In economics, market forms refer to the structure and characteristics of a market. They are defined by:
- Number of Sellers and Buyers
- Nature of the Product (homogeneous or differentiated)
- Degree of Control Over Price
- Barriers to Entry and Exit
Broadly, we classify markets into:
- Perfect Competition
- Monopolistic Competition
- Oligopoly
- Monopoly
Each has unique price determination mechanisms, which we’ll explore below.
Perfect Competition: The Ideal Market
Characteristics:
- Large Number of Buyers and Sellers: No single buyer or seller can influence the market.
- Homogeneous Products: Products are identical, e.g., agricultural goods.
- Free Entry and Exit: No barriers for firms entering or leaving the market.
- Price Takers: Firms accept the market price determined by demand and supply.
Price Determination:
Under perfect competition, price is determined by the intersection of market demand and supply curves.
- Market Equilibrium Price: The point where quantity demanded equals quantity supplied.
- Individual firms sell at this equilibrium price. Producing more or less won’t affect the price since firms are price takers.
Example:
Consider a wheat market where multiple farmers sell identical grains. The price per kilogram of wheat remains the same for all sellers.
Monopolistic Competition: A Blend of Competition and Monopoly
Characteristics:
- Large Number of Sellers: Many firms, but not as many as in perfect competition.
- Differentiated Products: Products are similar but not identical (e.g., toothpaste brands like Colgate, Pepsodent).
- Some Control Over Price: Firms can set prices within a range due to product differentiation.
- Free Entry and Exit.
Price Determination:
- Each firm faces a downward-sloping demand curve, as products are differentiated.
- Firms maximize profit by equating marginal cost (MC) to marginal revenue (MR).
- In the short run, firms may earn supernormal profits or incur losses.
- In the long run, entry of new firms erodes supernormal profits, leading to normal profits.
Example:
The shampoo market, where every brand offers a unique value proposition (anti-dandruff, herbal, etc.), allows price differentiation.
Oligopoly: The Market of the Few
Characteristics:
- Few Sellers: A small number of firms dominate the market (e.g., automobile or airline industries).
- Interdependence: Firms’ pricing and output decisions depend on competitors’ actions.
- Barriers to Entry: High due to economies of scale, legal restrictions, etc.
- Differentiated or Homogeneous Products.
Price Determination:
One popular model is the Price Leadership Model:
- A dominant firm sets the price, and other firms follow.
- Price wars are avoided as firms prefer stability.
- In the long run, firms compete on non-price factors like quality, branding, etc.
Example:
The Indian telecom sector, where dominant players like Jio often influence pricing.
Monopoly: The Single Seller
Characteristics:
- Single Seller, Many Buyers: One firm controls the entire market.
- No Close Substitutes: The product is unique (e.g., patented drugs).
- High Barriers to Entry: Legal or natural barriers prevent competitors.
- Price Maker: The monopolist has significant control over price.
Price Determination:
- A monopolist maximizes profit by producing the quantity where MR = MC.
- Price is set on the demand curve at this quantity.
- Monopolies can charge different prices through price discrimination.
Graph: The monopolist’s demand curve is downward-sloping. Profit-maximizing output and price are shown where MC and MR intersect.
Example:
Indian Railways is a classic example of a government monopoly in passenger rail transport.
Price Discrimination in Monopoly
Price discrimination occurs when a seller charges different prices to different buyers for the same product.
Types:
- First-degree: Maximum willingness to pay (e.g., auctions).
- Second-degree: Based on quantity (e.g., bulk discounts).
- Third-degree: Based on customer groups (e.g., student discounts).
Key Differences Between Market Forms
| Aspect | Perfect Competition | Monopolistic | Oligopoly | Monopoly |
|---|---|---|---|---|
| Number of Sellers | Many | Many | Few | One |
| Control Over Price | None | Some | Significant | Complete |
| Entry Barriers | None | Low | High | Very High |
| Product Nature | Homogeneous | Differentiated | Homogeneous/Differentiated | Unique |