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What is a market and its various forms?

A market is simply a collection of people who wish to buy and sell; these people may congregate in one place or be dispersed over a wide area and communicate by the press, TV, estate agents' windows, telephone calls, letters. For better understanding read this blog or avail the help of an economics homework helper. This description of eighteenth-century London gives a picture of the two types of markets that are of special interest to the economist:

  1. The market place Where buying and selling takes place on one particular site.
  2. The 'larger' market A sphere of influence synonymous with the extent of sale of a commodity.

The market place

Large commodity markets still exist, but it is not possible to adhere rigidly to the simple definition of markets as enumerated above. Some goods are bought and sold at a marketplace; others may have an extent of sale not confined to one place; while the markets for other goods may be a compromise between the main location and other ways whereby buyers and sellers communicate.

Markets take numerous different forms, e.g., a stock market, a street market, a livestock market, etc. (On the other hand, a supermarket ought not to be classified as a 'market' in the true economic sense because although there are thousands of buyers, there is only one selling organization at each store.) Markets are linked; one market is kept supplied by other markets. Distributors will link large commodity markets with local wholesale markets which supply the marketplace frequented by the ultimate consumer who will purchase according to his scale of values based upon his priorities.

In many cases, the whole world is involved in buying and selling; meat sold at Smithfield may come from New Zealand, while diamonds bought or sold at Hatton Garden may come from Amsterdam or Cape Town. People buying or selling commodities are in contact over a very wide area, but the large-scale commodity markets act as a focal point for their activities.

Organized commodity markets

Manufacturers go to markets to buy raw materials so that production may take place. Large wholesale commodity markets tend to develop when the commodity is:

  1. Produced on a comparatively large scale It is worthwhile for buyers and sellers to seek out a special place where they can buy in bulk.
  2. In relatively short supply There is an opportunity for specialist merchants to take calculated risks and speculate so that they can make a satisfactory "turn' or profit.
  3. Seasonally produced There is usually a need to ensure a regular supply flow. Merchants are often accused of being wealthy speculators who manipulate prices merely for their gain, but they often provide a useful service in leveling out wide price differences.
  4. Comparatively durable Stocks can be held long enough so that seasonal abundances and seasonal gluts can be turned into a regular and smooth supply.
  5. Able to be graded Large quantities need not be brought to the market, e.g., the distinctive features of grades of cotton have been authorized by the Liverpool cotton association, while grades for wheat are drawn up by the London and Liverpool corn trade associations.
  6. Distinguishable by representative samples, For example, cocoa, coffee, sugar, tea, wool, etc. At the London Commercial Sales Room, such commodities are sold by auction.

Later in the unit, we shall study the differences between perfectly competitive markets and imperfect markets. At this stage, it must be pointed out that organized markets conditions perfect competition. Pat Noble, in Markets and Entrepreneurs (Institute of Economic Affairs), classifies dealers in the large wholesale markets as price-takers.

Where there are many buyers and sellers, as in the commodity markets for tea, cotton, sugar, etc, each entrepreneur is a price-taker, and his revenue is determined by the impersonal market price. Where buyers and sellers are few, they are price makers...In other words, entrepreneurs dealing in the commodity markets have to accept or 'take' the prevailing prices determined by the market forces.

Financial markets

Financial markets are dealt with more fully later, but a brief account of their importance is relevant here. Financial markets in London began with the arrival of the Lombards. These Italians were set up as money lenders and bankers in Lombard Street and the area around this famous street is still a hub of financial activity. The Lombards initiated the bill of exchange to finance world trade, especially in large-scale commodity dealings, and they added such terms as bank, creditor, and debtor to our financial language. Institutions involved in the money market may be both borrowers and/or lenders depending on time and circumstance. The main financial markets are:

  1. Money market Loans on a very short basis possibly overnight but rarely for more than seven days, i.e., 'money at call' or short notice.
  2. Discount market Specializes in bills of exchange (commercial bills) and Treasury Bills (short-dated government bonds-not more than three months duration).
  3. Foreign exchange market Authorized dealers are chiefly the banks or foreign exchange brokers.
  4. Capital market Provides short-term, medium-term, and long-term loans to commerce, industry, and the Government.
  5. New issue market Part of the capital market involved new public issues of stocks and shares.
  6. Stock market Enables the buying and selling of existing securities.


