastic (horizontal):
In short run, a competitive firm maximises profit where: Since MR = P, equilibrium is at:
In the long run, entry and exit occur. Supernormal profits attract new firms (increase supply, reduce price). Losses cause exit (reduce supply, raise price). Long run equilibrium occurs when: Firm earns normal profit only.
Merits: efficiency, low prices, consumer welfare, optimum resource allocation.
Limitations: unrealistic assumptions, absence of product variety, ignores innovation incentives in some cases.
Monopoly is a market structure where there is a single seller of a product with no close substitutes and strong barriers to entry. The monopolist is the price maker (subject to demand).
Since demand curve is downward sloping:
Monopolist maximises profit where: Price is then determined from AR (demand) curve corresponding to that output.
Price discrimination means charging different prices from different consumers for the same product, not due to cost differences. Conditions (brief): monopoly power, separate markets, no resale, different elasticities of demand.
Merits: economies of scale, ability to fund R&D, stable prices in some cases.
Demerits: higher prices, output restriction, consumer exploitation, inefficiency and less choice.
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Perfect competition has large number of buyers and sellers so no single firm controls price. The product is homogeneous, there is free entry and exit, and market participants have perfect knowledge. There are no selling costs and factors are mobile. Therefore firms are price takers and face AR = MR = price.
A competitive firm maximises profit where MR = MC. Since under perfect competition MR = price, equilibrium output is where P = MC. If at that output P > AC, firm earns supernormal profit; if P = AC, normal profit; if P < AC but P ≥ AVC, firm may continue in short run to minimise loss.
Perfect competition is a market structure with a large number of buyers and sellers, homogeneous product, free entry and exit and perfect knowledge. Because each firm is very small relative to the market, it cannot influence price and hence is a price taker.
Price determination: Industry price is determined by market demand and market supply. A single firm accepts this market price. Therefore, for a competitive firm, AR = MR = Price and the firm’s demand curve is horizontal.
Short run equilibrium: The firm maximises profit where MR = MC. Since MR = P, equilibrium output occurs where P = MC. If at this output P > AC, the firm earns supernormal profit; if P = AC, it earns normal profit; if P < AC but P ≥ AVC, it continues in short run to minimise loss. If P < AVC, the firm shuts down.
Long run equilibrium: In the long run, entry and exit of firms occur. Supernormal profits attract new firms, increasing supply and reducing price. Losses cause firms to exit, reducing supply and raising price. Long run equilibrium is reached when firms earn only normal profit and there is no incentive to enter or exit. The condition is P = MR = MC = AC, and the firm produces at minimum AC.
Thus, perfect competition leads to normal profit in the long run and efficient allocation of resources.