Central Bank

Central bank is regarded as an apex financial institution in the banking system. It is considered as an
integral part of the economic and financial system of a nation. The central bank functions as an
independent authority and is responsible for controlling, regulating and stabilising the monetary and
banking structure of the country.

In India, the Reserve Bank of India is regarded as the central bank. It was set up in 1935. Central banks
are responsible for maintaining the financial stability and economic sovereignty of the country.

Also see: Difference Between Central Bank and Commercial Bank

The functions of a central bank can be discussed as follows:

1. Currency regulator or bank of issue

2. Bank to the government

3. Custodian of Cash reserves

4. Custodian of International currency

5. Lender of last resort

6. Clearing house for transfer and settlement

7. Controller of credit

8. Protecting depositors interests

The above mentioned functions will be discussed in detail in the following lines.

Currency regulator or bank of issue:

Central banks possess the exclusive right to manufacture notes in an economy. All the central banks
across the world are involved in issuing notes to the economy.

This is one of the most important functions of the central bank in an economy and due to this the
central bank is also known as the bank of issue.

Earlier all the banks were allowed to publish their own notes which resulted in a disorganised economy.
To avoid this situation the government around the world authorised the central banks to function as the
issuer of currency, which resulted in uniformity in circulation and balanced supply of money in the
economy.

Bank to the government:

1
One of the important functions of the central bank is to act as the bank to the government. The central
bank accepts deposits and issues funds to the government. It is also involved in making and receiving
payments for the government. Central banks also offer short term loans to the government in order to
recover from bad phases in the economy.

In addition to being the bank to the government, it acts as an advisor and agent of the government by
providing advice to the government in areas of economic policy, capital market, money market and
loans from the government.

In addition to that, the central bank is instrumental in formulation of monetary and fiscal policies that
help in regulation of money in the market and controlling inflation.

Custodian of Cash reserves:

It is a practice of the commercial banks of a country to keep a part of their cash balances in the form of
deposits with the central bank. The commercial banks can draw that balance when the requirement for
cash is high and pay back the same when there is less requirement of cash.

It is for this reason that the central bank is regarded as the banker’s bank. Central bank also plays an
important role in the credit creation policy of commercial banks.

Custodian of International currency:

An important function of the central bank is to maintain a minimum balance of foreign currency. The
purpose of maintaining such a balance is to manage sudden or emergency requirements of foreign
reserves and also to overcome any adverse deficits of balance of payments.

Lender of last resort:

The central bank acts as a lender of last resort by providing money to its member banks in times of cash
crunch. It performs this function by providing loans against securities, treasury bills and also by
rediscounting bills.

This is regarded as one of the most crucial functions of the central bank wherein it helps in protecting
the financial structure of the economy from collapsing.

Clearing house for transfer and settlement:

Central bank acts as a clearing house of the commercial banks and helps in settling of mutual
indebtedness of the commercial banks. In a clearing house, the representatives of different banks meet
and settle the inter bank payments.

Controller of credit:

Central banks also function as the controller of credit in the economy. It happens that commercial
banks create a lot of credit in the economy that increases the inflation.

2
The central bank controls the way credit creation by commercial banks is done by engaging in open
market operations or bringing about a change in the CRR to control the process of credit creation by
commercial banks.

Protecting depositors interests: Central bank also needs to keep an eye on the functioning of the
commercial banks in order to protect the interests of depositors.

Perfect Competition Definition

Perfect Competition is defined as a market structure characterized by a complete absence of
rivalry among individual firms. In other words, Perfect Competition definition means a market
structure where there is a perfect degree of competition and a single price prevails.

Perfect Competition Definition – Prof. Benham

“A market is said to be perfect when all the potential sellers and buyers are promptly aware of
the price at which transactions take place and all of the offers made by other sellers and buyers,
and  when any buyer can purchase from any seller, and vice versa.”

Perfect Competition Definition – Prof. Marshall

“The more nearly perfect a market is, the stronger is the tendency for the same price to be paid
for the same thing at the same time in all parts of the market.”

A Perfect Competition is a hypothetical market structure where every seller takes the market
prices as the price of his own product. Further, firms cannot influence the market price either
alone or as a group.

Primary Features of Perfect Competition

Homogeneous Product

In perfect competition, a buyer cannot distinguish between the products of two firms. There are
no distinctive features associated with the product of a specific firm. In fact, the product is
homogeneous and undifferentiated. For the buyer, the products that one firm supplies are a
perfect substitute for those which any other firm supplies.

A Large Number of Sellers

There are a large number of firms in perfect competition. In this market structure, no individual
firm can significantly influence the total supply of the industry and thereby affect the price of the
product. Therefore, every firm is a price taker and can sell any quantity of its own product at the
market price.

3
Further, for a seller, the demand for his product is perfectly elastic. Also, the maximum quantity
that a firm can supply is insignificantly small as compared to the aggregate supply of the industry
as a whole.

A Large Number of Buyers

A Perfect Competition is also characterized by a large number of buyers. These buyers compete
with each other for the available supply. Their number is so large that any single buyer cannot
change the total demand in the market or affect the price of the product. Every individual buyer
is also a price taker. A buyer can buy any quantity of the product he likes at the market price.

Full Knowledge of Market

In perfect competition, it is assumed that all buyers and sellers have the complete knowledge of
the prevailing price of the product. Further, they are also aware of the prices that the sellers want
and the buyers offer. This knowledge helps buyers and sellers to use any opportunity to strike a
good bargain.

Economic Rationality

Another feature of perfect competition is economic rationality. In simple words, it means that
every buyer and seller is motivated by his own economic interest before buying or selling.
Coupled with the assumption of the perfect knowledge, this means that a uniform price prevails
in the market.

No Transaction Costs

In perfect competition, the buyers and sellers do not incur any transaction costs. The buyer pays
the price that is exactly equal to the price that the seller receives. There are no additional
transaction costs.

In other words, the seller incurs no additional costs like advertisements, etc. since his product is
not differentiated from the other sellers.

Free Entry and Exit

Another important feature of perfect competition is free entry and exit. It means that any firm
can close down and the leave the industry or any new firm can enter at any time.

Further, this does not involve any legal, institutional, or technical hurdle. Similarly, buyers can
enter and exit the market whenever they like too.

Perfect Mobility of factors of production

4
The factors of production are perfectly mobile in perfect competition. This means that they can
freely move from one firm to another. Also, workers are free to move between different firms.
Therefore, people can learn skills easily.

No Government Regulation

In perfect competition, there is no government regulation. In other words, the government has no
interference in this market structure in terms of the tariff, subsidies, etc.

Solved Question Perfect Competition

Q1. What is the Perfect Competition Definition and what are its primary features?

