Market: Concept and Classification of Market

In simple terms, market refers to a physical place where goods and services are exchanged between buyers and sellers at a particular price. However, in economic sense, market does not require a physical location or personal contact between buyers and sellers for the transaction of a product.

“Economists understand the term market not any particular marketplace in which things are bought and sold but the whole of any region in which buyers and sellers are in such free relationship with one another that the price of the same goods tends to equality easily and quickly” – Cournot.

In economics, market is defined as a set of buyers and sellers who are geographically separated from each other, but are still able to communicate to finalize the transaction of a product. The market for a product can be local, regional, national, or international. A market can have a number of interconnected characteristics, including level of competition, number of sellers and buyers, type of products, and barriers to entry and exit. These interlinked characteristics are combined to form a market structure. Among various characteristics of a market, the level and nature of competition contribute a significant part in the classification of market structure. Depending on the degree and type of competition, market structures can be grouped into three main categories, namely, purely competitive market, perfectly competitive market, and imperfectly competitive market. A purely competitive market is one which is characterized by a large number of independent sellers and buyers dealing in standardized products.

A perfectly competitive market is a wider term than a purely competitive market. In a perfectly competitive market, a large number of buyers and sellers are involved in the transaction of homogenous products. In this type of market, buyers and sellers are fully aware about the prices of products. Therefore, the market price of a product is fixed in a perfectly competitive market. However, this type of market structure cannot exist in the real world. On the other hand, an imperfectly competitive market is defined as a market in which buyers and sellers deal in differentiated products. Moreover, in an imperfectly competitive market, sellers have the power of influencing the market price of products.

Concept of Market:

In general terms, the word market is associated with a place where transaction occurs between sellers and buyers. It is defined as an area where a large number of shops sell a particular product. For example, Mahatma Phule market in Pune is a retail market of vegetables and Dalai Street in Mumbai is the stock exchange market. Apart from this, there are certain cities that specialize in the manufacturing of a particular product and become national markets. For example, Ahmedabad is known for textiles, Banaras for silk, Kashmir for shawls, and Darjeeling for tea. Similarly, there are certain countries that specialize in a particular product, which are termed as international markets. For example, China is known for electronic products.

However, in economics, the meaning of market is different from the general meaning of market. In economic terms, market is defined as a system under which buyers and sellers negotiate the price of a product, settle the price, and transact their business.

Moreover, it is not necessary that sellers need to sell their products at a particular place; they can distribute the products round the world. In economic sense, personal or physical contact between buyers and sellers is also not necessary.

They can perform transaction through various modes of communication, such as telephone, Internet, or video conferencing. According to Cournot, “Economists understand the term market not any particular marketplace in which things are bought and sold but the whole of any region in which buyers and sellers are in such free intercourse with one another that the price of the same goods tends to equality easily and quickly.” Thus, market does not imply a particular place, but comprises local, regional, national and international market.

As per the definition given by Cournot, following are the essentials of a market:

i. Products which are dealt with

ii. Presence of buyers and sellers

iii. A place, whether a certain region, country, or the whole world

iv. A type of interaction between buyers and sellers, so that the same price prevails for same products at the same time

Classification of Market:

Market refers to a system under which buyers and sellers negotiate the price of a product, settle the price, and transact their business. The buyers and sellers behave differently in different markets and influence the prices of products. Therefore, markets need to be classified on the basis of various factors.

Some of factors are as follows:

i. Size: Refers to an important basis of classification of market. The size of market varies according to the type of product.

Along with the product, there are some other factors that affect the size of market, which are as follows:

a. Type of Product: Helps in determining the size of a market. A product that has high portability’ and durability and whose supply varies with time, then the market size of that product would be large. For example, market size of wheat, petroleum, and coal. On the other hand, perishable products, such as fruits and vegetables, have narrow markets.

b. Demand: Constitutes a significant factor for determining market size. A product whose demand is high would have a large market size due to a large number of buyers. On the other hand, a product that has less demand would have a small market size, as only few buyers are willing to buy it.

c. Mobility of Products: Affects the market size to a large extent. Generally, a product that can be easily transported to different regions has a large market size. For example, products, such as food grains and clothes, are easily transportable. On the contrary, fast moving consumer goods (FMCG), such as eatables and flowers, are difficult to be transferred due to short life span. Therefore, these products have a small market size.

d. Peace and Security: Refers to the type of political, social and economic environment of a country or region. The regions or countries that are not considered as peaceful places do not attract organizations to establish or market their products. Therefore, the market size of products is restricted in the regions where security is limited.

