Economics 4 Marks Question

It is a form of market in which there are many sellers of the product, but the product of each seller is somewhat different from that of the other, e.g. firms producing different brands of toothpastes, viz colgate, closeup, pepsodent, etc.
In such a market, a seller has a partial control over price due to product differentiation. However, full control over price is not possible because of the fact that there are a large number of close substitutes available in the market.

One possible step can be to reduce tax on medicine (or alternatively give subsidy). This will bring down cost and in turn ‘increase’ supply. Demand remaining unchanged, a situation of ‘excess supply’ will emerge which will lead to competition between sellers. This will lead to fall in price of the medicine.

Maximum price ceiling refers to the imposed upper limit on the price of a good charged by the government. Since price ceiling is lower than the equilibrium price OP, it leads to excess demand or shortage to the tune of AB as shown in the diagram.
Maximum price ceiling is normally imposed on essential items needed by the masses like food grains, medicines, wheat, sugar, rice etc.

A product being perfectly homogeneous implies that the products are identical in size, quality and quantity. Perfectly homogeneous product is sold in the market at a uniform price.
If even an individual firm tries to charge a higher price, it would lose all its buyers to a large number of other sellers. Hence, they sell homogeneous product at the prevailing market price as decided by the market forces of demand and supply.

A perfectly competitive firm in the long-run can earn normal profits only. In case an industry is showing supernormal profits (TR > TC or AR > AC) in short-run, new firms will join the industry leading to increase in supply and will shift market supply curve to the right. Accordingly market price will be reduced and supernormal profits will be wiped out.
In case of negative abnormal profits (losses) in the short-run when (TRCTC or AR < AC) some of the existing firms will leave the industry. Accordingly, supply will fall and market supply curve will shift to the left forcing the price to move up till the situation of zero normal profit is reached.

Market price or equilibrium price is determined by the forces of market demand and market supply. Considering market demand schedule on one hand and market supply schedule on the other, we identify equilibrium price as the one where market demand is equal to market supply or where market demand curve and market supply curve intersect each other.

S. No	Pdce of commdity X (₹)	Quantity supplied of a commodity X (Dozen)	Quantily demanded lor a commodity X (Dozen)
1.	5	50	10	Excess supply
2.	4	40	20
3.	3	30	30	(Equilibrium)
4.	2	20	40	Excess demand
5.	1	10	50

In the above schedule and diagram, demand and supply become equal only at the price of 3.00, so it will be our equilibrium price. Also, it is clear that equilibrium price is determined at the point, where demand and supply curves intersect each other at 30 units of commodity 'X'.

On the basis of the diagram drawn above Equilibrium Price = ₹ 6 and Equilibrium Quantity = 60kg.

• Increase in income increases demands at the given price.
• This leads to excess demand.
• Leads to competition among buyers. As a result, price starts rising.
• Rise in price leads to rise in supply and fall in demand.
• These changes continue till supply and demand become equal at a new equilibrium price.
• Equilibrium price rises.

If the equilibrium price (Rs. 8) in the above figure (of Q-5) is above the minimum of average cost, then it implies that the firm is earning supernormal profits. This situation will attract new firms in the market. As the new firms enter, the industry supply of output will also increase. New firms will continue to enter the industry that will lead the price to fall until it becomes equal to the minimum of the average cost. Thus, the supernormal profits are wiped out and all the firms earn normal profits
When the free entry and exit of firms is allowed, the equilibrium is determined by the intersection of demand curve and the 'P = min AC' line.

It is true that firms under perfect competition can sell any quantity at the existing market price. They cannot increase the price of their commodity as it will lead to zero supply because each firm is selling homogeneous goods. On the other hand, firms are reluctant to reduce the price because of the following two reasons.

1. They are earning only normal profits in the long-run. Selling before the prevailing price will result in abnormal losses.
2. There is no logic in lowering the price, as unlimited quantity can be sold at the prevailing price.

A firm's demand curve is indeterminates under oligopoly because there is high degree of interdependence between the firms. Price and output policy of one firm has a significant impact on the price and output policy of the rival firms in the market. When one firm lowers its price, the rival firms may also lower the price. Contrarily, when one firm raises the price, the rival firms may not do it. Accordingly, it becomes very difficult to estimate change in firm's sale caused by a change in price. So, a precise relationship between price and sales cannot be established or the firm's demand curve cannot be drawn.

1. Product Differentiation: It is a distinct feature of monopolistic competition. A product is often differentiated by way of trademarks and brand names. The differentiated products are close substitutes of each other like colgate and closeup toothpaste.

Because of product differentiation, each firm can influence its price. So that, each firm has a partial control over price of its product.

1. Free Entry or Exit of Firms: Firms are free to enter the industry or leave it. However, new firms have no absolute freedom of entry into industry. Products of some firms may be legally patented. New firms cannot produce those products, e.g. no rival firm can produce or sell a patented item like Woodland shoes.

A firm under perfect competition is a price taker because of the following reasons:

1. A firm under perfect competition is contributing such a small fragment to the market supply that total supply schedule remains unaffected by any change in individual firm's supply.
2. All firms are selling homogeneous product. Accordingly, even partial control over price is not possible.
3. If any firm tries to fix its own price, it won't succeed. Higher price would drive the buyers to a large number of other sellers. Lower price would bring so many buyers to a firm that it cannot cope with the demand.

