What do we men by market ? In general sense market refers to a place where goods are sold.

. But in economics market refers to place where buying and selling of goods and services takes place. In broad sense it is a mechanism where people get involved in selling and buying of goods and services. There is no need of place of transaction, just it requires buyers, sellers, price of the commodity and the amount of the commodity. Economists have developed different market models to explain the process of price and output determination.

Those are depending upon number of firms in the market, the degree of market power of firm in affecting the price of the product, types of products (identical or differentiated), and son on. The major market structures categorized by the economists are perfect competition, monopoly, monopolistic competition and oligopoly. Here, we just study about the process of price and output determination under perfect competition and monopoly market structure. Before proceeding to the discussion on price and output determination under perfect competition and monopoly market we need to know about the concept of the equilibrium of the firm.

EQUILIBRIUM OF THE FIRM The word 'equilibrium' means a state of balance. When two opposing forces working on an object are in balance so that the objects has no tendency to change, it is said to be in equilibrium. In other words, when the objects under the pressure of forces working in opposite directions has no tendency to move in either direction, the object is said to be in equilibrium. Similarly, a firm is said to be in equilibrium when it has no tendency to change its level output. That means the firms equilibrium is a condition in which the firm neither want to increase nor decrease its level of output.

 At

the equilibrium condition the firm will produce the equilibrium level of output and will charge the price at which the equilibrium output can be sold in the market. Major objectives of a firm is to maximize maximize its profit and to minimize the cost of production. The firms profit maximization objectives is fulfilled when the firm is in equilibrium condition. There are two approaches to explain the equilibrium of the firm; 1. TR-TC Approach.

1 . TR-TC Approach of Determining Equilibrium Level of Output The TR-TC approach uses the concept of total revenue (TR) and total cost (TC) to determine the equilibrium of a firm. Firms objective is to maximize its profit and according to this approach, a firm will maximize its profit when the difference between total revenue (TR) and total cost (TC) is maximum. According to this approach, an equilibrium position will be determined at the point where the difference between total revenue and total cost is highest. Hence, total profit is the difference between total

i.e. = TR TC

Where, = Total Profit, TR = Total Revenue and TC = Total Cost. In above formula, we can see three cases; i. When TR > TC then there exist excess profit. ii. When TR < TC then there exist loss. iii. When TR = TC then there exist normal profit. In this approach profit is maximized at that point where the difference between TR and TC is maximum.

It can be explained with the help of total revenue (TR) curve and total cost (TC) curve of perfectly competitive and monopoly firm. The graphical illustration of equilibrium of perfectly competitive and monopoly firm are as follows as shown by Panel-A and Panel-B respectively. Here in panel-A, we explain the equilibrium of perfectly competitive firm whose total revenue curve is upward sloping straight line from origin due to the fixed price. On the other hand, cost curve is inverse S-shaped due to operation of law of variable proportion in the process of production.

 Graphically,

PANEL-A
B

TC TR

D TR and TC

T1 MAXIMUM PROFIT

LOSS

LOSS

E
A

T O Q0 Q2 Q1 Quantity Output

In the above figure, along x-axis we plot quantity output and along y-axis we plot TR and TC. TR is the total revenue curve which is originated from origin O and upward sloping from left to the right. This is due to constant price in perfect competition market. TC is the total cost curve which is inverse sshaped, due to application of law of variable proportions. In perfect competition market structure, profit is maximum when the gap between TR and TC is maximum. And it is obtained by drawing parallel line with TR curve and which is tangent to the TC curve.

In

the above figure, the shaded area shown before point A is the case of loss bearing situation. Where TC > TR. And similarly, shaded area beyond the point B is also loss bearing situation. Where TC > TR. Hence, any level of output in this range are loss bearing. At point A and B, TR = TC, so, this is the situation of normal profit. That means, OQ0 and OQ2 level of output shown in the figure are the level of output which provides normal profit to the producer in perfect competition market. In the above figure, if we draw parallel line with TR curve and which is tangent to the TC curve then, we can get the maximum difference between TR and TC. This is situation of maximum profit.

 In

the figure, we draw parallel line TT1 with TR curve and which is tangent with TC curve at point E. If we extend the line from this point upto pint D, we get the maximum gap between TR and TC which is denoted by DE, this is excess profit of the firm. This is the situation of equilibrium of a firm with maximum profit DE and equilibrium level of output Q1, which is shown in above figure. The firm can earn profit in between the range of A and B but the maximum profit earning range is the DE.