Answer:

Perfect Competition is a market structure characterized by a complete absence of rivalry among

individual firms. It means a market structure where there is a perfect degree of competition and a
single price prevails.

The primary features of perfect competition are:

 Homogeneous Product
 A large number of sellers
 A large number of buyers
 Full knowledge of the market
 No transaction costs
 Free entry and exit
 Economic Rationality
 Perfect mobility of the factors of production
 No government regulation

What are the features of Perfect Competition?

Solution
The following are the features of perfect competition are as follows:

i. Large number of buyers and sellers –

Under perfect competition, there are a large number of buyers and sellers. The number of sellers is so
large that no individual firm has control over the market price of the commodity.

5
ii. Free entry and exit of firms –

There is no restriction on the entry and exit of firms. This free entry and exit of the firms ensure that no
firm earns either abnormal losses or abnormal profits in the long run.

iii. Homogeneous product –

The product of each and every firm in the perfectly competitive market is a perfect substitute to others’
products in terms of quantity, quality, colour, size, features, etc.

iv. Perfect knowledge –

In a perfectly competitive market, the buyers are aware of the prevailing market price of the product at
different places and the sellers are aware of the prices at which the buyers are willing to buy the
product.

v. Perfect mobility of factors of productions:

In a perfect competition the factors of production are perfectly mobile. Such mobility implies that there
is optimum utilisation of the factors of production.

vi. Absence of transport cost:

In a perfect competition it is assumed that there is no transport cost. This further ensures that there is
uniform price in the market.

What are the features of monopolistic competition?

Solution

6
The following are the features of monopolistic competition:

i. Large number of buyers and sellers

There are a large number of buyers and sellers in a monopolistic market.

ii. Differentiated product

Products of a firm are slightly different from those of other firms, but they are close substitutes. Product
differentiation is achieved through brand name, trade mark and advertisements.

iii. Selling cost –

The need of the selling cost arises due to the sole aim that a monopolistic firm tries to convince the
consumers by distinguishing its product from its substitutes on qualitative basis.

iv. Free entry and exit of firms –

There is no restriction on the entry and exit of firms in this form of market. But at certain times, due to
some legal barriers and patent rights, it is not so free for the new firm to enter the market.

v. Imperfect Knowledge-

Both the buyers and the sellers do not have complete knowledge about the prevailing market
conditions. Due to product differentiation, it is very difficult to acquire complete knowledge about prices
and quantities of different products.

Definition of market:

Market

is a place or space where buyers and sellers meet to exchange product or services in a
specific period of time.

7
Definition of marketing structure:

Marketing structure is a group of factors that determined how buyers and sellers interact
in market (how the price change, how is the different levels of the production and selling
process interact.)

The first definition in Perfect competition

The definition of the perfect competition is that there is an equal level for all firms
involved in the industry to produce the best possible outcomes for consumers. All the
firms have the perfect knowledge and information that they are free to sell the same
product with different prices and no one can stop them.
There are…show more content…
All the buyers can make the decisions from their own.

The advantages of perfect competition:

1) They can achieve the maximum consumer surplus and economic welfare.
2) All the perfect knowledge is available so there is no information failure.
3) Only normal cost profits cover the opportunity cost.
4) They allocate resources in the most efficient way.

The disadvantages of the perfect competition:

1) There is no chance to achieve the maximum profit because of the huge number of
other firms that are selling the same products.
2) There is no courage to develop new technology because of the perfect knowledge
and the ability to share all of the information.
3) Lack of productdifferentiation because all of the products are the same and they are
not branded.
4) Reducing the research and development process.

8
Examples about the perfect competition:

Actually, there are no perfect market in the real world but there are some industries that
might be close to this perfect competition. For example, street food vending or farmers
that will sell the fruits and vegetable in the same price.

What is Monopolistic Competition: Pros and Cons

Find out the features of monopolistic competition, the way it differs from a monopoly and see the
examples

Monopolistic competition is a market model that involves many companies offering differentiated products
(differing in quality, branding, style, and reputation) and competing with each other. The goods or services
they provide to their customers are similar but aren

Why is monopolistic competition inefficient?

This market model is a type of imperfect competition and is considered inefficient because of selling
costs, excess capacity, lack of specialization, and unemployment. It's worth noting that firms engaged in
this kind of market system often spend significant sums of money on advertising. This step isn't crucial
since it increases the price of a product or service and makes a company lose leads and customers.

The resources often lie idle because companies don't fully use their production capacity despite it being
large. This leads to unemployment because workers have nothing to do.

Since mass production is a complicated process, companies can't fully exploit their fixed factors, and it
results in firms demonstrating excess capacity. In the long and short run, these businesses show that
they are productively inefficient.

Now that we have cleared that up, it's time to proceed to the features of monopolistic competition.

What is Monopolistic Competition?

Monopolistic Competition:

‘Monopolistic competition is a market situation in which there are many sellers of a particular
product but the product of each seller is in some way differentiated in the minds of consumers
from the product of every other seller.’

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‘Monopolistic competition has today come to mean a state of affairs in which there is a large
number of sellers selling non-homogenous or slightly differentiated products and in which
freedom of entry exists.

Therefore, in this market structure, each seller is a monopolist of his ‘differentiated product’. The
buyers can get the specific product only from him. Having said that, there are several close
substitutes available in the market too.

Therefore, buyers compare the prices of the products along with the perceived quality of each.
Hence, there is competition between sellers for the market share. So you can see that in this
market structure, a group of firms compete against each other while remaining monopolists of
their own products.

Unfortunately, we cannot define a Monopolistic Competition in detail due to the following

problems:

 The products are not homogeneous. Therefore, it is impossible to determine the market
demand for the product precisely. In fact, it is difficult to determine the average revenue curve
of the industry as well.
 Since the firms are not providing the same product, defining an industry becomes complex too.
The best definition is a group of firms who sell products which are close substitutes of each
other.
 It is also difficult to define a ‘group’ since the product group under consideration is competing
with other product groups too!

Now that you have a better idea about what is Monopolistic Competition, let’s take a look at its
features.

Features of a Monopolistic Competition

1. In Monopolistic Competition, a buyer can get a specific type of product only from one producer.
In other words, there is product differentiation.
2. The firms have to incur selling expenses since there is product differentiation.
3. There is a large number of sellers with inter-dependent demand and supply conditions. Sellers
are price-makers and the demand curve for the product of an individual seller is downward
sloping. The demand is not perfectly elastic.
4. The firm can improve or deteriorate the quality of its products too. Improving the quality helps
in increasing the demand and price of the product. On the other hand, deteriorating the quality
helps reduce the average cost of production.
5.  The firms compete for inputs too. Also, they need to operate within a given technological range.
Therefore, no firm can produce a better quality product at a lower average cost.