Price ceiling means deciding lower prices as compared to market price of goods. In India, there are many goods on which government has imposed price ceiling, in order to keep them available within the reach of the BPL (below poverty line) people. These goods are kerosene, sugar, wheat, rice, etc.
The following are the consequences of price ceiling:

1. Excess demand: Due to artificially imposed price, cutting lower than the equilibrium price leads to the emergence of the problem of excess demand.
2. Fixed Quota: Each consumer gets a fixed quantity of good (as per the quota). The quantity often falls short of meeting the individual's requirements. This further leads to the problem of shortage and the consumer remains unsatisfied.
3. Inferior goods: Often it has been found that the goods that are rationed are usually inferior goods and are adulterated.
4. Black marketing: The needs of a consumer remain unfulfilled as per the quota laid by the government. Consequently, some of the unsatisfied consumers get ready to pay higher price for the additional quantity. This leads to black-marketing and artificial shortage in the market.

When both demand and supply of a commodity increase (i.e., when both the demand and supply curve of a commodity shift to the right), the equilibrium quantity will increase but the equilibrium price may or may not be affected. There may be three situations:

1. When both demand and supply of a commodity increase in equal proportion, the equilibrium price will remain the same.

2. When both demand and supply increase but increase in demand is more than the increase in supply, equilibrium price will rise.

3. When both demand and supply increase but the increase in demand is less than increase in supply, equilibrium price will fall.

Difference between collusive and non-collusive oligopoly are:

S. No	Basis	Collusive oligopoly	Non-collusive oligopoly
1.	Meaning	Under this form, firms might decide to collude together and not to compete with each other.	In this form of oligopoly, firms do not collude, but compete with each other.
2.	Firms behave	Under this oligopoly, the firms would behave as a single monopoly.	Under this oligopoly, the firms behave independently.
3.	Aim	They aim at maximising their collective profit rather than their individual profit.	The firms aim to maximising its own profits and decides how much quantity to be produced assuming that the other firms would not change their quantity supplied.

There are no obstacles in the way of new firms joining the industry and existing firms leaving the industry in the long run. This ensures that there are neither abnormal profits nor losses by any firm in the long run. In the short run, profits and losses are possible. If firms are making profits, new firms enter and raise the total supply of the industry. This reduces market price and wipes out profits. However, if the firms are incurring losses, the existing firms start leaving the industry and reduce the total supply. This raises the price till all the losses are wiped out.

Price floor means the minimum price fixed by the government for a good in the market. The government fixes this price on agricultural products and food grains in particular. A minimum price is fixed which the traders must pay to the farmers in the wholesale market. Thus, the income of the farmer is regulated and a continuous production is assured.Implications of price floor:

1. The government ensures to buy the full produce of the farmers which are not sold in the market at the price floor. Hence, they are able to produce the maximum level of output.
2. Farmers are ensured with the minimum returns as their products are completely sold in the market at comparatively higher price. This leads to an increase in their level of income.
3. Because of price floor, consumers and traders in the market are forced to pay higher price than the equilibrium price.

'Freedom of Entry', signifies that there are no barriers to the entry of new firms into industry. When the existing firms are earning supernormal profits, the new firms, attracted by the prospects of profit, enter the industry. This raises market supply which in turn leads to fall in market price and consequently profits. The entry continue still each firm is earning just the normal profits.
'Freedom to exit', signifies that there are no barriers which restrict the existing firms from leaving the industry. The firms try to leave when they are facing losses. As the firms start leaving market supply falls leading to rise in market price and consequently reduction in losses. The firms continue to leave till the losses are wiped out and each existing firm is earning just the normal profits.

• If price was above the equilibrium (e.g. P1), then supply (Q1) would be greater than demand (Q3) and therefore there is too much supply. There is a surplus.
• Therefore firms would reduce price and supply less. This would encourage more demand and therefore the surplus will be eliminated. The market equilibrium will be at Q2 and Pe.

Three features of monopolistic competition are as follows:

1. Large Number of Buyers and Sellers As under perfect competition, in this form also, there are a large number of buyers and sellers. Also, the size of each firm is sniall. Each firm has a limited share of the market.
2. Product Differentiation It is a distinct feature of monopolistic competition. A product is often differentiated by way of trademarks and brand names. The differentiated products are close substitutes of each other, like colgate and closeup toothpaste. Because of product differentiation, each firm can decide its price policy independently, so that each firm has a partial control over price of its product.
3. Selling Cost Each firm has to incur selling costs (expenditure on advertisement, etc) to promote its sales. This is because there are a large number of close substitutes available in the market.

Under oligopoly, there is a high degree of interdependence between the firms. Price and output policy of one firm has a significant impact on the price and output policy of the rival firms in the market.
When one firm lowers its price, the rival firms may also lower the price. And when one firm raises the price, the rival firms may not do it. Accordingly, while taking an action on price or output, a firm must take into account the possible reaction of the rival firms in the market.