Here in Panel-B, we show equilibrium of monopoly firm. where TR curve initially increases at increasing rate, increases at decreasing rate, reaches to its maximum point and finally it starts to decline as shown by TR. i.e. TC curve is bell shaped. On the other hand, TC curve is inverse SShaped due to operation of law of variable proportion in the process of production. Since, the objective of the monopolist firm is to maximize the profit. And the profit will be maximum when the difference between TR and TC is highest. Mathematically,

i.e. = TR TC

Where, = Total Profit, TR = Total Revenue and TC = Total Cost. In above formula, we can see three cases; i. When TR > TC then there exist excess profit. ii. When TR < TC then there exist loss. iii. When TR = TC then there exist normal profit. The profit is maxized at the output where there is the biggest gap or highest difference between TR and TC. It can be illustrated by the following figure.

 Graphically,

PANEL-B
B D

TC

T2

LOSS T1 MAXIMUM PROFIT TR

TR and TC

LOSS E A

Q0

Q2 Q1 Quantity Output

2. MR MC Approach of Determining Equilibrium Level of Price and Output Marginal Revenue and Marginal Cost (MR-MC) Approach another method of finding profit maximizing level of output in case of perfectly competitive market and monopoly market structure. In this approach following two conditions must be satisfy by the firm for equilibrium. a. First Condition (Necessary Condition): Marginal Revenue (MR) should be equal to the Marginal Cost (MC), i.e. MR = MC. This means, a firm will be equilibrium in that level of output where cost of production of one more unit (MC) is equal to the revenue obtained from the sale of that unit (MR).

b. Secondary Condition ( Sufficient Condition): Only MR = MC condition is not sufficient for the firms equilibrium in perfect competition and monopoly market. For the equilibrium of the firm, the sufficient condition is, at the point of equilibrium MC curve must cut MR curve from below, i.e. slope of MC > slope of MR. For both perfectly competitive and monopoly market structure two conditions mentioned above are the necessary and sufficient conditions. Which are common for both in case of MR-MC approach. This approach simultaneously determines equilibrium level of output and equilibrium price of a product.

It can be explained with the help of graph, in following graph. Where Panel-A represents equilibrium condition of perfectly competitive market and Panel B represents the equilibrium condition of monopoly market. Graphically, Panel - A
MR, MC and Price MC P

e1

AR=MR

Qo

Quantity Output

Q1

 In

the above figure, along x-axis we plot quantity output and along y-axis we plot, MR, MC and Price. In the perfect competition market AR and MR and Price are constant so curve is horizontal and parallel to x-axis as shown in the figure. First order condition is satisfied at point e and pint e1. where, MR=MC. But sufficient condition is satisfied only at point e (where slope of MC > slope of MR), which is equilibrium point and the equilibrium level of output is OQ1 and equilibrium price OP in case of perfectly competitive market.

- OQo level of output is not equilibrium level of output, because, at point e1 first order condition of equilibrium is satisfied (i.e. MR = MC) and second order condition is not satisfied (i.e. slope of MC < slope of MR). Panel-B
MC

MR, MC and Price

Pe

E AR MR O Qe Quantity Output

Price and Output Determination Under Perfect Competition 1. Meaning of Perfect Competition: Perfect competition is a market structure in which there are large number of sellers sells a homogeneous product to a large number of buyers. There is absence of rivalry among individual firms. An individual buyer and seller can not influence the equilibrium price, because they have negligible effect on the total market. Therefore, in a perfectly competitive market, the individual seller is only a price taker and output adjuster.

2. Features of Perfect Competition Market: a. Large Number of Buyers and Sellers: There is a large number of buyers and sellers in a perfectly competitive market. Individual consumer and individual seller can not influence the market price. They has no significant effect on total market demand. Because, both the individual consumer and buyer are only a small unit of the whole market. In this type of market price is assumed to be fixed for both individual buyers and sellers, therefore, sellers are only price takers and output adjusters.

b. Homogeneous Product: In a perfectly competitive market all the goods are homogeneous. The goods produced in various industries are similar to each other. The trademark, label, packing and other things such as color, size, quantity, nature, weight and all other things of goods should be very much similar to each other. So that they are perfectly substitutable. Thus in this kind of market structure, goods are similar from all point of view. Hence they are called homogeneous products. Large number of buyers and sellers and homogeneous product imply that individual firm is price taker and demand curve is perfectly elastic.

c. Free Entry and Exit of the Firms: In this kind of market any firm is completely free to enter into the industry and to exit from the industry. If there is abnormal profit in the industry in shortrun, then new firms inter into the industry and if there is loss then the firm exit form the industry. Hence, there is always normal profit in the industry in the long-run. d. Perfect Knowledge About the Market: In this kind of market, all buyers have perfect knowledge about the current and future condition of the market and sellers have perfect knowledge about prices of goods and prices of the factors of production.

