Forms of Market and Price Determination Under Perfect Competition

Monopolistic Competition refers to Competition among a large number
of sellers producing close but not perfect substitutes

Teaching Points
5.1     Introduction
5.2     Definition
5.3     Types of Market
5.3.1  Features of Perfect Competition
5.3.3  Pure Competition
5.4     Price Determination under Perfect Competition
5.5     Monopoly and its Features
5.5.1  Types of Monopoly
5.6     Monopolistic Competition Definition and its Features

Teaching Objectives
To enable the students to get acquainted with different forms of Market and Price Determination under Perfect Competition.

Competition is a Soul of Science

5.1     Introduction
         In common languages the terms market means a specific place where buyers and sellers of a commodity meet and exchange their goods. But in Economics, market does not necessarily mean a place, but it is an arrangement through which buyers and sellers come in contact with each other directly or indirectly and exchange of goods takes place among them.


5.2     Definition of Market
         To quote Cournet "Economist understand by the term market, not any particular market place in which things are bought and sold, but eh whole of any region in which buyers and sellers are in such close contact with one another that prices of the same goods tend to equality, easily and quickly."

5.3     Types of Market
         On the basis of degree of competition markets are classified as follows :
         a)       Perfect competition
         b)       Pure competition
         c)       Monopoly
         d)       Monopolistic competition

5.3.1  Perfect competition
         A perfectly competitive market is one which has a large number of buyers and sellers of a homogeneous product. According to John Robinson "Perfect Competition prevails when the demand for the output of each producer is perfectly elastic."
         This indicates that the number of sellers is large. So the output of any one seller is a negligible small portion of the total output of the commodity.

5.3.2  Features of Perfect Competition :
         Features of Perfect Competition are as follows :
         1)       Large number of sellers
         2)       Large number of buyers
         3)       Free entry and exit
         4)       Homogeneous product
         5)       Single price
         6)       Perfect knowledge
         7)       Perfect mobility of factors of production
         8)       No transport cost
         9)       No-intervention of government

1)      Large number of sellers/sellers are price takers
There are many potential sellers selling their commodity in the market. Their number is so large that a single seller cannot influence the market price because each seller sells a small fraction of total market supply. The price of the product is determined on the basis of market demand and market supply of the commodity which is accepted by the firms, thus seller is a price taker and not a price maker.
2)      Large number of buyers:
There are many buyers in the market. A single buyer cannot influence the price of the commodity because individual demand is a small fraction of total market demand.
3)      Free entry and exit:
New firms can enter and exit the market without any restrictions.
4)      Homogeneous product:
Firms produce and sell identical units of a given product, in perfectly competitive market, i.e., units of a commodity produced by each of them is uniform, in respect of size, shape, colour, quality, etc. Thus commodities have perfect substitute for each other.
5)      Perfect knowledge:
The buyers as well as sellers in the perfectly competitive market have perfect knowledge of the market conditions. Such knowledge will prevent the buyers from paying a higher price and a seller charging a different price than what is prevailing in the. market.
6)      Single price:
In Perfect Competition all units of a commodity have uniform or a single price. It isdeteriniried. by the forces of demand arid supply.
7)      Perfect mobility of factors of production:
         Under Perfect Competition the factors of production that is land, labour, capital and organisation, enjoy complete freedom to move from one place to another and from one occupation to another. This implies optimum use of each factor input which can be available easily to the producers. Thus they will not face any problem in production of any commodity.
8)      No transport cost:
There is no transport cost under perfect competition. It is assumed that in perfect competition all the firms are close to each other. There will not be any difference in transport cost and price will remain uniform.
9)      Non Government Intervention:
Laissez faire policy prevails under perfect competition which means there is no government intervention in respect of production, transportation price determination of goods etc.
After analyzing a11 the features of perfect. competition, it is clear that perfect competition is ideal form of market, but it is very difficult to realize the above conditions practically. Thus, perfect competition is an imaginary concept.