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 6. Firms are expected to know its demand and cost conditions. Further, they must use this
knowledge to maximize its expected profit income.
7. Any firm can leave the group of firms belonging to a specific product group. Also, new firms can
enter the group and produce close substitutes of the existing products in the group. This ensures
that no firm incurs losses or earns super-normal profits.
8. In Monopolistic Competition, every firm must pursue the goal of profit maximization.
9. It is assumed that all firms in this market structure have identical cost and demand conditions.

Two features which form the foundation of Monopolistic Competition are – product
differentiation and selling expenses. Let’s look at them a little further.

Product Differentiation

Product differentiation covers all aspects which help in distinguishing the product of one firm
from that of the other. This differentiation can be real (technical) or imaginary (non-technical).

The real differentiation refers to the technical features like the product’s technical life and
performance, durability, cost of operation and maintenance, etc.

On the other hand, the non-technical differentiation may take the form of brand names,
trademark, packing, shape, size, etc. The non-technical differentiation adds a subjective appeal to
a product inducing buyers to increase its demand or pay more for it.

In reality, however, the two forms of differentiation are intertwined to the extent that it is
impossible to separate them. No matter which differentiation a firm adopts, it expects to increase
the demand of the product in doing so.

Firms use the differentiation to tell buyers why their product’s quality and price combination is
better than their competitors.

In Monopolistic Competition, a firm is not a price-taker and its demand curve has an inverse
relationship with the price of the product.

Therefore, it can raise the price of its product and lose some customers or drop the price to sell
more. The demand curve is downward sloping and not parallel to the X-axis.

Since in Monopolistic Competition, products are close substitutes of each other, they have high
positive cross-elasticities.

The market for the product of one firm is not separate from the markets of its rival firms. A firm
can lose the market share of its products due to its price decisions or the price decisions of its
rivals.

11
Further, selling expenses also play a major role in determining the demand conditions for the
product of a firm.

Selling Expenses

Selling expenses are all the costs that a firm incurs to create and/or increase the demand for its
products. The firm tries to shift the demand curve of the advertised product to the right so that
buyers are willing to pay more for the same quantity or buy more quantity at the same price.

They include advertisement through media, showrooms, selling campaigns, discounts, and
incentives to buyers, etc.

They also include informative and educative campaigns where the buyer is informed about the
benefits of using their product over something else.

These expenses also neutralize the perceived impact that the selling campaigns of the rival
companies create. Many firms increase their selling expenses to capture a bigger market share as
well.

Solved Question on Monopolistic Competition

Q1. What is Monopolistic Competition and what are its two main features?

Answer: In a Monopolistic Competition, each seller produces a differentiated product which is

easily distinguishable from its close substitutes. The two main features of Monopolistic
Competition are product differentiation and selling expenses.

Characteristics of Monopolistic Competition

Many companies

The differentiation of goods

Low market power

A few barriers to entry

Freedom in decision-making

Let's explore the characteristics of this market structure that will enable you to understand the
principles of monopolistic competition.

Many companies. This market structure works out when many companies offer similar but not
identical goods. These firms operate according to the rules of the market and make decisions
independently from other businesses.

12
The differentiation of goods. Products and services have only a slight non-price difference. It can
be the location of the product or its intangible aspects. However, these products can't completely
replace the products of competitors. We can't omit the fact that these goods perform a similar function.
However, they still differ in quality, packaging, style, reputation, branding, and appearance.

Low market power. Firms have market power, albeit very low. They have control over the terms
and conditions of exchange. Besides, companies are price makers and can increase the prices without
losing customers and triggering a price war among their competitors. Their power lies in the number of
competitors, which is relatively low, independence in decision making, and differentiated goods.

A few barriers to entry. Businesses can easily enter and exit the market. New firms are inclined to
join it when existing businesses obtain great revenue. With the arrival of new companies, the supply
increases, and the price decreases. This affects the profits of the existing firms and doesn't allow these
companies to obtain abnormal profits.

Freedom in decision-making. Firms in monopolistic competition don't take into consideration

how their decisions influence competitors. Therefore, each firm can operate without fear of starting
heightened competition.

Now when you are acquainted with the features, let's make the difference between monopolistic
competition and a monopoly clear.

Monopolistic Competition vs. Monopoly

In this section, we'll review two market systems. First and foremost, you should remember that these
market models can be distinguished by the number of players, the presence or absence of competition,
barriers to entry, and profits. So let's dive in.

Monopolistic Competition

It is a market model in which many sellers provide products or services that are slightly different from
competitors'. These products are not perfect substitutes since they can differ in branding, style, or
quality. New companies can easily enter or leave this competitive environment as the barriers to entry
are low. This system combines some characteristics of a monopoly and perfect competition.

Companies in monopolistic competition are price makers, but they don't possess a big market share.
This market structure can be found in industries the products of which you use in your everyday life,
including restaurants, barbershops, clothing stores, or hotels.

Monopoly

It is a market structure in which there is only one seller that dominates the industry. Companies in
monopolies usually have an advantage over possible competitors since they are the only providers of
goods or services in particular industries and control most of the market share. The firm that operates a

13
monopoly is a price maker, which means that this company decides and sets the price for its goods or
services. Besides, its owner can raise the price at will.

In monopolistic competition, you can find two and more sellers that compete with each other, whereas
in a monopoly, there is only one seller. If compared with a monopoly where a company has to comply
with the high standards to enter or exit, monopolistic competition has low barriers to entry, which
enables businesses to join the market easily.

Now that you know the difference, let's proceed to the next section, where you'll get to know who is
responsible for setting the price in this market model.

Who sets the price in monopolistic competition?

Since each company produces a unique product that slightly differs from the competitors' alternatives, it
can decide whether to charge customers more or less money for this product. Unlike companies in
oligopoly, firms in this market structure shouldn't collude to set the prices and are independent.

Companies often use advertising to compete with their rivals and win the trust and love of their
customers. Ads allow firms to inform consumers about their products and show how they differ from
other companies' goods.

Let's move to the advantages and disadvantages of this market model.

Advantages and Disadvantages of Monopolistic Competition

Restaurants and clothing stores, hair salons, hotels, and pubs operate under monopolistic competition.
Just like any other market model, it has its pros and cons. It's essential to be aware of those before
entering this market structure.

The advantages of monopolistic competition include:

a few barriers to entry;

active business environment;

customers can obtain a great variety of products and services since they are differentiated;

consumers are informed about goods and services available in the market;

higher quality of products;

The disadvantages include:

excess waste of resources;

limited access to economies of scale because of a considerable number of companies;

misleading advertising;

14
excess of capacity;

lack of standardized goods;

inefficient allocation of resources;

impossibility to obtain abnormal profits.