e. Perfect Mobility of the Factors of Production: All the factors of production are free to enter into and exit from the industry. There is no monopoly power on raw materials, any factors of production and labor. This means if a laborer get higher wages in any other factory then he is free to quit the existing factory for higher wage in another factory. f. No Transportation Cost: In the perfectly competitive market there is no costs of transportation. If transportation cost is imposed then the prices will not be uniform. Which violates the assumption of constant price.

g. No Government Intervention/ Regulation: In the free market economy there is no government intervention. It means government should not charge tariffs, subsidies, taxes and other barriers in the market. Two market forces demand and supply determines the equilibrium price and output in the market. Thus, perfectly competitive market is the free game of demand and supply. Hence, government intervention should be prohibited. i. Profit Maximization Goal: In this type of market, all firms in the industry have the objective of profit maximization.

Price and Output Determination Under Perfect Competition Interaction of market demand and market supply determines the equilibrium level of price and output under the perfect competition market. Equality of demand and supply gives an equilibrium position. That is when two market forces demand and supply equals to each other at that time equilibrium level of output and equilibrium level of price are simultaneously determined. These two market forces can be explained as follows:

A. Demand: According to the law of demand, other things remaining the same there exist inverse relationship between price and quantity demand. Hence, demand curve is downward sloping. But the degree of change in quantity demand due to change in price depends on elasticity of demand. B. Supply: According to the law of supply, other things remaining the same there exist positive relationship between price and quantity supply. But the degree of change in quantity supply due to change in price depends on elasticity of supply.

The process of determination of price and output under perfect competition market can be explained with the help of following table, Demand & Supply Schedule
Quantity Demanded (Qd)
50 40 30 20

Price (Rs.)
2 4 6 8

Quantity Supplied (Qs)

10 20 30 40

Status
Qd>Qs Qd>Qs Qd=Qs Qd<Qs

Effect on Price
Rise Rise Stable Fall

10

10

50

Qd<Qs

Fall

The price and output determination process under perfectly competitive market can be illustrated with the help of following graph, Graphically: Excess Supply

Qs>Qd
D P1 Price Pe A B S1

E C S D

Qd=Qs

Po

Excess Demand Qd>Qs

Qe Quantity of Goods

D1

Alternative Method Short-Run Equilibrium of the Firm and Industry In Case of Perfectly Competitive Market Short-run refers to that period of time where a producer can not change the amount of fixed inputs. A firm can increase level of output by changing amount of variable factors of production only. In short run a firm bears two types of cost i.e. fixed and variable cost. Fixed cost remains constant with every increase in level of output and the variable cost varies with every increase in level of output. For the equilibrium of a perfectly competitive firm, according to MR-MC Approach, following two conditions must be fulfilled

Necessary Condition: MR = MC 2. Sufficient Condition: Slope of MC Curve > Slope of MR Curve. i.e. MC Curve must cut MR curve from below. When these two conditions are fulfilled, the firm is supposed to be in equilibrium condition. In short-run equilibrium, the firm and industry under perfect competition may face following three situations: a. Equilibrium with Supernormal Profit. (AR>AC). b. Equilibrium with Normal Profit. (AR = AC). c. Equilibrium Incurring Losses.(AR<AC). These three situation can be explained with the help of following figure:
1.

Graphically,
Fig.A: Equilibrium of Industry Fig.B: Firm-A Equilibrium of a firm with supernormal Profit AR>SAC Supernormal Profit SMC SAC E1 A

Price

D Pe

S1

Price

P
B

AR=MR=P

S O Qe Quantity

D1

Q1 Quantity

Graphically,
Fig.A: Equilibrium of Industry Fig.C: Firm-B Equilibrium of a firm with Normal Profit AR=SAC Normal Profit

Price

SMC

D Pe

S1

SAC

Price

P
E2 AR=MR=P

S O Qe Quantity

D1

Q1 Quantity

Graphically,
Fig.A: Equilibrium of Industry Fig.D: Firm-C Equilibrium of a firm incurring loss AR<SAC LOSS

Price

SMC

D Pe

S1

SAC B P A E1 AR=MR=P

Price

S O Qe Quantity

D1

Q1 Quantity

LONG-RUN EQUILIBRIUM OF PERFECT COMPETITION FIRM In long-run all factors of productions are assumed to be variable. Hence, in long-run firms have enough time to adjust their outputs by changing the factors of production. In long-run cost is not divided into variable cost and fixed cost. Due to which all the firms have identical cost curves. Entry and exit of new firms are allowed in the long-run. If the profit level is high, then the new firms enter into the industry. If profit level is low or loss the existing firms quit the industry. When all competitive firms earn normal profit, then there is no tendency for the entry of new firms into the industry and exit of existing firms from the industry.