e. Currency and Credit System: Influences the size of a market to a greater extent. A well-developed currency and credit system of a country helps organizations to flourish and expand more, which plays a very important role in increasing the market size of a product.

f. State Policy: Plays an important role in increasing or decreasing the market size of a product. If the state policy supports and encourage the expansion of a product, it would result in increase in the size of the market. For example, eco-friendly products are encouraged by government. On the other hand, products that are restricted according to the state policy would lose the market size, such as tobacco and alcohol.

ii. Competition:

Refers to the most important basis of classification of market. On the basis of competition, markets are classified as perfect market and imperfect market. In a perfect market, buyers and sellers are fully aware about the prices of products prevailing in the market.

Therefore, the price of a product is same all over the market. On the other hand, in an imperfect market, the price of a product is different all over the market as buyers and sellers do not have any information regarding prices of products.

Types of Market Structures on the Basis of Competition

A market structure comprises a number of interrelated features or characteristics of a market. These features include number of buyers and sellers in the market, level and type of competition, degree of differentiation in products, and entry and exit of organizations from the market. Among all these features, competition is the main characteristic of a market. It acts as a guide for organizations to react and take decisions in a particular situation. Therefore, market structures can be classified on the basis of degree of competition in a market. 

Figure-1 shows different types of market structures on the basis of competition:

These different types of market structures (as shown in Figure-1).

1. Purely Competitive Market:

A Purely competitive  market is one in which there are a large number of independent buyers and sellers dealing in standardized products. In pure competition, the products are standardized because they are either identical to each other or homogenous. Moreover, the price of products is same in the entire market.

Therefore, buyers can purchase products from any seller as there is no difference in the price and quality of products of different sellers. Under pure competition, sellers cannot influence the market price of products. This is because if a seller increases the prices of its products, customers may switch to other sellers for getting products at lower price with the same quality.

On the other hand, if a seller decreases the prices of its products, then customers may become doubtful about the quality of products. Therefore, in pure competition, sellers act as price takers. In addition, in a purely competitive market, there are no legal, technological, financial, or other barriers for the entry and exit for organizations.

In pure competition, the average revenue curve or demand curve is represented by a horizontal straight line. This implies the homogeneity of products with fixed market price.

Figure-2 shows the average revenue curve under pure competition curve:

In Figure-2, OP is the price level at which a seller can sell any quantity of products at the fixed market price.

2. Perfectly Competitive Market:

In a purely competitive market, there are a large number of buyers and sellers dealing in homogenous products. A perfectly competitive market is a wider term than a purely competitive market. A perfectly competitive market is characterized by a situation when there is perfect competition in the market.

Some of the definitions of perfect competition given by different economists are as follows:

According to Robinson perfect competition can be defined as, “When the number of firms being large, so that a change in the output of any of them has a negligible effect upon the total output of the commodity, the commodity is perfectly homogeneous in the sense that the buyers are alike in respect of their preferences (or indifference) between one firm and its rivals, then competition is perfect, and its rivals, then competition is perfect, and the elasticity of demand for the individual firm is infinite.”

According to Spencer, “Perfect competition is the name given to an industry or to a market characterized by a large number of buyers and sellers all engaged in the purchase and sale of a homogeneous commodity, with perfect knowledge, of market price and quantities, no discrimination and perfect mobility of resources.” In the words of Prof. Leftwitch, “Perfect competition is a market in which there are many firms selling identical products with no firm large enough relative to the entire market to be able to influence market price.”

According to Bilas, “The perfect competition is characterized by the presence of many firms. The all sell identical products. The seller is a price taker, not price maker.” In perfect competition, there are a large number of buyers and sellers in the market. However, these buyers and sellers cannot influence the market price by increasing or decreasing their purchases or output, respectively.

In addition to conditions implied in pure competition, perfect competition also involves certain other conditions, which are as follows:

i. Large Number of Buyers and Sellers: Refers to one of the primary conditions of perfect competition. In perfect competition, the number of buyers and sellers is very large. However, level of output produced by a seller or purchases made by a buyer are very less as compared to the total output or total purchase in an economy. Therefore, under perfect competition, sellers and buyers cannot influence the market price. As a result, the market price remains unchanged, irrespective of any activity of buyers or sellers. Consequently, buyers and sellers are bound to follow the market price.

ii. Homogeneous Products: Refer to another important characteristic of perfect competition. In perfect competition, all the organizations produce identical products having same quality and features. Therefore, a buyer is free to purchase the product from any seller in the market. Consequently, the sellers are required to keep the same price for the same product.