Sale by auction is merely another type of market. All markets work in basically the same way: the seller wants to receive the highest price he can obtain, while the buyer wants to pay the lowest price possible compatible with the ability to purchase. The seller does not indicate a price but tries to gain the maximum sum for each separate 'lot'. The auctioneer's market is restricted largely to those present at the time. The seller aims to gain the maximum profit from each item and it is difficult to ascertain whether this is done most satisfactorily under the Dutch or English auction systems.

  1. Dutch auction The auctioneer starts the bidding at a high price which he gradually lowers. The bidder, who is hoping for a bargain, may be loath to allow the price to fall too far in case a counterbid is made and the goods are lost to him. It is, therefore, the highest bidder who determines the price, but whether this is the highest price that could have been obtained depends upon numerous exogenous factors including the psychology practiced by both buyers and sellers.
  2. English auction At an English auction, the bidding starts at a low price and rises gradually according to the skill of the auctioneer and the keenness of the buyers. The price is determined by the second most eager buyer, for it is only after he stops bidding that the final bid is made. The price might have been much lower if it had not been forced up by counterbidding. Whether or not higher prices or greater bargains are obtained in English or Dutch auctions depends not merely upon the wealth of those present and their eagerness to obtain the goods but upon the tactics of the auctioneer and the atmosphere inculcated by this special type of market.

Perfect markets and perfect competition

Professor Philip Wicksteed, in The Common Sense of Political Economy (Macmillan, 1910), devoted three chapters to markets because he considered that markets constituted the hub of all economic activity. We have already learned the six main criteria of a perfect market and we have seen in the last topic that supply and demand determine the price. From the demand side, the greatest influence upon price is marginal utility, but from the supply side, price and the quantity sold depend upon whether the product is offered for sale in a perfect market, an imperfect market, or a monopolistic market. In the real world, an 'imperfect' state of 'monopolistic competition' exists which is a compromise between the two hypothetical extremes of a perfect market and a monopolistic market. A perfect market is often referred to in a capitalist society as a 'free market', meaning that greater freedom of choice is offered than in a collectivist society. The term 'free market' is controversial and the amount of marketing free dom thought to prevail depends upon which economic system is considered preferable. The concept underlying the free market economy is that each individual has a free choice and can exercise this choice as a voter does in elections. The goods which receive the most votes, in the long run, will retain their position in the market. This is somewhat of a simplification and ignores the injustices brought about by different purchasing power potentials and propensity to consume possessed by the individuals within the market. In a mixed economy, many things are 'bought' in a market that is not free. Water and roads are not free economic goods; they have to be supplied and paid for-but in this case by local rates and central government taxes.

The terms perfect market and perfect competition are not synonymous, but they are very similar in meaning. So that there should be perfect competition, the main criteria of a perfect market must exist, i.e., there must be numerous buyers and sellers, homogeneous products, etc. In addition, the main criteria of perfect competition are:

  1. No single firm influences price Each firm produces a proportion of the output of the product. The price will have been determined by the interplay of the forces of supply and demand and must be accepted as such by the sellers.
  2. No restriction upon numbers This applies to firms entering or leaving the industry.

To study long-run influences affecting the = subjects of perfect, imperfect, and monopolistic selling conditions, the student must be introduced to -the problem of cost. In the short run, the price in the market is determined by supply and demand, but in the long run, the cost of production is most important. The term 'cost of production has no meaning =unless it is related to the number of articles produced. What would be the cost of production of a new mini-Metro as introduced in 1980? With all the initial research and changes in design, it may well be that the cost of the first few amounted to hundreds of thousands of pounds each, but by 1986 the cost of production might amount to about £3000 a car. Also under the cost of production one must include advertising and other selling costs. Economists accept that 'normal profit'. i.e., the profit that is just necessary to keep an entrepreneur in that particular line of production, should be included as part of the costs of production. Normal profit will differ as the risks involved vary from one industry to another. Where there is more risk the entrepreneur expects to earn high-profit margins. It is a customary accountancy technique, and a logical bookkeeping procedure, to consider that a firm must make a reasonable profit to remain in business; so normal profit is a legitimate cost of production. The firm that is just capable of earning normal profit is known as a marginal firm.