That situation is known as long-run equilibrium of the industry. In long-run also, following two conditions most be fulfilled to determine the equilibrium of the firms, i. MR = MC (necessary condition) ii. Slope of MC > Slope of MR. ( sufficient Condition.) (i.e. MC curve must cut MR curve from below) When all firms under the industry are operating at normal profit, industry is said to be in equilibrium. Where following conditions must be fulfilled by the industry to be in equilibrium. 1. All the firms under the industry should be in equilibrium.

2. All the firms should be operating at normal profit ( i.e. AR = P = AC ) so that there is no tendency of the firms to enter or quit the industry. 3. The quantity demand and quantity supplied of the product should be equal. (i.e. D = S ). Long-run equilibrium of the industry can be explained with the help of following table. Where, LMC = Long-run Marginal Cost LAC = Long-run Average Cost

Graphically,
Fig.A: Equilibrium of Industry Fig.B: Long-run Equilibrium of a firm Price AR=LAC Normal Profit LMC

D Pe

S1

LAC

Price

P
E AR=MR=P

S O Qe Quantity

D1

Q1 Quantity

PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY MARKET

Concept of Monopoly 2. Features of Monopoly Determination of Price and Output Under Monopoly. A) Short-Run Equilibrium of Monopoly B) Long-Run Equilibrium of Monopoly
1.

3.

1. Concept of Monopoly: The term Monopoly has been derived from the two Greek words 'Mono' and 'Poly'. Where mono means single and poly means seller. It is opposite to the perfect competition. Thus, monopoly is a market structure where there is single seller of a product having no close substitute with large number of buyers. Single firm it self is industry and there is barrier to entry new firms into the industry. In this type of market structure, a firm have full control over the price and quantity supply of the product. That means monopoly firm is price maker. It sets price of the product itself. Monopolist is like a king without crown.

Hence, the demand curve of monopoly firm is downward sloping from left to the right. This signifies that, monopoly can sale more goods at lower price and vice-versa. 2. Features of Monopoly: The main features of the monopoly market structures are as follows: 1. Single seller and many buyers. 2. The goods produced by single seller have no close substitutes. 3. Barriers to entry the new firms into the industry. 4. A firms itself is industry. 5. Monopoly firm is price maker. It sets the price of product itself.

6. The ultimate aim of the monopoly firm is to maximize profit. 7. The demand curve of monopoly firm is downward sloping from left to the right. This signifies, at lower price monopolist can sale more output and vice-versa. 3. Price and Output Determination Under Monopoly Market Concept of Industry: there is no concpet of industry in monopoly due to single firm. In other words, the firm itself is the industry. Revenue Curves: AR and MR curves both are downward sloping. Cost Curves: Traditional U-shaped AC and MC curves are considered.

Equilibrium Condition: a. MC = MR b. MC curve must cut MR curve from below. i.e. the slope of MC > the slope of MR. A. Short-Run Equilibrium of Monopoly Firm: In short-run equilibrium analysis generally we can see three cases, a. Abnormal Profit (AR > AC) b. Normal Profit (AR = AC) c. Losses (AR < AC) In short-run equilibrium, it does not mean that a firm makes abnormal profits. Whether a firm makes abnormal profit or normal profit or incurs loss depends upon the level of AC.

Thus, it is important to analyze the above mentioned three cases as per the level of AC with the help of following graphs. Case a : Equilibrium of a firm Graphically, with abnormal profit (AR>AC)

Abnormal Pofit A

MC

AC

Pe C, R, P C

B E AR MR

Qe

Output

Case b : Equilibrium of a firm with normal profit (AR = AC)

AC MC

Normal Pofit
A

Pe C, R, P

E AR MR

Qe

Output

Case c : Equilibrium of a firm incurring loss AC (AR<AC)

Loss

MC
C Pe C, R, P B A

E AR MR

Qe

Output

Thus, we conclude that in short-run equilibrium of a firm, the level of AC determines whether a firm bears losses or enjoys abnormal profit or just stay with normal profit at equilibrium. In this way at equilibrium price Pe, a firm sells Qe level of equilibrium output. A firm in monopoly bears losses in rare conditions only, i.e. at the time of depression and initial stage of production. Otherwise it enjoys with abnormal or normal profit. B. Long-run Equilibrium of Monopoly Firm: A monopolist firm in the long-run always enjoys abnormal profit (AR>AC) due to strict barriers to entry of new firms and there is enough time for a firm to adjust its factors of production and level of output.

Long-run equilibrium of a monopolist firm can be explained with the help of following graph: Graphically,

Long-Run Equilibrium of a firm

Abnormal Pofit A LMC LAC

Pe C, R, P C

B E AR MR

Qe

Output