Market: Meaning and Forms, Pure/Perfect Competition, and Imperfect Competition

Multiple Choice Questions (MCQs)

In economics, a "market" refers to:

a) A specific physical location where goods are bought and sold.

b) The mechanism or arrangement through which buyers and sellers interact to determine prices and exchange goods.

c) A retail store that sells various products.

d) A place where only agricultural products are traded.

Correct Answer: b) The mechanism or arrangement through which buyers and sellers interact to determine prices and exchange goods.

 

Which of the following is NOT a feature of perfect competition?

a) Large number of buyers and sellers

b) Homogeneous product

c) Barriers to entry and exit

d) Perfect knowledge among buyers and sellers

Correct Answer: c) Barriers to entry and exit

 

In perfect competition, an individual firm is a:

a) Price maker

b) Price setter

c) Price taker

d) Price discriminator

Correct Answer: c) Price taker

 

Under perfect competition, the demand curve faced by an individual firm is:

a) Downward sloping

b) Upward sloping

c) Perfectly inelastic

d) Perfectly elastic (horizontal)

Correct Answer: d) Perfectly elastic (horizontal)

 

Equilibrium price under perfect competition is determined by the interaction of:

a) Individual demand and individual supply

b) Market demand and market supply

c) Government regulations

d) The dominant firm

Correct Answer: b) Market demand and market supply

 

If the market demand curve shifts to the right under perfect competition, the equilibrium price will:

a) Decrease

b) Increase

c) Remain unchanged

d) Become indeterminate

Correct Answer: b) Increase

 

A single seller of a product with no close substitutes faces which market structure?

a) Perfect Competition

b) Monopolistic Competition

c) Oligopoly

d) Monopoly

Correct Answer: d) Monopoly

 

Which of the following is a key feature of monopolistic competition?

a) Homogeneous products

b) Few sellers

c) Product differentiation

d) Significant barriers to entry

Correct Answer: c) Product differentiation

 

The term "kinked demand curve" is often associated with which market structure?

a) Monopoly

b) Perfect Competition

c) Monopolistic Competition

d) Oligopoly

Correct Answer: d) Oligopoly

 

In a monopoly, barriers to entry can arise from:

a) Patent rights

b) High capital requirements

c) Government regulations

d) All of the above

Correct Answer: d) All of the above

 

Under monopolistic competition, firms compete by:

a) Only lowering prices.

b) Product differentiation, advertising, and branding.

c) Forming cartels.

d) Only increasing output.

Correct Answer: b) Product differentiation, advertising, and branding.

 

In an oligopoly, the behavior of one firm is largely dependent on the behavior of:

a) All buyers in the market.

b) The government.

c) Its rival firms.

d) Foreign competitors.

Correct Answer: c) Its rival firms.

 

If the market supply curve shifts to the left under perfect competition, the equilibrium price will:

a) Decrease

b) Increase

c) Remain unchanged

d) Become indeterminate

Correct Answer: b) Increase

 

When demand increases and supply decreases, the equilibrium price will:

a) Increase

b) Decrease

c) Remain unchanged

d) Be indeterminate

Correct Answer: a) Increase (Equilibrium quantity may be indeterminate, but price will definitely increase)

 

An example of a good produced under monopolistic competition is:

a) Electricity supply in a city

b) Wheat

c) Toothpaste

d) Steel

Correct Answer: c) Toothpaste (due to branding and differentiation)

 

Short Questions

What is the economic meaning of a 'market'?

Answer: In economics, a market refers to any arrangement or mechanism that brings together buyers and sellers of a particular good or service to facilitate their interaction and exchange, leading to the determination of price and quantity. It does not necessarily refer to a physical place.

 

List any two essential features of 'perfect competition'.

Answer: Two essential features of perfect competition are:

 

A large number of buyers and sellers.

 

Homogeneous products (all firms sell identical products).

 

Why is an individual firm under perfect competition considered a 'price taker'?

Answer: An individual firm under perfect competition is a price taker because it is so small relative to the entire market that its output decisions have no perceptible impact on the market price. It must accept the price determined by the overall market demand and supply.

 

How is the equilibrium price determined under perfect competition?

Answer: Under perfect competition, the equilibrium price is determined at the intersection of the market demand curve and the market supply curve, where the quantity demanded by all buyers equals the quantity supplied by all sellers.

 

What is a 'monopoly'?

Answer: A monopoly is a market structure characterized by a single seller or producer of a unique product with no close substitutes, and significant barriers to entry for new firms.

 

Mention two sources of barriers to entry in a monopoly.

Answer: Two sources of barriers to entry in a monopoly are:

 

Legal barriers: Patents, copyrights, government licenses/franchises.

 

Natural barriers: Control over essential raw materials, large economies of scale (natural monopoly).

 

What is 'monopolistic competition'?

Answer: Monopolistic competition is a market structure characterized by a large number of firms selling differentiated products that are close substitutes, with relatively easy entry and exit, and firms engaging in non-price competition (like advertising).