It is intended here to treat the problems of cost in as simple a manner as possible and to introduce the student only to those terms that are strictly necessary:

  1. Fixed costs (FC) (or supplementary costs) Costs that do not vary with output, e.g., factory, rent, rates, etc.
  2. Variable costs (VC) (or prime costs) Costs of producing one unit of output, e.g., labor (wages), raw materials, power, etc.
  3. Average cost (AC) Total cost divided by the number of units produced.
  4. Marginal cost (MC) The cost of producing an extra unit.
  5. Average revenue (AR) Total revenue divided by the number of units sold.
  6. Marginal revenue (MR) The extra revenue obtained from the sale of an extra unit.

The last four terms above (AC, MC, AR, and MR) are of special significance in the study of the price and output of entrepreneurs under conditions of perfect competition, imperfect competition, and monopoly. The entrepreneur will attempt to maximize his profit, and it will always be the case that:

                                                                                            MC = MR

Figure 11.1 illustrates the situation prevailing under conditions of perfect competition. It is possible to compile complex schedules showing average revenue, total revenue, average cost, total cost, marginal cost, profit, etc., for given units of output. However, whether the economic truth is expressed in verbal, numerical, or graphical terms makes no difference to the essence of the argument. In this section, we shall lean heavily upon the use of graphical material because it is easier to visualize the basic facts, and it serves as a type of shorthand. If the student wishes, he can make out his statistical schedules based on the graphs; indeed it may help to clarify the essential principles if the student compiles hypothetical cost and revenue schedules.

One of the main purposes of distinguishing between fixed or supplementary costs on the one hand and variable costs on the other is that a firm will continue producing, at least in the short run, so long as the prime costs are covered. If the firm can pay the worker's wages at the end of the week and meet the bills for raw materials, electricity, gas, etc., then production will continue. It does not require much insight to realize that if the labor force were not paid on Friday, then the workers would not report on Monday morning. If the factory gates are shut temporarily, the fixed costs still have to be met: debenture-holders are legally entitled to payment, the rates and rent have to be paid, and the machinery will depreciate rapidly if left idle. Further, it will be difficult to get the factory ticking over again. Production has to be restarted, the labor force reconstituted, and fresh orders attracted; it may be months or even years before lost goodwill can be made up.

In all conditions of production (from the hypothetical extremes of perfect competition to pure or absolute monopoly), the entrepreneur will maximize his profits when marginal cost equals marginal revenue. This is because if the marginal revenue, i.e., the extra income from the sale of an additional unit, is greater than the marginal cost, i.e., the extra cost

of producing an additional unit, it must be to the entrepreneur's advantage to increase his output, for each extra unit will add to his profit, But if he goes past the point where MC MR, then the cost of the extra unit is more than the revenue from the additional unit and he would be either a fool or ill-informed on the economic position to push on beyond this point. Study Fig. 11.1 carefully and note the following points:

  1. MR = AR (=price) Since the entrepreneur, under conditions of perfect competition, only produces an infinitesimal part of the total supply and can in no wise influence the price, whether he sells one unit, or one thousand and one, he will gain the same price per unit.
  2. MC = AC At first, the average cost will be higher than the marginal cost because MC does not contain any part of the fixed cost; MC includes only such variable costs as wages, primary products, and power. But AC includes the cost of the factory, plant, machinery, rent, rates, etc. However, when the MC curve cuts the AC curve, the AC curve will begin to rise. The underlying principle involved can be seen easily by using the analogy of cricket. If a batsman scores more run in one innings than his average score for the season, his 'average' is bound to be pushed up if he has had 10 innings and scored 1000 runs his average will be 100. If, however, in the next innings he scores 111 then his total runs will be 1111 for 11 innings and his average will be 101 (even if he scored 101, it would push up his average by 0.1).
  3. If MR = MC and {MR = AR

