ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev

Economics for CA CPT

Created by: Aditi Mittal

CA Foundation : ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev

The document ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev is a part of the CA Foundation Course Economics for CA CPT.
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Learning Objectives

  • know the meaning of market in Economics.
  • know various types of markets.
  • understand the concepts of total, average and marginal revenue.
  • understand behavioural principles underlying markets.

1.0 MEANING OF MARKET 

Consider the following situation. You go to the local market to buy a pair of shoes. You enter one shop which sells shoes. The shoes which you like are priced at Rs. 600. But you think that they are not worth more than Rs. 500. You offer Rs. 500 for the shoes. But the shopkeeper is not ready to give them at less than Rs. 550. You finally buy the shoes for Rs. 550.

This is an example of a local market. In this market some are buyers and some are sellers. The market fixes the price at which those who want something can obtain it from those who have it to sell.

Note that it is only exchange value which is significant here. The shopkeeper selling the shoes may have felt that the shoes ought to have made more than Rs. 550. Considerations such as ‘sentimental value’ mean little in the market economy. Most goods such as foodstuffs, clothing and household utensils etc., are given a definite price by the shopkeeper. But buyers will still influence this price. If it is too high, the market will not be cleared; if it is low, the shopkeeper’s stock will run out.

A market need not be formal or held in a particular place. Second-hand cars are often bought and sold through newspaper advertisements. Second-hand furniture may be disposed of by a card in the local shop window.

However, in studying the market economy it is essential to understand how price is determined. Since this is done in the market, we can define the market simply as all those buyers and sellers of a good or service who influence the price.

The elements of a market are: 

(i) buyers and sellers;

(ii) a product or service;

(iii) bargaining for a price;

(iv) knowledge about market conditions; and

(v) one price for a product or service at a given time.

Classification of Market: In Economics, generally the classification is made on the basis of

a. Area

b. Time

c. Nature of transaction

d. Regulation

e. Volume of business

f. Types of Competition.

On the basis of Area: On the basis of geographical area covered, markets are classified into

a. Local Markets: Generally, markets for perishable like butter, eggs, milk, vegetables, etc., will have local markets. Like wise, bulky articles like bricks, sand, stones, etc., will have local markets as the transport of these over a long distance will be uneconomic.

b. Regional Markets: Semi-durable goods command a regional market.

c. National Markets: In this market durable goods and industrial items exist

d. International markets: The precious commodities like gold, silver etc. are traded in the international market.

On the basis of Time: Alfred Marshall conceived the ‘Time’ elements in marketing and this is classified into

a. Very short period market: It refers to that type of market in which the commodities are perishable and supply of commodities cannot be changed at all. In a very short-period market, the market supply is almost fixed and it cannot be increased or decreased, because skilled labour, capital and organization are fixed. Commodities like vegetables, flower, fish, eggs, fruits, milk, etc., which are perishable and the supply of which cannot be changed in the very short period come under this category.

b. Short-period Market: Short period is a period which is slightly longer than the very short period. In this period, the supply of output will be increased by increasing the employment of variable factors to the given fixed capital equipments.

c. Long-period Market: It implies that the time available is adequate for altering the supplies by altering even the fixed factors of production. The supply of commodities may be increased by installing a new plant or machinery and the output adjustments can be made accordingly.

d. Very long-period or secular period: is one when secular movements are recorded in certain factors over a period of time. The period is very long. The factors include the size of the population, capital supply, supply of raw materials etc.

On the basis of Nature of Transactions

a. Spot Market: Spot transactions or spot markets refer to those markets where goods are physically transacted on the spot.

b. Future Market: It is related to those transactions which involve contracts of the future date.

On the basis of Regulation:

a. Regulated Market: In this market, transactions are statutorily regulated so as to put an end to unfair practices. Such markets may be established for specific products or a group of products. Eg. stock exchange

b. Unregulated Market: It is also called as free market as there are no restrictions on the transactions.

On the basis of volume of Business 

a. Wholesale Market: The wholesale market comes into existence when the commodities are bought and sold in bulk or large quantities.

b. Retail Market: When the commodities are sold in the small quantities, it is called retail market. This is the market for ultimate consumers.

On the basis of Competitions: Based on the type of competition markets are classified into

a. Perfectly competitive market and

b. Imperfect market.

We shall study these markets in greater details in the following paragraphs.

1.1 TYPES OF MARKET STRUCTURES 

For a consumer, a market consists of those firms from which he can buy a well-defined product; for a producer, a market consists of those buyers to whom he can sell a single well-defined product. If a firm knows precisely the demand curve it faces, it would know its potential revenue. If it also knows its costs, it can readily discover the profit that would be associated with different level of output and can choose the rate that maximizes the output. But suppose the firm knows its costs and the market demand curve for the product but does not know its own demand curve. In other words, it does not know its own total sales. In order to find this curve, the firm needs to answer the following questions. How many competitors are there in the market selling similar products? If one firm changes its price, will its market share change? If it reduces its price, will other firms follow it or not? There are so many other related questions which will need answers.