 

Give one key feature of monopolistic competition that distinguishes it from perfect competition.

Answer: The key feature distinguishing monopolistic competition from perfect competition is product differentiation, meaning products are similar but not identical, allowing firms some control over price.

 

What is 'oligopoly'?

Answer: Oligopoly is a market structure characterized by a few large firms dominating the market, producing either homogeneous or differentiated products, with significant barriers to entry, and strong interdependence among firms in their decision-making.

 

Why is 'interdependence' a significant feature of oligopoly?

Answer: Interdependence is significant in oligopoly because there are only a few firms, so the actions (e.g., pricing, output, advertising) of one firm directly affect and provoke reactions from its rival firms. This leads to strategic behavior and a high degree of uncertainty.

 

Long Questions (5 Marks each)

1.Explain the concept of 'perfect competition' by detailing its key features. How is the equilibrium price determined for an industry under perfect competition, and why is an individual firm a price-taker? Use diagrams to illustrate your answer.

Answer:

 

Concept of Perfect Competition:

Perfect competition is a theoretical market structure that serves as a benchmark for economic analysis. It describes a market where competition is at its maximum possible level.

 

Key Features of Perfect Competition:

 

Large Number of Buyers and Sellers: There are so many buyers and sellers in the market that no single participant can influence the market price. Each buyer and seller is a tiny fraction of the total market.

 

Homogeneous Product: All firms produce identical products. Consumers perceive no difference between the product offered by one firm and another. This ensures that consumers base their purchasing decisions solely on price.

 

Free Entry and Exit of Firms: There are no barriers (legal, technological, financial) preventing new firms from entering the market or existing firms from leaving. This ensures that in the long run, firms earn only normal profits.

 

Perfect Knowledge: Both buyers and sellers have complete and perfect information about market conditions, prices, and product quality. Buyers know the prices of all sellers, and sellers know the production techniques and prices of all competitors.

 

Perfect Mobility of Factors of Production: Resources (labor, capital) can move freely between industries and firms in response to price signals.

 

No Transportation Costs: It is assumed that there are no costs involved in transporting goods from sellers to buyers, otherwise, firms could charge different prices based on location.

 

Price Determination under Perfect Competition (for the Industry):

 

Under perfect competition, the equilibrium price and quantity for the entire industry are determined by the interaction of market demand and market supply.

 

Market Demand Curve: It is a downward-sloping curve, representing the sum of individual demands at various prices.

 

Market Supply Curve: It is an upward-sloping curve, representing the sum of individual firms' supplies at various prices.

 

The equilibrium price (P_E) and equilibrium quantity (Q_E) are established at the point where the market demand curve (D_M) intersects the market supply curve (S_M). At this price, the quantity that buyers are willing to purchase exactly matches the quantity that sellers are willing to supply.

 

Diagram (Market):

 

Price

^

| S_M

| /

P_E-----X----

| /|

| / |

| / |

+----+----+----> Quantity

Q_E D_M

 

(X represents the equilibrium point where D_M intersects S_M)

Why an Individual Firm is a Price-Taker:

 

Because of the features of perfect competition (especially a large number of firms and homogeneous products), an individual firm is insignificant compared to the overall market. It has no power to influence the market price.

 

If a firm tries to charge a price higher than P_E, it will sell nothing because buyers can get the identical product from numerous other sellers at P_E.

 

There is no incentive for a firm to charge a price lower than P_E because it can sell all its desired output at P_E. Lowering the price would only reduce its revenue unnecessarily.

 

Therefore, the firm must accept the market-determined price. The demand curve faced by an individual firm is perfectly elastic (horizontal) at the market equilibrium price (P_E). This means the firm can sell any amount of output at P_E, but nothing above it.

 

Diagram (Individual Firm):

 

Price

^

|

P_E------------------ D_Firm = AR = MR

|

|

+------------------> Quantity

 

(The horizontal line at P_E represents the demand curve for an individual firm)

In essence, the market dictates the price, and individual firms adjust their output decisions based on this given price to maximize their profits.

 

2. Discuss the effects of shifts in market demand and market supply curves on the equilibrium price and quantity under perfect competition. Illustrate with two separate scenarios: (a) an increase in demand and (b) a decrease in supply, using relevant diagrams.

Answer:

 

Under perfect competition, the equilibrium price and quantity are determined by the intersection of market demand and market supply curves. Changes in the non-price determinants of demand or supply cause these curves to shift, leading to new equilibrium outcomes.

 

Initial Equilibrium: Let the initial equilibrium be at point E_1, with equilibrium price P_1 and equilibrium quantity Q_1, determined by the intersection of initial market demand (D_1) and market supply (S_1).

 

Scenario (a): Effects of an Increase in Demand

 

Cause: An increase in demand occurs due to favorable changes in non-price determinants of demand, such as an increase in consumer income (for normal goods), an increase in tastes/preferences, or an increase in the price of a substitute good.