                                         MC = AC

            MR = MC = AR = AC

The output of the entrepreneur producing under conditions of perfect competition will, therefore, be when this four-term equilibrium occurs. Some students, glancing at Fig. 11.1, may ask: 'Where is the entrepreneur's profit? The answer is that the producer's profit is the 'normal profit' included in the average cost of production. This profit is just sufficient to induce the entrepreneur to stay in the industry. The equilibrium firm under perfect competition will find no advantage in changing its output, and its average cost of production will be at a minimum. Similarly, the equilibrium industry under perfect competition will not tend to change its size. Perfect equilibrium exists when every firm in an industry is making a normal profit.

All this is hypothetical. Although it may be contended that conditions of perfect competition may exist in the Stock Exchange or foreign exchange markets, in any industry, at any given moment, there are almost certain to be high-cost and low-cost firms. The differences in costs may be caused by differences in managerial efficiency, or the utilization of a new invention giving a short-term initial advantage until other entrepreneurs emulate the 'know-how', but in any case, the more efficient firm will earn a surplus profit in the short run (see Fig. 11.2). But the concept of the equilibrium is useful because we assume a static position first or a position to which market forces are tending.

Having examined the extreme of perfect competition and the equilibrium firm or industry under these conditions, we can look at particular cases and see how near these cases come to the equilibrium. Government action and the pressures of various consumer and social groups will work against complete economic freedom and perfectly competitive markets. No modern society can leave income distribution to the market alone', wrote Professor Grossman (Economic Systems, Prentice Hall Inc.). The interests of democracy and justice necessitate intervention, both in perfect and imperfect markets, on behalf of the socially underprivileged. The theme of modern economic thought is the challenge of scarcity: there are insufficient economic goods and services to satisfy an insatiable man.

Price and Output

Figure 11.1 Price and output under conditions of perfect competition MR = MC = AR = price.

A firm

Figure 11.2 A firm may earn more than normal profit, even under conditions of perfect competition, until new firms are attracted into the industry and an equilibrium position is reached.

Monopolistic markets

The opposite extreme of the perfect market is the monopolistic market. It is often contended that perfect monopoly (and perfect competition) only exist in the mind of the economist. However, the concept of monopoly is not merely a playful abstraction; it is useful to look at the two absolutes of perfect competition and perfect monopoly and to see how far along the scale (between the two extremes)

appear in particular firms and industries. The basis of supply under monopoly is governed by two conditions:

  1. A single producer The supply of particular goods or services must be controlled by one producer only, or by a group of producers acting with a unified policy.
  2. No substitute There is no adequate substitute available for the commodity or article produced. The monopolist is in a strong position to maximize his profits, and he can do this by supplying a smaller quantity to the market than would be the case under perfect competition. The large-scale producer can rationalize his business and enjoy the advantages of economies of scale, e.g., increasing output with decreasing costs, but because he is in a unique and dominating position he is unlikely to supply an output that would coincide with the lowest point on the average cost curve (AC). As the monopolist controls the market, he is not compelled by the entry of new competitive firms into the industry to produce at the lowest possible average cost of production per unit; but although the monopolist can control the price or the output in the market, he cannot sell as much as he likes at any price he chooses. The truism prevails: more will be sold for a low price than at a high price and vice versa. Even if close substitutes are not available, all goods are rivals for the consumers' purchasing power. The monopolist is unable to control demand (AR curve) although by expensive advertising campaigns he may be able to increase the market demand for his particular product.

