Market analysis: demand and supply, price and output under perfect competition and monopoly

1. Market and its forms

A market, in economics, is not a place but the whole set of buyers and sellers of a commodity in contact with one another so that one price tends to prevail. Markets are classified by the number of sellers, the nature of the product and the ease of entry:

2. Price determination by demand and supply

Demand factors are those of Unit II: price, income, related prices, tastes, expectations, population. Supply factors: the price of the good, prices of inputs, technology, prices of other goods the firm could make, number of sellers, taxes and subsidies, expectations, and natural factors (weather for crops). The law of supply: other things equal, more is supplied at a higher price.

Equilibrium price is where quantity demanded equals quantity supplied. Above it there is excess supply, and competition among sellers pushes the price down; below it, excess demand, and buyers bid the price up. Marshall compared demand and supply to the two blades of a pair of scissors: both determine price. An increase in demand (supply constant) raises price and quantity; an increase in supply (demand constant) lowers price and raises quantity.

Time element (Marshall). In the market period supply is fixed and demand alone sets price; in the short run supply can change with existing plant; in the long run plants and the number of firms change, and price tends to equal long-run average cost.

3. Perfect competition: features

1. A large number of buyers and sellers; no one can influence price.
2. Homogeneous product: units are perfect substitutes.
3. Free entry and exit of firms.
4. Perfect knowledge of market conditions among buyers and sellers.
5. Perfect mobility of factors.
6. No transport costs and no government interference.
7. Hence, a single uniform price: the firm is a price-taker.

Pure competition needs only the first three features; perfect competition needs all.

4. Price and output under perfect competition

The industry sets the price. Price is fixed by the intersection of market demand and market supply. The firm accepts it, and its demand curve is a horizontal line at that price: AR = MR = P. It can sell any quantity at that price and nothing above it.

Equilibrium of the firm. Two conditions: (1) MR = MC; (2) MC cuts MR from below (MC rising). Since MR = P, the firm produces where P = MC.

Short run. The firm may earn:

• supernormal profit if price is above AC at the equilibrium output;
• normal profit if price equals AC;
• losses if price is below AC. It still produces as long as price covers AVC, since fixed costs are incurred anyway. If price falls below minimum AVC, it shuts down. Minimum AVC is the shut-down point.

Long run. Supernormal profit attracts new firms; supply rises and price falls. Losses drive firms out; supply falls and price rises. In long-run equilibrium every firm earns only normal profit, and P = MR = AR = MC = minimum LAC. Each firm produces at the lowest point of its long-run average cost curve: optimum size, with no excess capacity.

The diagram, in words. Two panels. Left, the industry: downward demand and upward supply cross at price OP. Right, the firm: a horizontal line at OP is AR = MR; the U-shaped AC and MC are drawn; output OQ is where MC cuts the price line from below. If AC at OQ is below OP, the rectangle between price and AC over OQ is supernormal profit.

5. Monopoly: features

1. Single seller of the product; the firm is the industry.
2. No close substitutes: cross elasticity of demand is low.
3. Barriers to entry: legal (patents, licences, statutory monopoly), control of an essential raw material, large economies of scale (natural monopoly), heavy initial capital.
4. Price-maker: the monopolist fixes either price or output, not both; the market decides the other.
5. Downward-sloping demand curve: to sell more it must lower price, so MR is below AR.
6. Possibility of price discrimination.

6. Price and output under monopoly

The monopolist maximises profit where MR = MC and MC cuts MR from below. The price is read from the demand (AR) curve at that output, and is above MC.

Short run. At the equilibrium output, if AR exceeds AC, the monopolist earns supernormal profit; if AR equals AC, normal profit; if AR is below AC but above AVC, he bears a loss in the short run. A monopoly does not guarantee profit.

Long run. Because entry is blocked, supernormal profit can persist. The monopolist adjusts plant size to the most profitable scale, which need not be the optimum (minimum LAC), so there is usually excess capacity.

The diagram, in words. A downward-sloping AR curve with MR below it and steeper. U-shaped AC and MC. Equilibrium output OQ where MC cuts MR; go up from OQ to the AR curve to read price OP. The rectangle between OP and AC at OQ is monopoly profit. Note that the monopolist always operates on the elastic part of the demand curve, because MR is positive only there.

Price discrimination. Charging different prices to different buyers for the same product: by person (doctors’ fees), by place (domestic and export prices), by time (peak and off-peak electricity or rail fares). It requires that markets can be kept separate and have different elasticities. A higher price is charged in the less elastic market.

7. Perfect competition and monopoly compared

How this is examined

January 2026: “What is monopoly market? Explain how price and output are determined in this market” (10 marks). February 2025: “What is perfect competition market? Explain the determination of price and output under it” (10 marks) and “Features of monopoly” (6 marks). August 2024: the same perfect competition question. Define, list the features, state MR = MC, then cover the short run (three cases) and the long run, describing the diagram. Close with a comparison or the legal footnote.