5.3.3  Pure Competition
Pure competition is a part and parcel of perfect competition. According to Chamberlin, "a market becomes pure when monopoly is kept away."
Pure competition has certain conditions of perfect competition. They are
1)       Large number of sellers
2)       Large number of buyers
3)       Free entry and exist
4)       Homogeneous product
5)       Single Price

5.4     Price Determination under Perfect Competition
Equilibrium price: Equilibrium price is the price at which quantity demanded is equal to quantity supplied. The price of the product under perfect competition, is influenced by both buyers and sellers and equilibrium price is determined by the interaction of demand and supply forces. According to Marshall, demand and supply are like two blades of a pair of scissors. Just as cutting of cloth is not possible with the use of one blade, the equilibrium price of a commodity cannot be determined, either by the forces of demand or by supply alone. Both together determine the price.
We can study this with the help of the following table and graph.


Table No. 5.1 – Demand and Supply Schedule
Price (`)
Per Unit
Quantity Demanded (Units)
Quantity Supplied (Units)
5
100
500
4
200
400
3
300
300
2
400
200
1
500
100

Above table shows the effect of price on market demand and market supply. The table shows that when price of the commodity is ` 5, quantity demanded is 100 units and quantity supplied is 500 units. Since supply is more than demand, price falls to ` 4/- and ` 3/-, respectively and quantity demanded extends to 200 and 300 units whereas supply contracted to 400 and 300 units, respectively. It is seen that quantity demanded and that quantity supplied both are equal at ? 3 where quantity demanded is 300 units whereas quantity supplied is 300 units. Thus, ` 3 will be an equilibirim price.
If further price falls to ` 2 and ` 1, quantity demanded will expand to 400 and 500 units, respectively and quantity supplied will contract to 200 and 100 units respectively. Since demand is more than supply, competition among buyers will increase and price will rise up to ` 2 and ` 3. Thus equilibrium price will be ` 3 per unit because demand and supply both are equal at this price.
E     -    Equilibrium point
OP   -    Equilibrium price
OQ   -    Equilibrium quantity demanded and supplied
On the 'x' axis we measure quantity demanded and quantity supplied and on the 'y' axis we measure price of the commodity. In the above diagram 'DD' is a downward slopping demand curve indicating inverse relationship between price and quantity demanded. 'SS' is an upward slopping supply curve indicates direct relationship between price and quantity supplied. Both the curve intersects each other at point 'E'. At this point the equilibrium price is ` 3/- and equilibrium demand and supply is 300 units.



5.5     Monopoly – Meaning and its Features
'Mono' means single and poly means 'seller'. Thus monopoly means single seller who has complete control over the supply of the commodity. There is no close substitute of the commodity. Due to absence of competition, monopolist is a price maker and not a price taker.
According to H.L. Ahuja, "Monopoly is said to exist when one firm is the sole producer or seller of a product which has no close substitute."
According to Chemberlin, "A monopoly refers to a single firm, which has control over the supply of a product, which has no close substitute.
1)       Single seller
2)       No close substitute
3)       Barriers to entry
4)       No distinction between firm and industry
5)       Control over the market supply
6)       Price maker
7)       Profit maximization
8)       Price discrimination

1)      Single seller
In a monopoly market there is a single seller or a single producer. Under monopoly he has no rivals and he faces no competition.
2)      No close substitute
There are no close substitutes for the commodity sold in the market. Likewise other firms may not produce the same product. Hence, monopolists do not face any competition.
3)      Barriers to entry
Under monopoly the entry of other firm is strictly restricted. The seller has complete hold over the supply in the market. Such provision protects the monopoly powers.
4)      No distinction between firm and the industry
Under monopoly there is only one seller, there is no distinction between the firm and the industry. Thus, under monopoly the firm is an industry.
5)      Control over the market supply
The monopolist has complete hold over the market supply. He is a sole producer of the commodity. Therefore entry barriers such as natural, economic, technological or legal do not allow competitors to enter the market.
6)      Price maker        
The firm under monopoly is price maker and not the price taker. He can charge any price for the commodity as he has complete control over the supply of the product.
7)      Super normal profit
The monopolist always wants to earn supernormal profit. His decision regarding the price and the level of output are guided by the profit maximization motive. Thus, sometimes at high price, he supplies the product as per the demand and sometimes he controls the supply of the product and sells the product at high prices.
8)      Price discrimination
         This implies charging different prices for the same product to different buyers. The monopolist succeeds in increasing his profit by adopting the technique of price discrimination.