In practice, the market is only perfectly Monopol istic in the case of nationalized industries. But even these goods and services have substitutes. Coal, electricity, and gas as forms of power supplied by the public sector compete with oil supplied mainly by producers in the private sector. Similarly, public rail transport competes with road and air transport; but if you are determined to go from Manchester to London by train, then you must use British Rail. The private sector provides a few examples approaching a situation where one firm supplies 100 percent of a particular product sold on the market. The British Oxygen Company supplies over 90 percent of the market total. It is controversial whether or not the exercise of near-monopolistic power will provide conditions of supply conducive to goods being offered for sale in the market at slightly cheaper prices than would be the case in a perfect market. Although thousands of firms in a perfect market may be spurred towards maximum efficiency and to produce at the lowest average cost of production, what would be the lowest AC for them is not the lowest AC for an efficient monopolist who is able vertically or horizontally to integrate and eliminate all the duplications of the productive process. The Monopolies Commission considered that Pilkington's near monopoly enabled the UK market to purchase plate-glass cheaper than if the glass had been manufactured by scores of small firms. The pseudo monopolist may be the sole possessor of industrial practice, apart from having a monopoly in terms of percentage share of the market for a particular product. When Pilkington's developed the plate-glass method of production, all the older expensive methods of polishing glass were rendered uneconomic.

A monopolistic situation of demand in a market is known as monopsony. The public sector of the economy provides the best examples: e.g., the Gas Corporation has the monopsony of purchasing natural gas from companies supplying the gas from under the North Sea. So the Corporation was able to exert great pressure upon the private companies to supply natural gas at a relatively low price per therm. The companies could have rejected the price offered and gone elsewhere, but so many millions of pounds had been invested in initial research and methods of supplying the gas to the market, that the private companies were to a large extent under the power of the monopsonistic Gas Corporation.

Risks exist both in monopolistic and competitive markets. In a situation approaching perfect competition, the annual bankruptcy rate among small building firms is relatively high. The monopolist does not produce without risk for he has resources committed to highly specialized capital equipment. Technological changes may render his plant obsolete, c.g., a huge steel concern may be compelled to write off converters for the sake of modernization. In the long run, the improved techniques may lower production costs, but in the short run, it is an expensive business.

The percentage of the market controlled by a producer is unlikely to be 100 percent, but as Professor Nevin, in Textbook of Economic Analysis (Macmillan), has contended:

To say that a firm does not have a monopoly because it produces only 95 percent and not 100 percent of the total supply would be unrealistic. ... The essential point about monopoly, then, is that there ceases to be a distinction between the firm and the industry.

Figure 11.3 illustrates the equilibrium price and output of the monopolist. Compare Fig. 11.3 and Fig. 11.1; they indicate the average revenue, marginal revenue, average cost, and marginal cost of a firm under (a) perfect competition and (b) monopoly. Notice the following differences:

  1. Under monopoly, the AR curve slopes downwards from left to right. The monopolist can sell more at a lower price, but under perfect competition, AR is fixed by the free interplay of market forces of supply and demand.
  2. Under monopoly, the MR curve is always to the left of the AR curve; the two curves are not synonymous as in a perfectly competitive market. The reason for MR being less than AR can best be illustrated by a very simple table (see Table 11.1).
  3. Under conditions of monopoly and perfect competition, the price will be where MR MC, but the monopolist does not fix his output at the lowest point on the AC curve. In Fig. 11.3, if a vertical line is extended from the point where MR = MC:
    1. Downwards to the horizontal axis-this determines the monopolist's output.
    2. Upwards to the average revenue curve-this indicates the price the monopolist will charge to maximize his profits. As the monopolist's price is higher than the AC cost curve at this point, the monopolist makes an excess or surplus profit, i.e., an 'economic rent'.

The monopolist

Figure 11.3 The monopolist will charge a higher price and gain a profit above the 'normal' for the industry.

Table 11.1 Why MR is less than AR

Quantity (m)


Total revenue

Imperfect markets and imperfect competition

An imperfect market arises when any one of the conditions required for a perfect market does not exist. Such a definition suffers from a negative approach, so in this text, we shall consider imperfect competition as a compromise between perfect competition and perfect monopoly. The practical norm, in this case, has been referred to by E. H. Chamberlin as 'monopolistic competition' (The Theory of Monopolistic Competition). In conditions of monopolistic competition, the imperfect market results from the differentiation of products; there may be many producers but their goods are not identical. Advertisers persuade consumers that these differentiated products are not homogeneous even though the differences (either by brandings or wrappings) may be more apparent than real. The producer of Brand X has a monopoly on the supply of that particular product in the market. Attempting a positive assessment of the main criteria of imperfection in a market, an imperfect market may be said to exist where there are:

  1. Limited number of buyers or sellers
    1. Duopoly. Two buyers or two sellers, e.g., in the case of production, a duopoly may be regarded as existing in the UK in the sugar industry, e.g., British Sugar Corporation and Tate and Lyle.
    2. Oligopoly. Few (from the Greek oligos) buyers or sellers, e.g., in the production of:
      1. soapless detergents, e.g., Procter and Gamble, Hedley Brothers, and Unilever;
      2. motorcars, c.g... Chrysler, Vauxhall, Ford, and British Leyland Motor Corporation dominate UK domestic production of cars.
  2. Heterogeneous products For example, if the goods are differentiated in any way, then only one manufacturer is capable of producing that particular brand. This is usually considered to cause imperfection of markets and competition. However, it is only fair to point out that this traditional view put forward by Mrs. Joan Robinson, in The Economics of Imperfect Competition, has been challenged by some modern economists. George Cyriax, in Monopoly and Competition (The Institute of Economic Affairs), has argued:
  3. That competition has tended to shift away from pure competition on price-which in the old markets for unbranded produce was almost the only competition there could be. Competition today is for quality, service, prompt delivery, and design.

    There can be intense competition between branded goods; manufacturers have subtle techniques of packaging, advertising, and optional extras through which they fiercely compete with other large-scale producers.

  4. Discrimination against buyers or sellers For example, at one time the Electricity Council was compelled by the Government to use coal instead of oil in CEGB power stations; this discrimination in favor of the coal industry was prejudicial to the oil companies.
  5. Buyers and sellers who are not in close contact For example, since the Second World War, the once economical movement of Western European industrial and commercial goods, in exchange for agricultural and primary products from Eastern European countries, has been interrupted by the so-called political 'iron curtain'. Gibraltar may have been next door to La Linea in Spain, but if the trade was prevented by customs barriers or political disagreements, then a state of imperfect competition existed between those two places that were only a few hundred yards apart.
  6. Economic goods which are not always portable or transferable For example, discoveries of oil and gas in the Norwegian section of the North sea cannot be utilized by Norway because of a deep gorge in the sea bed. In the retail trade, examples of imperfect competition abound; a shop on a housing estate situated on the periphery of a large city is not in perfect competition with a shop selling similar products but sited in a different vicinity. The shop on the estate possesses a local monopoly.

The double equilibrium of imperfect competition

It has been seen that in situations of perfect competition and absolute monopoly MC MR. However, in a state of imperfect marketing or imperfect competition not only will MC = MR but AC AR. Therefore, there is a double equilibrium. This double equilibrium is not just fortuitous; it is an equilibrium between the firm and the equilibrium of the industry.

In Fig. 11.4, at output OQ the equilibrium of the industry is assured when AC = AR, and the equilibrium of the firm when MC = MR. At output OQ the two curves AC and AR are tangential to one another. If the output were less than OQ, the curve AC would be steeper than AR and MC would be less than the MR; therefore, the AC curve is being decreased to a larger extent than AR is being decreased.

Using Fig. 11.4 as an example:

At OQ     Decrease in revenue = 80-60 = 20

                Decrease in cost =85-50 = 35

But at any point to the right of OQ, the AC curve is less steep than the AR curve-it is pulling the AC curve down less rapidly than the MR curve is pulling down the AR curve. Therefore, only at OQ is the dual equilibrium fulfilled, for at this output:

  1. The slopes of the marginal cost and marginal revenue curves must be equal (point Y).
  2. The slopes of the average cost and average revenue curves must be equal (point X).

So the firm producing under conditions of imperfect competition will not necessarily be making an abnormal profit (see Fig. 11.4) where at output OQ, average cost = average revenue (or price). 'So long as new firms can move into the industry, they will prevent abnormal profits from continuing, while firms will leave the industry if profits fall below the normal level' (Professor Nevin, Textbook of Economic Analysis, Macmillan).

equilibrium under imperfect competition

Figure 11.4 The double condition of equilibrium under imperfect competition.

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