iii. Free Entry and Exit: Constitutes a significant feature of perfect competition. Under perfect competition, there are no legal, social, or technological barriers on the entry or exit of organizations. In the condition of perfect competition, all organizations earn normal profit. If the level of profit increases within a particular industry, then new organizations would be attracted toward the particular industry. In such a case, the extra profit would be transferred to new organizations. On the contrary, if the total profit in an industry is normal, then some organizations may prefer to exit from the industry. However, if there are restrictions on the entry of new organizations, then the existing organizations may earn supernormal profit. Therefore, organizations would earn normal profits, if there are no restrictions on entry and exit.

iv. Perfect Knowledge: Implies that under perfect competition, buyers and sellers have perfect knowledge about the prices of products prevailing in the market. In such a case, when the sellers and buyers are fully aware about the current market price of a product, then none of them would sell or buy at a higher rate. As a result, the same price would prevail in the market.

v. Absence of Transport Cost: Refers to one of the necessary condition for perfect competition. In perfect competition, the transportation cost is zero, so that the rule of same price can be applied. If transportation cost is present, then the prices of products would vary in different sectors of the market.

vi. Perfect Mobility of Factors of Production: Helps organizations in regulating their supply with respect to demand, so that equilibrium can be maintained. This implies that the factors of production are free to move from one industry to another.

Firms cannot influence the market price because the individual firm’s production is an insignificant part of the total market. Firms are “price-takers.”

- Market demand and market supply determine the market price and quantity.

- The demand for a firm’s product is perfectly elastic (i.e. one firm’s product is a perfect substitute for another firm’s product).

- In perfect competition, the firm’s marginal revenue equals the market price.

- If MR = MC, economic profit is maximized.

Nature of Revenue curves

Under perfect competition, the market price is determined by the market forces namely the demand for and the supply of the products. Hence there is uniform price in the market and all the units of the output are sold at the same price. As a result the average revenue is perfectly elastic. The average revenue curve is horizontally parallel to X-axis. Since the Average Revenue is constant, Marginal Revenue is also constant and coincides with Average Revenue. AR curve of a firm represents the demand curve for the product produced by that firm.

Short run equilibrium price and output determination under perfect competition with Super-normal Profit

1. Since a firm in the perfectly competitive market is a price-taker, it has to adjust its level of output to maximize its profit. The aim of any producer is to maximize his profit.

2. The short run is a period in which the number and plant size of the firms are fixed. In this period, the firm can produce more only by increasing the variable inputs.

3. As the entry of new firms or exits of the existing firms are not possible in the shortrun, the firm in the perfectly competitive market can either earn super-normal profit or normal profit or incur loss in the short period

When the average revenue of the firm is greater than its average cost, the firm is earning super-normal profit. 

Long run equilibrium, price and output determination In the long run, all factors are variable.

The firms can increase their output by increasing the number and plant size of the firms. Moreover, new firms can enter the industry and the existing firms can leave the industry. As a result, all the existing firms will earn only normal profit in the long run. If the existing firms earn supernormal profit, the new firms will enter the industry to compete with the existing firms. As a result, the output produced will increase. When the total output increases, the demand for factors of production will increase leading to increase in prices of the factors.

This will result in increase in average cost. On the other side, when the output produced increases, the supply of the product increases. The demand remaining the same, when the supply of the product increases, the price of the product comes down. Hence the average revenue will come down. A fall in average revenue and the rise in average cost will continue till both become equal. (AR = AC). Thus, all the perfectly competitive firms will earn normal profit in the long run. Competitive firms are in equilibrium at the minimum point of LAC curve. Operating at the minimum point of LAC curve signifies that the firm is of optimum size i.e. producing outputat the lowest possible average cost.

In figure represents long run equilibrium of firm under perfect competition. The firm is in equilibrium at point S where LMC = MR = AR = LAC. The long run equilibrium output is ON. The firm is earning just the normal profit. The equilibrium price is OP. If the price rises above OP, the firm will earn abnormal profit, which will attract new firms into the industry. If the price is less than OP, there will be loss and the tendency will be to exit. So in the long run equilibrium, OP will be the price and marginal cost will be equal to average cost and average revenue. Thus the firm in the long run will earn only normal profit. Competitive firms are in equilibrium at the minimum point of LAC curve. Operating at the minimum point of LAC curve signifies that the firm is of optimum size i.e. producing outputat the lowest possible average cost.