5.5.1. Types of Monopoly
1)     Natural monopoly
2)     Public monopoly
3)     Private monopoly
4)     Legal monopoly
5)     Simple monopoly
6)     Discriminating monopoly
7)     Voluntary monopoly
1)    Natural monopoly
Natural monopoly emerges due to availability of natural resources. A particular type of natural resource is available, therefore that region enjoys monopoly in the product which requires that natural resource. Natural advantages like good location, old establishment, involvement of huge investment, business reputation, etc. confirm natural monopoly of many firms. e.g., tea from Assam.

2)      Public monopoly
Public monopoly refers to sole ownership of the supply of goods or services by the government. Such monopoly functions with the primary motive of providing maximum welfare to the society, thus, it is also known as welfare monopoly. It is not based on profit motive. e.g., Indian Railway.
3)      Private monopoly
Private monopoly refers to sole ownership of the supply of goods or services by the private firm or individual. The main objective of private monopoly is profit maximization, for e.g. Tata group and Reliance group.
4)      Legal monopoly
When monopoly is created by law, it is known as legal monopoly. Legal provisions like patents, trade marks, copy rights etc. give rise ­to legal monopolies e.g. some producers use a particular trademark for their product and they take legal permission from the government for that brand, thus law forbids the potential competitors to imitate the design, form and shape of product. If any firm tries to violate the rights action can be taken against them e.g., Parle-G etc.
5)      Simple monopoly
It is that organization which charges a simple uniform price for all consumers. There is no price discrimination among the consumers.
6)      Discriminating monopoly
When different prices are charged to different customers for the same product or services, it is known as price discrimination or discriminating monopoly. e.g., a doctor or a lawyer may charge different fees to the people.
7)      Voluntary monopoly
When number of big business companies acquire monopoly through voluntary agreement, business firms join together through trusts, cartels, syndicates etc. They are called joint monopolies. Mergers and amalgamations may also lead to monopoly e.g., OPEC (Oil Producing and Exporting Countries). This is also known as Joint Monopoly.

5.6     Monopolistic Competition – Definition and its Features
Another type of market structure is Monopolistic Competition, which is very realistic in nature. In this market, there are some features of monopoly and some features of perfect competition acting together. This mixture of two markets gives birth to a new form of market known as Monopolistic Competition, Prof. E.H. Chamberlin coined this concept in his book, "Theory of Monopolistic Competition" which was published, in 1933.
Definition : According to Chamberlin, "Monopolistic competition refers to competition among a large number of sellers producing close but not perfect substitute."
"When markets, which have a large number of producers producing differentiated products which are close substitute to each other, engage in non price competition, we call it as a Monopolistic Competitive market."
         Following are the features of Monopolistic Competition
         1)       Fairly large number of buyers
2)       Fairly large number of sellers
3)       Product differentiation
4)       Close substitute
5)       Selling cost
6)       Free entry and exit
7)       Demand curve of the seller
8)       Concept of group
         Following are the features of Monopolistic Competition :
         1)      Fairly large number of buyers
In this market, there are fairly large number of buyers. Consequently, no single buyer can influence the price of the product by changing his individual demand.
         2)      Fairly large number of sellers:
The number of sellers in a monopolistic competition is large. It is still smaller than that in a perfectly competitive market. Since the number of sellers is large. Each seller has a limited control over supply. The seller has complet control over his brand. This control is possible because of patents, trade mark, copyrights etc., that the producer possesses. Thus, each producer enjoys an element of monopoly on one hand and on the other they have to face competition from sellers selling close substitute in the market.
        