 

Impact on Curves: This causes the entire market demand curve to shift to the right from D_1 to D_2, while the market supply curve (S_1) remains unchanged.

 

Effect on Equilibrium:

 

At the original price P_1, there is now excess demand (Q_DQ_S).

 

This excess demand pushes the price upwards.

 

As the price rises, quantity demanded falls, and quantity supplied rises, until a new equilibrium is reached at E_2.

 

At E_2, the new equilibrium price (P_2) is higher than P_1, and the new equilibrium quantity (Q_2) is higher than Q_1.

 

Diagram (Increase in Demand):

 

Price

^

| S1

| /

P2---E2

| /|

P1--E1-+---- D2

| / | \

| / | \

+----+----+----> Quantity

Q1 Q2 D1

 

(D1 shifts to D2, E1 moves to E2, P increases, Q increases)

Scenario (b): Effects of a Decrease in Supply

 

Cause: A decrease in supply occurs due to unfavorable changes in non-price determinants of supply, such as an increase in input prices, a decrease in technology, an increase in taxes, or a decrease in the number of firms.

 

Impact on Curves: This causes the entire market supply curve to shift to the left from S_1 to S_2, while the market demand curve (D_1) remains unchanged.

 

Effect on Equilibrium:

 

At the original price P_1, there is now excess demand (Q_DQ_S).

 

This excess demand pushes the price upwards.

 

As the price rises, quantity demanded falls, and quantity supplied rises (along the new S_2), until a new equilibrium is reached at E_2.

 

At E_2, the new equilibrium price (P_2) is higher than P_1, and the new equilibrium quantity (Q_2) is lower than Q_1.

 

Diagram (Decrease in Supply):

 

Price

^

| S2 S1

| / /

P2-E2--

| / | \

P1-E1--+--D1

| |

+---+---+----> Quantity

Q2 Q1

 

(S1 shifts to S2, E1 moves to E2, P increases, Q decreases)

These analyses show how market forces (demand and supply shifts) dynamically adjust the equilibrium price and quantity, reflecting changes in underlying market conditions.

 

3. Differentiate between Monopoly, Monopolistic Competition, and Oligopoly based on their key features. Provide a brief example for each market structure.

Answer:

 

Here's a differentiation of Monopoly, Monopolistic Competition, and Oligopoly based on their key features:

 

Feature	Monopoly	Monopolistic Competition	Oligopoly
Number of Firms	Single seller	Large number of firms	Few large firms (usually 2-10 dominant firms)
Nature of Product	Unique product with no close substitutes	Differentiated products (close substitutes)	Homogeneous (e.g., steel) or Differentiated (e.g., automobiles)
Control over Price	Significant control (price maker)	Some control (due to product differentiation)	Considerable control, but interdependent decisions
Barriers to Entry	High/Significant barriers (legal, natural)	Relatively easy entry and exit	High barriers to entry (capital, technology)
Non-Price Competition	Little to none (unless for public relations)	Extensive (advertising, branding, quality)	Significant (advertising, R&D, customer service), but can lead to price wars
Interdependence	None (single seller)	Minimal (many firms)	High (decisions of one firm significantly impact rivals)
Demand Curve	Downward sloping and relatively inelastic	Downward sloping and relatively elastic	Downward sloping, often 'kinked' for price rigidity

Explanation of Key Features:

 

Number of Firms: This is the most straightforward differentiator. From one (monopoly) to many (monopolistic competition) to a handful (oligopoly).

 

Nature of Product: Determines the extent of competition. Monopolies have unique products, while monopolistically competitive firms differentiate similar products. Oligopolies can have either identical or differentiated products.

 

Control over Price: Directly linked to the uniqueness of the product and the number of competitors. A monopolist has the most power, while an oligopolist's power is constrained by rivals. A monopolistic competitor has some power due to differentiation.

 

Barriers to Entry: These determine how easily new firms can enter the market. High barriers protect existing firms' market power.

 

Non-Price Competition: Firms use strategies other than price (like advertising, branding, quality improvements) to attract customers, especially where products are differentiated.

 

Interdependence: A defining characteristic of oligopoly, where each firm must consider the likely reactions of its rivals when making decisions.

 

Examples:

 

Monopoly:

 

Example: A local utility company providing electricity or water supply (often natural monopolies regulated by government).

 

Reason: Typically a single supplier due to high infrastructure costs or government regulation, offering a service with no close substitutes.

 

Monopolistic Competition:

 

Example: Restaurants, clothing brands, shampoo brands, toothpaste manufacturers.

 

Reason: Many firms, but each tries to differentiate its product (through brand name, quality, advertising, location, ambiance) to gain some degree of market power. Consumers perceive these differences, even if the underlying product is similar.

 

Oligopoly:

 

Example: Automobile industry, telecommunications services (e.g., Jio, Airtel, Vodafone Idea in India), soft drink manufacturers (Coca-Cola, Pepsi), major airline companies.

 

Reason: A few large firms dominate the market. Their decisions are highly interdependent. Significant capital is often required to enter these industries.