Market Structure – SS2 Economics Lesson Note (Second Term)

A market is any arrangement or system that brings buyers and sellers of goods and services into contact to do business. In its physical sense, it is a fixed place where people meet to buy and sell goods, that is, a marketplace. Markets are grouped by commodity, channel of distribution and price.

Behavioural objectives

By the end of the lesson, students should be able to:

1. define a market in the physical and the economic sense;
2. list the types of market based on commodity, channel of distribution and price;
3. state the conditions necessary for a perfect market;
4. explain the short-run and long-run equilibrium of a perfect competitor;
5. explain when a competitive firm makes a loss.

What is a market?

In a physical sense, a market means a fixed place where people meet to buy and sell goods; that is, a marketplace.

In economics, a market can be defined as any arrangement, system or organisation whereby buyers and sellers of goods and services are brought into contact with one another to transact business or for buying and selling.

What are the types of market?

Markets based on types of commodity

• Consumer goods market: It is made up of buyers and sellers of consumer goods.
• Labour market: It is made up of workers and employers and deals with the recruitment of unskilled, semi-skilled, skilled and professional workers.
• Capital market and money market: The capital market is a financial market which deals in long-term loans. The money market deals in short-term loans.
• Stock exchange market: It consists of buyers and sellers of second-hand securities.
• Foreign exchange market: This is a market that deals with foreign exchange transactions.

Markets based on the channel of distribution

• Wholesale market
• Retail market

Markets according to price

• Perfect market
• Imperfect market

What is a perfect market?

A perfect market is a market structure in which prices are determined by the forces of demand and supply.

Conditions necessary for a perfect market

1. Homogeneous commodity and existence of close substitutes: The commodities bought and sold must be homogeneous; that is, identical. They must be of the same size, shape, colour, etc.
2. Large number of buyers and sellers: There is a large number of buyers and sellers, each of whom has no control over the prevailing prices.
3. Free entry and exit: In this type of market, there is no barrier to entry and exit from the industry. There is no form of restriction.
4. No preferential treatment: All buyers must be treated equally.
5. Perfect knowledge: There must be perfect information or knowledge about the price of the goods or services.
6. Uniformity of prices: Each perfect competitor is a price taker. In a perfect market, there are no transport costs.
7. Portable goods: The goods to be sold must be easy to carry from place to place.
8. Easy transfer of factors of production.

At the equilibrium price, the marginal cost (MC) equals marginal revenue (MR).

How are price and quantity determined under perfect competition?

Price and quantity are determined by the interaction of the forces of supply and demand. All the firms in the market are price takers.

What are the short-run and long-run positions of a perfect competitor?

Equilibrium in the short run

The short run is the period in which a firm can vary its output by changing the variable factors of production. In the short run, a firm can make an abnormal profit. Since the market determines the prices at which goods should be sold, a firm can choose the quantity that will maximise its profits.

Equilibrium occurs when the following conditions are satisfied:

1. Marginal cost is equal to marginal revenue (MC = MR).
2. Marginal cost cuts the marginal revenue from below at the point of equality.

In the figure below, at point b price is greater than the marginal cost; therefore it is better to increase output. The firm is at equilibrium at point S where MC = MR = P = AR. At this point, the firm is making abnormal profits. This is represented by rectangle PORS.

Equilibrium in the long run

The long run is a period in which all costs vary with the level of output. During this period, firms can adjust their scale of operation. To enjoy the abnormal profit, new firms are likely to enter the market. With the entrance of new firms, supply will increase and price may fall if demand remains constant. Both the new and old firms will therefore adjust their output to the new price.

In the long run, the firms will make normal profits because all the firms will just be covering average costs. Equilibrium will be reached when marginal cost is equal to marginal revenue and price (MC = MR = AC = AR = P = D+).

The firm produces Oqi and sells at OP. The producer will be making a normal profit because the average cost is tangential to average revenue.

When does a competitive firm make a loss?

A perfect firm will be making a loss if the price is below the average cost.

In the figure above, at price P, the firm suffers losses since the price is below the average cost. The loss is represented by apbc. If the firm cannot cover its average cost it may close down. This may be the point of exit from the market.

Evaluation

1. Define a market in economics.
2. List four conditions necessary for a perfect market.
3. State the two conditions that must be satisfied for a firm to be in equilibrium in the short run.
4. Why do firms in a perfect market make only normal profits in the long run?
5. When does a competitive firm make a loss?

Assignment

1. Describe the types of market based on the type of commodity.
2. Explain the difference between the short-run and long-run equilibrium of a perfect competitor.