Let's now move to the examples to understand how it all works.

Examples of Monopolistic Competition

You can find this type of market structure in your day-to-day life, and now we'll prove it with some
examples.

Fast food. McDonald's and Burger King are great examples of the market model we review. They sell
similar types of products, but they can't replace each other. This is due to the difference in taste, shape,
packaging, etc. Everything depends on their consumers — they decide what company to choose
according to their tastes and preferences.

Bakeries. You can see a lot of bakeries in each town. They offer products that differ in appearance,
taste, and branding. However, if there is only one bakery in a town, it can charge consumers a higher
price for its products. In case there is a bakery famous for its tasty pastry, and it has many clients, for
sure, this place can also charge a higher price since customers are ready to pay more for the quality of
products.

Running shoe brands.

The market for running shoes is considered one with a high level of competition. Adidas, Nike, New
Balance, and Reebok are just a few brands from which people prefer to buy. They compete for
customer loyalty. Although all the mentioned companies produce sneakers, their products are still
unique because of each brand's design and features. That's why companies have the power to charge a
price that is usually different from their competitors.

Restaurants. You can find a wide variety of restaurants in any town. One can charge $70 for a
product, while a similar one can cost $40 at another place. This depends on many factors, including
location, quality, and other services.

Simply put, monopolistic competition is often considered inefficient because of the excess funds
companies spend on advertising and publicity instead of increasing the quality of their products.
However, this market model is realistic because many companies offer differentiated goods, and there
are still barriers to entry, albeit very low. That's why you can see a lot of examples of such businesses
around you.

Monopolistic Competition: Advantages and Disadvantages

15
In a monopolistic competition market, firms offer products or services that are highly similar, highly
substitutable, but not identical. A monopolistic competition market consists of a large number of
producers/sellers. High competition is available because the barriers to entry and exit are low.

Advantages (Pros / Positives / Benefits) of Monopolistic Competition

1. Few Barriers to Entry

Markets experiencing monopolistic competition has fewer barriers to entry. The advantage is with both
consumer point of view and industry as a whole. There will be new rivalries in the market which brings a
healthy situation for the industry. Also, consumers will not stagnate to few products since there are
more producers available.

2. Differentiated Products and Services

Consumers will get the freedom to experience different products and services in the monopolistic
competition market. When compared with a monopoly market, the number of products is high in the
monopolistic competition market.

3. Uplift Innovation of the Industry

Since there is much competition in the market, firms try to do innovative things and uplift their
product/service offering. This is a healthy situation for the industry as innovation will drive the industry
to success.

4. A Large Number of Sellers / Producers

Since barriers to entry are low, there will be many sellers/producers who will join the market
continuously. This is a very positive factor for the consumers and the industry as a whole.

5. Consumer Has More Information

Usually, there is a high level of advertising in monopolistic competition firms. This provides a greater
advantage for the consumers with information and hence, lowers search costs. This results in more
informed consumers.

6. Active Business Environment

Monopolistic competition results in an active business environment. There is good competition, since or
group can not dominate in the market, market share is shared between many firms. These will result in
many benefits for the industry.

7. Low Price High-Quality Products

16
Since with the competition, firms have to lower their profit margin and provide consumers low price
competitive products. Otherwise, the market share will be loosened. Also, firms have less chance to
compromise the quality since consumers can move from one brand to another easily.

Disadvantages (Cons / Negatives / Drawbacks / Risks) of Monopolistic

Competition

1. Less Production Efficiency of Individual Firms

Monopolistic competition market disallows monopoly to be in place. There are many competitors in the
market. This results in difficulty for the companies to achieve economies of scale. A company can not
reach the optimum production efficiency capability due to the unavailability of economies of scale.

2. Advertising Focus More Than Product Quality

Companies focus on advertising and promotional activities to set a particular product or service as
superior to competitors. The focus shifts from product improvement to advertisements. This is a
disadvantage from the consumer’s point of view.

3. More Product Alternatives for Consumers

Consumers will be dissatisfied because there are many product alternatives available for them. There
will be many similar products in the market and customers will be misled to choose the correct
according to the expected quality.

4. Predatory Pricing

Firms that have a large investment potential can set the prices low to attempt to drive out competitors
and create a monopoly. Competitors will not be able to hold if a firm set the prices low for a consecutive
duration. This is known as predatory pricing.

5. Misleading Advertising

Since with the competition and substitutable products, firms will try to invest more and more in
adverStising. Some advertisements will be false and misleading, uplifting the product quality more than
what it is, which is not a good situation from a consumer’s point of view.

6. Excess Resource Waste

Many firms compete in the market to produce similar products, using the same resources. But with the
difficulty to reach economies of scale, neither firm will hit the optimum production optimization level.
This will increase the resource waste in the industry as a whole.

17
7. Lack of Standardized Products

Since many firms pump investment into advertisements to increase sales, firms will not focus on product
quality. This will bring up the question of whether firms will produce standardized products.

Oligopoly Market – Definition, Types, Characteristics, Examples

Definition of Oligopoly Market

An oligopoly market is a type of market structure where few firms have the entire market control. These
few firms have the capability to decide the entire prices and supply of the market on a collaborative
basis. But they don’t have the capacity to influence the market on their own.

The market share which individual firms have can vary from little as 5% to more than 50%. Despite the
individual market share each firm has, an oligopoly market is where they have the collective power to
dictate price, supply, and demand.

2. Examples of Oligopoly Market

i) Mass Media Industry in the USA

In the first two decades of the 21st century, the mass media industry in America was an example of an
oligopoly, with the ownership of the majority share of the industry owned by just a few corporations,

CBS

Time Warner

General Electric (GE)

News Corporation

Walt Disney

Viacom

You may refer to the below article published by BusinessInsider.com for more information,

ii) Computer Operating Systems in the USA

The computer operating system market in the USA and world was dominated by four players,

18
Microsoft (owner more than 50% of market share)

Apple

Linux

Google

Four players dominate the entire market share of computer operating systems.

You may refer to the below article published by StatCounter.com for more information,

iii) Mobile Network Operator Market in the USAg market in the USA

There are only a few companies established in the mobile network operating market in the USA.

