Market Definition, Types and Perfect Competition

Market Definition and Types

• Traditionally, a market was where buyers and sellers met for transactions.
• Modern markets involve direct or indirect contact between buyers and sellers, even without physical presence.
• Online shopping is an example of a modern market.
• Markets are classified based on area, time, regulation, volume of business, and competition.
• Area classifications: local, regional, national, international.
• Time classifications: very short period, short period, long period, very long period.
• Regulation classifications: spot market, future market.
• Volume of business classifications: wholesale, retail.
• Competition classifications: perfect competition, monopoly, monopolistic competition, oligopoly, duopoly.

Perfect Competition: Historical Context and Importance

• Adam Smith initially touched upon perfect competition in "Wealth of Nations."
• Studied in "mathematical psychics".
• Frank Knight provided a more complete discussion in "Uncertainty and Profit" (1921).
• Perfect competition is a key market structure for economic analysis.
• It is rarely found in practice, mainly in some agricultural commodities with homogeneous units.
• Perfect competition is a theoretical solution to many economic problems, according to Professor Marcel.

Definitions of Perfect Competition

• Mrs. Robinson defined perfect competition as a situation where the demand for each producer's output is perfectly elastic.
• Leftwich defined perfect competition as a market with many firms selling identical products, where no single firm can influence the market price.

Characteristics of Perfect Competition (According to Professor Marshall)

• Large number of buyers and sellers: no individual can influence total demand or supply.
• Market price is determined by overall market demand and supply.
• Producers and sellers are "price takers."
• Homogeneous or identical products: all units of the commodity are the same in quality, quantity, color, taste, shape, size, and packing.
• Producers cannot charge different prices because buyers won't pay more for the same product.
• Free entry and exit of firms: new firms can freely enter the industry, and marginal firms can freely exit.
• Entry occurs with abnormal profits; exit occurs with abnormal losses.
• This process stops in the long run when only normal profits prevail.
• Perfect knowledge: all buyers and sellers know the quality, quantity, and price of the commodity.
• Buyers won't pay different prices for the same product.
• Producers can't charge different prices.
• Perfect mobility of factors of production: land, labor, capital, and entrepreneurship move freely between occupations, places, and uses.
• All units of a particular factor receive maximum and equal remuneration.
• Zero transport cost: there is a uniform price for the same product.
• Many local sellers exist; transport costs are negligible or non-existent.
• The market price remains the same across the entire market.

Relationship Between Average Revenue (AR) and Marginal Revenue (MR)

• In perfect competition, firms are price takers.
• Firms can sell any quantity at the same market price.
• Price, AR, and MR are equal.
• The demand line is perfectly elastic and parallel to the x-axis.
• Illustration: If the market price of commodity X is Rs 10, a firm can sell any amount at this price.

Conditions of Short-Run Equilibrium for a Firm

• Short-run: fixed factors of production cannot be changed.
• Price determination: demand is more effective than supply.
• Firm equilibrium: production level where profit is maximized or loss is minimized.
• Conditions for equilibrium (according to Professor Marshall): Marginal revenue (MR) equals marginal cost (MC), and marginal cost (MC) is increasing (MC curve intersects MR curve from below).

Explanation of Short-Run Equilibrium

• At the equilibrium point, Marginal Revenue (MR) = Marginal Cost (MC).
• Marginal cost intersects marginal revenue from below at equilibrium.
• Production before or after the equilibrium is not viable.
• Before the intersection, Marginal Cost is greater than Marginal Revenue, and a loss is prevailing.
• Point A is the optimum point; revenue is more than cost, so it is beneficial.
• This is beneficial up to point A, where profit is maximized given the conditions.

Short-Run Equilibrium: Three Types of Firms

• Short-run: only variable factors can be changed; demand is more effective than supply in price determination.
• Types of firms possible: few representative firms earning abnormal profits, few marginal firms experiencing losses, and most firms earning normal profits.
• Marginal firms might continue production, expecting profit later.

Abnormal Profit Position of the Firm

• Few representative firms can experience abnormal profits in the short run.
• At equilibrium, average revenue exceeds average cost, creating abnormal profit.
• Total revenue exceeds total cost, represented by area c d ER.

Loss Situation of Firm

• Few marginal firms experience losses but continue production, hoping for future improvement.
• At equilibrium, average cost exceeds average revenue, resulting in abnormal loss.
• The loss is represented by area c d e r.

Normal Profit Position of the Firm

• Most firms achieve normal profits.
• At equilibrium, average revenue equals average cost, resulting in normal profit.
• Price = Average Revenue = Average Cost = Marginal Revenue = Marginal Cost, creating an optimum firm.

Long-Run Equilibrium of the Firm

• Long-run: both fixed and variable factors can be changed; supply is more effective than demand in price determination.
• Firms making abnormal profits in the short run attract new firms, increasing competition and decreasing profit margins until equilibrium is established.
• Marginal firms will attempt to leave during the loss time.
• All firms are under normal conditions in the long run.

Conclusion

• Perfect competition is an ideal market structure used to develop new economic theories.
• Short-run equilibrium may involve supernormal profits or losses.
• Long-run equilibrium results in normal profits for all firms because of the free entry and exit of firms.