Answers to questions of this type will be different in different circumstances. For example, if there is only one firm in market, the whole of the market demand will be satisfied by this particular firm. But if there are two large firms in the industry they will share the market demand in some proportion. They will have to be very cautious of the reactions of other firm to every decision they make. But if there are say more than 5,000 small firms in an industry, each firm will be less worried about the reactions of other firms to its decisions because each firm sells only a small proportion of the market. Thus, we find that the market behaviour is greatly affected by market structure. We can conceive of more than thousand types of market structures but we focus on a few theoretical market types which mostly cover a high proportion of cases actually found in marketing world. These are :

Perfect Competition : Perfect competition is characterised by many sellers selling identical products to many buyers.

Monopolistic Competition : It differs in only one respect, namely, there are many sellers offering differentiated products to many buyers.

Monopoly : It is a situation of a single seller producing for many buyers. Its product is necessarily extremely differentiated since there are no competing sellers producing near substitute products.

In Oligopoly : There are a few sellers selling competing products for many buyers.

Table 1 summarises the major distinguishing characteristics of these four major market forms.

Table 1 - Distinguishing features of major types of markets

AssumptionMarket Types

Pure 

Competition

Monopolistic 

Competition

OligopolyMonopoly
Number of sellersmanymanya fewone
Product differentiationnoneslightnone to substantialextreme
Price elasticity of demand of a firminfinitelargesmallsmall
Degree of control over pricenonesomesome

very 

considerable

 

Before discussing each market form in greater detail it is worthwhile to know concepts of total, average and marginal revenues and behavioural principles which apply to all market conditions.

1.2 CONCEPTS OF TOTAL REVENUE, AVERAGE REVENUE AND MARGINAL REVENUE

Total Revenue : If a firm sells 100 units for Rs.10 each, what is the amount which it realises? It realises Rs. 1,000 (100 x 10), which is nothing but total revenue for the firm. Thus we may state that total revenue refers to the amount of money which a firm realises by selling certain units of a commodity. Symbolically, total revenue may be expressed as 

TR = P x Q
 Where, TR is total revenue
 P is price
 Q is quantity of a commodity sold.

Average Revenue : Average revenue is the revenue earned per unit of output. It is nothing but price of one unit of output because price is always per unit of a commodity. Symbolically, average revenue is :

AR = TR/Q

Where AR is average revenue
 TR is the total revenue 
 Q is quantity of a commodity sold

ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev 

If, for example, a firm realises total revenue of Rs. 1,000 by the sale of 100 units. It implies that the average revenue is Rs. 10 (1,000/100) or the firm has sold the commodity at a price of Rs. 10 per unit.

Marginal Revenue : Marginal revenue (MR) is the change in total revenue resulting from the sale of an additional unit of the commodity. Thus, if a seller realises Rs. 1,000 after selling 100 units and Rs. 1,200 after selling 101 units, we say marginal revenue is Rs. 200. We can say that MR is the rate of change in total revenue resulting from the sale of an additional unit.

ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev 

Where MR is marginal revenue
 TR is total revenue
 Q is quantity of a commodity sold
 Δ is the rate of change.

For one unit change in output
 MRn = TR– TRn-1
 Where TR is the total revenue when sales are at the rate of n units per period. TRn-1 is the total revenue when sales are at the rate of n - 1 units per period. 

Marginal Revenue, Average Revenue, Total Revenue and Elasticity of Demand : It is to be noted that marginal revenue, average revenue and price elasticity of demand are uniquely related to one another through the formula :
ICAI Notes 4 - Meaning and Types of Markets CA Foundation Notes | EduRev

In a straight line demand curve, we know that the elasticity of the middle point is equal to one. It follows that marginal revenue corresponding to the middle point of the demand curve (or AR curve) will be zero.

1.3 BEHAVIOURAL PRINCIPLES

Principle 1 : A firm should not produce at all if total revenue from its product does not equal or exceed its total variable cost.

It is a matter of common sense that a firm should produce only if it will do better by producing than by not producing. The firm always has the option of not producing anything. If it does not produce anything, it will have an operating loss equal to its fixed cost. Unless actual production adds as much to revenue as it adds to cost, it will increase the loss of the firm.

Principle 2 : It will be profitable for the firm to expand output whenever marginal revenue is greater than marginal cost, and to keep on expanding output until marginal revenue equals marginal cost. Not only marginal cost should be equal to marginal revenue, its curve should cut marginal revenue curve from below.

The above principle states that if any unit of production adds more to revenue than to cost, that unit will increase profits; if it adds more to cost than to revenue, it will decrease profits. Profits will be maximum at the point where additional revenue from a unit equals to its additional cost.

SUMMARY

The term market is a place where buyers and sellers bargain over a commodity for a price. There are many factors which determine the extent of a market like nature of the commodity, size of production, extent of demand and so on.

Markets can be classified on the basis of area, volume of business, time, status of sellers, regulation and competition. On the basis of competition a market is classified into perfect competition, monopoly, imperfect competition and oligopoly.

The firms can operate with a complex set of objectives and under various constraints. However, we assume that firms act as if they are maximizing their profits. With this assumption, we study the behaviour of firms in different types of market structure.      

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