AT&T

Sprint

T-Mobile

Verizon

U.S. Cellular

Cellcom

The country’s biggest cellphone providers T-Mobile and Sprint merged together in 2018. Industry
analysts aren’t optimistic about the promised lower prices, due to the oligopoly created with this
merger. Please refer to the below article for more information on this merger,

Please refer to the Below Article for Another Five Real Examples of Oligopoly
Market in the USA and Canada,

TYPES OF OLIGOPOLY MARKET

There are 10 Types of Oligopoly Markets Applicable as Follows,

i) Perfect (Pure) Oligopoly

19
If the products produced by firms in the market are homogeneous the oligopoly is set to be pure or
perfect. Oligopoly is named as pure or perfect oligopoly if the firms produce products of the same kind
or nature. This is an oligopoly type based on product differentiation.

ii) Imperfect (Differentiated) Oligopoly

If the products produced by firms in the market are heterogeneous the oligopoly is set to be imperfect
or differentiated. Oligopoly is named as imperfect or differentiated oligopoly if the firms produce
dissimilar or diverse products. This is an oligopoly type based on product differentiation.

iii) Open Oligopoly

In an open oligopoly, new firms have the freedom to enter into the industry. New firms can join the
market and compete with existing firms. An open oligopoly provides no restriction for the desiring firms
to enter the market. This is an oligopoly type based on the entry of firms.

iv) Closed Oligopoly

Entry of the new entrants is restricted in the closed oligopoly. Entry of new firms to the market is strictly
banned. Only a few established firms control the entire market and new firms are not allowed to enter
the industry. The closed oligopoly is the opposite of an open oligopoly. This is an oligopoly type based on
the entry of firms.

v) Collusive Oligopoly

In a collusive oligopoly market, firms collaborate to decide the price and the output of the products. This
occurs when firms cooperate to a common policy of the price and products. Simply, firms combine to
evade the competition of themselves. This is an oligopoly type based on product differentiation.

vi) Competitive (Non-Collusive or Non-Cooperative) Oligopoly

Competitive oligopoly occurs when there is a lack of understanding between the firms and they create
invariable competition. This is also known as a non-collusive or non-cooperative oligopoly. There is no
agreement among the firms regarding the price and output of the entire market. Firms act
independently in a competitive (non-collusive or non-cooperative) oligopoly. This is an oligopoly type
based on product differentiation.

vii) Partial Oligopoly

Partial oligopoly emerges when one big firm dominates the industry and this firm is the price leader.
Other firms follow the big firm in deciding the price policy. This is an oligopoly type based on price
leadership.

20
viii) Full Oligopoly

Full (Total) oligopoly occurs when there is no price leadership in the market. It is the opposite of partial
oligopoly and none of the firms dominates the market. There is no price leadership setter in the market.
This is an oligopoly type based on price leadership.

ix) Syndicated Oligopoly

A syndicated oligopoly is when the firms come together and sell their products with a common interest
(centralized syndicate). This is an oligopoly type that depends on how the firms coordinate with each
other.

x) Organized Oligopoly

An organized oligopoly is where the firms have a central association for fixing the prices, outputs, and
quotas. There is a central association formed to fix prices, quotas, and output.

4. Characteristics of Oligopoly Market

There are seven main characteristics of a market that can

identify it as an oligopoly. These can be treated as conditions
to enable oligopoly.
i) Heightened Barriers to Entry

Markets with oligopolies naturally have several barriers to entry. As an example, patents, licenses, high
start-up costs, etc. These make it difficult for new entrants to join the competition.

ii) Each Firm Has Minor Own Market Power

In an oligopoly market, each firm has little market power. As an example, if a firm in an oligopolistic
market raises its price then there is a risk of losing customers to other competitors. One oligopolistic
firm cannot dictate prices independently.

iii) Pricing Unique Pattern Not Available

21
In an oligopoly market, each firm is keen to remain independent and to get the maximum possible
profit. They react to the price-output movements of one another which are a continuous element of
uncertainty.

iv) Few Firms with Large Market Share

In an oligopoly market, it may have many sellers, but the top 5 firms have a combined market share of
over 50 percent. This is because the market power is concentrated between a few top firms.

v) Inter Dependency Between Firms

In an oligopoly market, any action taken on one film will strongly affect the actions of its competitors
(other firms). An oligopolistic firm operates based on competitor actions. If one firm reduces prices,
other firms will also tend to follow the same to safeguard their market share.

vi) Higher Prices than Perfect Competition

Firms in an oligopoly market have combined market power, which all firms usually tend to keep prices
higher to obtain larger profits. If any firms reduce prices, others would also follow.

vii) Efficiency

Firms in an oligopoly market benefit from high levels of market share which they naturally benefit from
economies of scale. Firms can the product at a lower cost.

5. Importance of Oligopoly

Firms see more economic advantages in collaborating with the competitors on a specific price rather
than reducing prices to challenge their competitors. By this kind of collaborative price control,
oligopolies can raise their barriers to entry.

HOW DO OLIGOPOLIES CAUSE MARKET FAILURE (NEGATIVE

EFFECTS OF AN OLIGOPOLY)

Oligopoly cause market failure in the following ways,

i) Interdependence

Firms strongly depend on each other in an oligopoly market. If one firm reduces the price then other
firms will also do the same to retain their customers. But this has negative effects where any of the firms

22
could not obtain a profit due to the price reduction war. This may result in a collapse of some firms in
the market, which may result in a monopoly situation.

ii) Inefficiency

Firms in an oligopoly market benefit from high levels of market share which they naturally benefit from
economies of scale. But this could result in diseconomies of scale as well.

iii) Less Room For New Entrants

Markets with oligopolies naturally have several barriers to entry. As an example, patents, licenses, high
start-up costs, etc. These make it difficult for new entrants to join the competition. This will not be a
healthy situation for the markets in the long run.

1. Definition of Oligopoly Market

An oligopoly market is a type of market structure where few firms have the entire market control. These
few firms have the capability to decide the entire prices and supply of the market on a collaborative
basis. But they don’t have the capacity to influence the market on their own.

The market share which individual firms have can vary from little as 5% to more than 50%. Despite the
individual market share each firm has, an oligopoly market is where they have the collective power to
dictate price, supply, and demand.

2. Examples of Oligopoly Market

i) Mass Media Industry in the USA

In the first two decades of the 21st century, the mass media industry in America was an example of an
oligopoly, with the ownership of the majority share of the industry owned by just a few corporations,

CBS

Time Warner

General Electric (GE)

News Corporation

Walt Disney

Viacom

You may refer to the below article published by BusinessInsider.com for more information,

6 Corporations Control 90% Of The Media In America

23
ii) Computer Operating Systems in the USA

The computer operating system market in the USA and world was dominated by four players,

Microsoft (owner more than 50% of market share)

Apple

Linux

Google

Four players dominate the entire market share of computer operating systems.

You may refer to the below article published by StatCounter.com for more information,

iii) Mobile Network Operator Market in the USAg market in the USA

There are only a few companies established in the mobile network operating market in the USA.