         3)      Product differentiation:
The most important feature of Monopolistic Competition is product differentiation. Each product in-this market is different from other product in some form or the other. The differences could be in its colour, shape, wrapper, after - sales services etc. Their products, though different, are close substitute to each other e.g., Hamam soap is close substitute to Lux soap. Producers also adopt various techniques such as discounts, gifts, advertisements etc. to attract the consumers. This is known as product differentiation. In this market producers compete with each other on the basis of product differentiation and not on the price differentiation. Therefore, Monopolistic Competition is also known, as 'non-price competition.
         4)      Close Substitute:
In Monopolistic Competition goods have close substitute to each other. For e.g. Goldspot is close substitute to Limca.
         5)      Selling cost:
The uniqueness of this market lies in the fact that a difference is made between cost of production and selling cost. Product differentiation leads to emergemce of selling cost. Thus, the cost that producer have to incur, in order to differentiate their product is known as selling cost. Hence, medium such as television, radio, newspaper, magazine, exhibitions, incentives and salaries of sales representatives etc., are used by firms to increase the sales. The price of the product includes cost of production as well as selling cost.
         6)      Free entry and exist:
Under Monopolistic Competition, there is freedom of entry and exit i.e.. new firms are free to enter the market, if there is super normal profit. Similarly, they can leave the market, if they find it difficult to survive.
       7)        Demand curve of the seller:
Due to product differentiation and availability of close substitute, demand curve is highly price elastic and downward slopping.
It means a slight change in price of the product will bring about a change in quantity demanded.
       8)        Concept of group:
Chamberlin introduced the concept of group as the substitute for industry concept. The firm producing identical product, are clubbed together in one industry under perfect competition. However, in the Monopolistic Competition the products are differentiated. All the firms producing close substitutes are taken together in a 'group concept'. For example – group of firms producing medicines, cement etc.

Q.1A) Fill in the blanks with appropriate alternative given in brackets.
         1)       Under perfect competition commodities are ............ in nature. (homogeneous/classified/heterogeneous/ supplementary)
         2)       ........ appears in a monopoly market (product differentiation / price discrimination I individual differentiation/ packing differentiation)
         3)       The price at which demand and supply equate to each other is called ..... price.
                  (general / equilibrium / short run / reserve)
         4)       In ........ market, seller creates products differentiation. (competition/perfect/pure/monopolistic competition)
         5)       Monopolist means .............. competitive.
                  (single seller/several sellers/single buyer/ several buyers)
B)      Match the following groups
         Group "A"                      Group "B"
         1.    Monopoly                 a)    Public monopoly
         2.    Product                    b)    Abnormal differentiation profit
         3.    Railway                    c)     Monopolistic Competition
         4.    Perfect                     d)    Prof. Camberlin competition
         5.    Pure competition       e)    Homogenous product
                                               f)     Cartel
                                               g)    Selling cost
C)      State the following statements are True of False.
         1)       There is no price discrimination under Monopolistic Competition.
         2)       In a monopoly market, firm and industry are the same.
         3)       Product differentiation is not possible under perfect competition.
         4)       Under perfect competition price is determined by equilibrium of demand and supply.     
Q.2 A) Define or explain the following concept.
         1)       Market
         2)       Price discrimination
         3)       Monopolistic Competition
         4)       Selling cost
         5)       Equilibrium price
B)      Give reason or explain
         1)       Single price prevails in perfect competition.
         2)       Price discrimination is possible under monopoly.
         3)       Selling cost is incurred by a firm in Monopolistic Competition.
         4)       A monopolist can control the supply of goods.
         5)       Sellers and buyers are the price takers in perfect competition.

Q.3 A) Distinguish between the following
         1)       Perfect competition and Pure competition
         2)       Perfect competition and monopoly.
         3)       Natural monopoly and social monopoly.
         4)       Natural monopoly and legal monopoly.
         5)       Perfect Competition and Monopolistic Competition    
B)      Write short notes.
         1)       Types of monopoly
         2)       Features of pure competition

Q.4)   Answer the following questions
         1)       What are the features of perfect competition?
         2)       What are the features of monopoly?
         3)       What are the features of monopolistic competition?


Q.5)   State with reason whether you agree or disagree with the following statements
         1)       Perfect Competition means Monopolistic Competition.
         2)       A seller is price maker in monopoly.


Q.6)   Answer in details
         1)       What is Perfect Competition? Explain price determination under Perfect Competition?
         2)       What is monopoly? Explain in detail the features of monopoly?
         3)       What its Monopolistic Competition? Explain in detail the features of Monopolistic Competition.

Project :
1)       Study the advertisements that you watch on the television carefully and make a list of the branded commodities that you or your acquaintances purchase and then do the comparative study of effect of advertisement on the buyers demand.
2)       Find out how many firms in India manufacture soaps and tooth paste.
3)       Collect information from your area about the prices of grains that are sold in the open market and those that are sold through the fair price shops, make a comparative study of these figure.






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