AT&T

Sprint

T-Mobile

Verizon

U.S. Cellular

Cellcom

The country’s biggest cellphone providers T-Mobile and Sprint merged together in 2018. Industry
analysts aren’t optimistic about the promised lower prices, due to the oligopoly created with this
merger. Please refer to the below article for more information on this merger,

Please refer to the Below Article for Another Five Real Examples of Oligopoly Market in the USA and
Canada,

3. Types of Oligopoly Market

There are 10 Types of Oligopoly Markets Applicable as Follows,

i) Perfect (Pure) Oligopoly

24
If the products produced by firms in the market are homogeneous the oligopoly is set to be pure or
perfect. Oligopoly is named as pure or perfect oligopoly if the firms produce products of the same kind
or nature. This is an oligopoly type based on product differentiation.

ii) Imperfect (Differentiated) Oligopoly

If the products produced by firms in the market are heterogeneous the oligopoly is set to be imperfect
or differentiated. Oligopoly is named as imperfect or differentiated oligopoly if the firms produce
dissimilar or diverse products. This is an oligopoly type based on product differentiation.

iii) Open Oligopoly

In an open oligopoly, new firms have the freedom to enter into the industry. New firms can join the
market and compete with existing firms. An open oligopoly provides no restriction for the desiring firms
to enter the market. This is an oligopoly type based on the entry of firms.

iv) Closed Oligopoly

Entry of the new entrants is restricted in the closed oligopoly. Entry of new firms to the market is strictly
banned. Only a few established firms control the entire market and new firms are not allowed to enter
the industry. The closed oligopoly is the opposite of an open oligopoly. This is an oligopoly type based on
the entry of firms.

v) Collusive Oligopoly

In a collusive oligopoly market, firms collaborate to decide the price and the output of the products. This
occurs when firms cooperate to a common policy of the price and products. Simply, firms combine to
evade the competition of themselves. This is an oligopoly type based on product differentiation.

vi) Competitive (Non-Collusive or Non-Cooperative) Oligopoly

Competitive oligopoly occurs when there is a lack of understanding between the firms and they create
invariable competition. This is also known as a non-collusive or non-cooperative oligopoly. There is no
agreement among the firms regarding the price and output of the entire market. Firms act
independently in a competitive (non-collusive or non-cooperative) oligopoly. This is an oligopoly type
based on product differentiation.

vii) Partial Oligopoly

Partial oligopoly emerges when one big firm dominates the industry and this firm is the price leader.
Other firms follow the big firm in deciding the price policy. This is an oligopoly type based on price
leadership.

viii) Full Oligopoly

Full (Total) oligopoly occurs when there is no price leadership in the market. It is the opposite of partial
oligopoly and none of the firms dominates the market. There is no price leadership setter in the market.
This is an oligopoly type based on price leadership.

25
ix) Syndicated Oligopoly

A syndicated oligopoly is when the firms come together and sell their products with a common interest
(centralized syndicate). This is an oligopoly type that depends on how the firms coordinate with each
other.

x) Organized Oligopoly

An organized oligopoly is where the firms have a central association for fixing the prices, outputs, and
quotas. There is a central association formed to fix prices, quotas, and output.

4. Characteristics of Oligopoly Market

There are seven main characteristics of a market that can identify it as an oligopoly. These can be
treated as conditions to enable oligopoly.

i) Heightened Barriers to Entry

Markets with oligopolies naturally have several barriers to entry. As an example, patents, licenses, high
start-up costs, etc. These make it difficult for new entrants to join the competition.

ii) Each Firm Has Minor Own Market Power

In an oligopoly market, each firm has little market power. As an example, if a firm in an oligopolistic
market raises its price then there is a risk of losing customers to other competitors. One oligopolistic
firm cannot dictate prices independently.

iii) Pricing Unique Pattern Not Available

In an oligopoly market, each firm is keen to remain independent and to get the maximum possible
profit. They react to the price-output movements of one another which are a continuous element of
uncertainty.

iv) Few Firms with Large Market Share

In an oligopoly market, it may have many sellers, but the top 5 firms have a combined market share of
over 50 percent. This is because the market power is concentrated between a few top firms.

v) Inter Dependency Between Firms

In an oligopoly market, any action taken on one film will strongly affect the actions of its competitors
(other firms). An oligopolistic firm operates based on competitor actions. If one firm reduces prices,
other firms will also tend to follow the same to safeguard their market share.

vi) Higher Prices than Perfect Competition

Firms in an oligopoly market have combined market power, which all firms usually tend to keep prices
higher to obtain larger profits. If any firms reduce prices, others would also follow.

vii) Efficiency

26
Firms in an oligopoly market benefit from high levels of market share which they naturally benefit from
economies of scale. Firms can the product at a lower cost.

5. Importance of Oligopoly

Firms see more economic advantages in collaborating with the competitors on a specific price rather
than reducing prices to challenge their competitors. By this kind of collaborative price control,
oligopolies can raise their barriers to entry.

5. How do Oligopolies Cause Market Failure (Negative Effects of an Oligopoly)

Oligopoly cause market failure in the following ways,

i) Interdependence

Firms strongly depend on each other in an oligopoly market. If one firm reduces the price then other
firms will also do the same to retain their customers. But this has negative effects where any of the firms
could not obtain a profit due to the price reduction war. This may result in a collapse of some firms in
the market, which may result in a monopoly situation.

ii) Inefficiency

Firms in an oligopoly market benefit from high levels of market share which they naturally benefit from
economies of scale. But this could result in diseconomies of scale as well.

iii) Less Room For New Entrants

Markets with oligopolies naturally have several barriers to entry. As an example, patents, licenses, high
start-up costs, etc. These make it difficult for new entrants to join the competition. This will not be a
healthy situation for the markets in the long run

n the figure above, Price is on the Y-axis and Quantity on the X-axis. The left side of the figure
represents the industry and the right side the case of a firm. The market demand curve is DD and
the market supply curve is SS.

Further, the point at which the market’s demand and supply curves intersect each other is the
equilibrium point. The price at this level is the equilibrium price and the quantity is the
equilibrium quantity.

All firms receive this price in a perfectly competitive market. Also, firms are the price-takers and
the industry is the price-maker. The Average Revenue (AR) Curve is the demand curve of the
firm as it can sell any quantity it wants at the market price.

27
Short-run Equilibrium of a Competitive Firm

In the short-run, there the following assumptions:

 The price of the product is given and the firm can sell any quantity at that price
 The size of the plant of the firm is constant
 The firm faces given short-run cost curves

We know that the necessary and sufficient conditions for the equilibrium of a firm are:

1. MC = MR
2. MC curve cuts the MR curve from below

In other words, the MC curve must intersect the MR curve from below and after the intersection
lie above the MR curve. In simpler terms, the firm must keep adding to its output as long as
MR>MC.

This is because additional output adds more revenue than costs and increases its profits. Further,
if MC=MR, but the firm finds that by adding to its output, MC becomes smaller than MR, then it
must keep increasing its output.

Since it is a perfectly competitive market, the demand for the product of the firm is perfectly
elastic. Further, it can sell all its output at the market price. Therefore, its demand curve runs
parallel to the X-axis throughout its length and its MR curve coincides with the AR curve.

On the supply side, recall the four cost curves – AFC, AVC, MC, and ATC? Of these, the supply
curve is that portion of the MC curve which lies above the AVC curve and is upward sloping.

In the short-run, the firm cannot avoid fixed costs. Even if the production is zero, the firm must
incur these costs. Therefore, the firm cannot avoid losses by not producing and continues
producing as long as its losses do not exceed its fixed costs. In other words, a firm produces as
long as its average price equals or exceeds its AVC.

Three Possibilities in Short-run

In a perfectly competitive market, a firm can earn a normal profit, super-normal profit, or it can
bear a loss. At the equilibrium quantity, if the average cost is equal to the average revenue, then
the firm is earning a normal profit.

28
On the other hand, if the average cost is greater than the average revenue, then the firm is bearing
a loss. However, if the average cost is less than average revenue, then the firm is earning super-
normal profits.

Normal Profit

In the above figure, you can see that the costs and revenue are on the Y-axis and the Quantity is
on the X-axis. Further, marginal costs cut the marginal revenue curve from below at point A. At
point ‘A’, P is the equilibrium price and ‘Q’ is the equilibrium quantity.

Note that corresponding to the equilibrium quantity, the average cost is equal to the average
revenue. It also means that the firm is earning a normal profit.

LossIn the figure above, the cost and revenue curves are on the Y-axis and the
quantity demanded is on the X-axis. Further, the marginal cost curve cuts the
marginal revenue curve from below at point ‘A’, the equilibrium point.

Corresponding to point ‘A’, P* and Q* are the equilibrium price and quantity respectively. Also,
corresponding to Q*, the average cost is more than the average revenue.

In this case, the per unit cost of OQ* (average cost) is more than the per unit revenue of OQ*
(average revenue). As per the figure, the per unit revenue is OP and the per unit cost is OP’. this
means that the per unit loss is PP’. Also, the total loss on quantity OQ* is P*P’BA.

Super-normal

In the figure above, the per unit revenue or average revenue is OP* while the per
unit cost or average cost is OP’. Therefore, the per unit receipts are high in
comparison with the per unit cost.

That’s why the average revenue curve lies above the average cost curve corresponding to Q*.
The firm is earning super-normal profits. The per unit profit is P’P* and the total profit is for
quantity OQ* is P’P*BA.

Summary of the Equilibrium of a Competitive firm in the Short-run

In the figure above, we have taken five different prices to illustrate the supply behaviour and
equilibrium of the firm. Further, each price has an average revenue curve which runs parallel to
the X-axis and coincides with the MR curve.

MR0

When the price is OP0, the corresponding MR0 curve cuts the MC curve at two points – A and B.
At point ‘A’, none of the conditions of equilibrium are satisfied.

29
At point ‘B’, the MC curve cuts the MR0 curve from below but AR is less than AVC. Therefore,
the firm incurs a loss which is greater than its fixed cost if it decides to produce when the price is
OP0. Hence, the firm closes down.

MR1

If the price is equal to OP1 (equal to the least possible average variable cost), then the firm
decides to produce. In this case, the MC curve cuts the MR1 curve from below at point C and
AR1 is equal to AVC. Therefore, the firm either does not produce at all or produces equal to
OM1.

MR2

If the price is equal to OP2, it exceeds AVC but is less than ATC. The MR2 and MC curves
intersect each other at point D. The firm produces an output – OM2. The firm still incurs a loss
but it is less than its fixed costs.

MR3

If the price rises to OP3, the firm can recover all its costs including the fixed costs. The MC
curve cuts the MR3 curve from below at point E and AR3 is equal to ATC. Therefore, all the
conditions of the equilibrium are satisfied and the firm produces an output – OM3.

MR4

If the price rises even higher, the point of intersection of MR4 and MC curves moves to point F.
In this case, the firm earns super-normal profits and produces OM4.

Therefore, in the short-run, even if a firm incurs losses, it continues production until it loses start
exceeding its fixed costs. On the other hand, if the firm earns super-normal profits, then new
firms entering the market wipe it out.

Solved Question on Perfect Competition

Q1. What are the main assumptions under the short-run period of a competitive firm?

Answer: The main assumptions under the short-run period of a competitive firm are:

 The price of the product is given and the firm can sell any quantity at that price
 The size of the plant of the firm is constant
 The firm faces given short-run cost curves

Q2. What are the three possibilities for a firm’s equilibrium in a perfectly competitive
market?

Answer: The three possibilities are:

30
 1. The firm earns normal profits
2. It incurs losses
3. It earns super-normal profits

Measurement of National Income

There are three ways of measuring the National Income of a country. They are from the income
side, the output side and the expenditure side. Thus, we can classify these perspectives into the
following methods of measurement of National Income.

Methods of Measuring National Income

 Product Method
 Income Method
 Expenditure Method

1. Product Method

Under this method, we add the values of output produced or services rendered by the different
sectors of the economy during the year in order to calculate the National Income.

In this method, we include only the value added by each firm in the production process in the
output figure.

Hence, we use the value-added method. The value-added output of all the sectors of the economy
is the GNP at factor cost.

However, this method is unscientific as it adds the value of only those goods and services that
are sold in the market or are available for sale in the market

Browse more Topics under National Income

 The concept of National Income

 The concept of Consumption, Saving, and Investment
 Economic Growth
 Economic Fluctuations

2. Income Method

Under this method, we add all the incomes from employment and ownership of assets before
taxation received from all the production activities in an economy.

Thus, it is also the Factor Income method. We also need to add the undistributed profits of the
private sector and the trading surplus of the public sector corporations.

31
However, we need to exclude items not arising from productive activities such as sickness
benefits, interest on the national debt, etc.

3. Expenditure Method

This method measures the total domestic expenditure of the economy. It consists of two
elements, viz. Consumption expenditure and Investment expenditure.

Consumption expenditure includes consumption expenditure of the household sector on goods

and services and consumption outlays of the business sector and public authorities.

Investment expenditure refers to the expenditure on the making of fixed capital such as Plant and
Machinery, buildings, etc.

Difficulties in Measurement of National Income

Following are the difficulties in estimating the National Income

 Conceptual difficulties
 Statistical difficulties

A. Conceptual difficulties

1. It is difficult to calculate the value of some of the items such as services rendered for free and
goods that are to be sold but are used for self-consumption.
2. Sometimes, it becomes difficult to make a clear distinction between primary, intermediate and
final goods.
3. What price to choose to determine the monetary value of a National Product is always a difficult
question?
4. Whether to include the income of the foreign companies in the National Income or not because
they emit a major part of their income outside India?

B. Statistical difficulties

1. In case of changes in the price level, we need to use the Index numbers which have their own
inherent limitations.
2. Statistical figures are not always accurate as they are based on the sample surveys. Also, all the
data are not often available.
3. All the countries have different methods of estimating National Income. Thus, it is not easily
comparable.

Questions on National Income

What is the usefulness of estimating the National Income?

Ans.

32
The usefulness of estimating National Income is as follows:

1. It depicts the change in the production to output and also the effects of the Government policies
on the economy.
2. The National Income studies the relation between the input of one industry and the output of
the other.
3. It shows the income distribution among different economic units.
4. It also shows the change in the tastes and preferences of the consumers and thus, helps the
producers to decide what to produce and for whom to produce.
5. The quantum of the National Income of a country indicates its ability to pay its share for
international purposes, such as membership of IMF, World Bank or SAARC.

33
What is National Income?
We often hear the GDP in India. The national income of India is the sum total of income
everyone earns in India. GDP, GNP are also parts of this national income.

GDP is the gross domestic products while GNP is a gross national product. Further, the savings
rate and investment in the economy are the determinantal factors in the national income of India.

For a nation, the value of the final goods and services,  it produces in terms of money for the
residents living in the country is the national income.

So, what is national income? It is generally for that particular fiscal year or financial year. In
India, this financial year means the year from April 1st to March 31st for the next year. Thus, the
formula to calculate national income is,

N.I. = C + I + G + (X -M)

Here, C stands for consumption, I stands for total investment expenditure, G stands for the
expenditure done by the government, and X and M stand for export and import respectively.

X and M are interchangeable depending upon whether the trades are trade surplus or trade
deficit.

To determine the estimates of national income, there are three methods:

 Product or production method

 Income method
 Expenditure method

Factors of National Income

As discussed above, there are factors which determine the national income of a country. Below
are the details of these factors:

GDP (Gross domestic product)

The final products within the boundaries of India within that specific period of time are in the
GDP of India. Further, the effect of inflation on these products is also calculated.

GDP includes government expenditures, consumption, exports, imports, and investment of India.

For example, if Honda decides to manufacture it’s parted in India than that will go into the GDP
of India. But the revenues got through the sales are included in the GDP of Japan.

GNP (Gross national product)

34
GNP of the country is measured by the income which is collected due to the various factors of
production that are owned by the residents or the citizens of India.

The GNP of India is calculated by adding the net inflow coming from the abroad countries to the
GDP of India while subtracting net outflow to the foreign countries from India.

As per the previous example, if Honda is an Indian company and it is selling it’s parted in other
countries than that revenue become the GNP for India.

Consumption and Investment expenditure

The money spent on durable as well as nondurable goods in India is included in the consumption
expenditure. The durable items are the items which are expected to last more than 3 years while
nondurable items include clothing and foods. Services are also included in this section.

Investment expenditures include the spending on business inventories and residential and non-
residential investment. Nonresidential includes spending on various equipment and plants. While
residential includes spending on multi-family homes and single-family homes.

History and Present of National Income

Before independence, Dadabhai Naoroji is considered as the first person who calculated the
national income of India. While, VKRV Rao divided the economy into sectors, corporate sectors,
and agriculture sectors.

After independence, a committee called the national income committee was formed. It was set-
up in 1949, and its first chairman was Prof. P.C. Mahalanobis.

Practice Questions
Q. In India, the financial year is  from:

A. March 1st to February 28th

B. January 1st to December 31st

C. March 1st to April 30th

D. April 1st to March 31st

Answer: D. April 1st to March 31st

Q. Methods to calculate national income are:

A. Production method

35
B. Income method

C. Expenditure method

D. All of the method

Answer: D. All of the method

Types of Inflation
 Demand Pull Inflation
 Cost-Push Inflation
 Open Inflation
 Repressed Inflation
 Hyper-Inflation
 Creeping and Moderate Inflation
 True Inflation
 Semi-Inflation

Demand Pull Inflation

This is when the aggregate demand in an economy exceeds the aggregate supply. This increase
in the aggregate demand might occur due to an increase in the money supply or income or the
level of public expenditure.

This concept is associated with full employment when altering the supply is not possible. Take a
look at the graph below:

In the graph above, SS is the aggregate supply curve and DD is the aggregate demand curve.
Further,

 Op is the equilibrium price

 Oq is the equilibrium output

Exogenous causes shift the demand curve to the right to D1D1.  Therefore, at the current price
(Op), the demand increases by qq2. However, the supply is Oq.

Hence, the excess demand for qq2 puts pressure on the price, increasing it to Op1. Therefore,
there is a new equilibrium at this price, where demand equals supply. As you can see, the excess
demand is eliminated as follows:

36
  The price rises which leads to a fall in demand and a rise in supply.

Cost-Push Inflation

Supply can also cause inflationary pressure. If the aggregate demand remains unchanged but the
aggregate supply falls due to exogenous causes, then the price level increases. Take a look at the
graph below:

In the graph above, the equilibrium price is Op and the equilibrium output is Oq. If the aggregate
supply falls, then the supply curve SS shifts left to reach S1S1.

Now, at the price Op, the demand is Oq but the supply is Oq2 which is lesser than Oq. Therefore,
the prices are pushed high till a new equilibrium is reached at Op1.

At this point, there is no excess demand. Hence, you can see that inflation is a self-limiting
phenomenon.

Open Inflation

This is the simplest form of inflation where the price level rises continuously and is visible to
people. You can see the annual rate of increase in the price level.

Repressed Inflation

Let’s say that there is excess demand in an economy. Typically, this leads to an increase in price.

However, the Government can take some repressive measures like price control, rationing, etc. to
prevent the excess demand from increasing the prices.

Hyper-Inflation

In hyperinflation, the price level increases at a rapid rate. In fact, you can expect prices to
increase every hour. Usually, this leads to the demonetization of an economy.

Creeping and Moderate Inflation

 Creeping – In this case, the price level increases very slowly over an extended period of
time.
 Moderate – In this case, the rise in the price level is neither too fast nor too slow – it is
moderate.

True Inflation

37
This takes place after the full employment of all the factor inputs of an economy. When there is
full employment, the national output becomes perfectly inelastic. Therefore, more money simply
implies higher prices and not more output.

Semi-Inflation

Even before full employment, an economy might face inflationary pressure due to bottlenecks
from certain sectors of the economy.

Solved Question on Forms of Inflation

Q1. What are the different types of inflation?

Answer: The different types of inflation are:

 Demand Pull
 Cost-Push
 Open
 Repressed
 Hyperinflation
 Creeping
 Moderate

38