Unit 5: Analysis of Markets

Basic Concepts of Revenue, Revenue Curves, Relationship between Average, and

Marginal Revenue Curve; Various forms of Market -Price and Output, under

Determination Perfect Competition, Monopoly, Monopolistic Competition and

Oligopoly.

Revenue

Revenue is the income a firm retains from selling its products once it has paid indirect tax,

such as VAT. Revenue provides the income which a firm needs to enable it to cover its costs

of production, and from which it can derive a profit. Profit can be distributed to the owners,

or shareholders, or retained in the business to purchase new capital assets or upgrade the

firm’s technology.

Revenue is measured in three ways:

Total revenue: Total revenue (TR), is the total flow of income to a firm from selling a given

quantity of output at a given price, less tax going to the government. The value of TR is

found by multiplying price of the product by the quantity sold.

Average revenue: Average revenue (AR), is revenue per unit, and is found by dividing TR

by the quantity sold, Q. AR is equivalent to the price of the product, where P x Q/Q = P,

hence AR is also price.

Marginal revenue: Marginal revenue (MR) is the revenue generated from selling one extra

unit of a good or service. It can be found by finding the change in TR following an increase

in output of one unit. MR can be both positive and negative.

Revenue schedule

A revenue schedule shows the amount of revenue generated by a firm at different prices.
 Qd TR (000) AR MR (000)
1 10 10
2 18 9 8
3 24 8 6
4 28 7 4
5 30 6 2
6 30 5 0
7 28 4 -2
8 24 3 -4
9 18 2 -6
10 10 1 -8
Revenue curves

Total revenue Curve

Initially, as output increases total revenue (TR) also increases, but at a decreasing rate. It

eventually reaches a maximum and then decreases with further output.

Less competition in a given market is likely to lead to higher prices and the possibility of

higher super-normal profits.

TR = PxQ, (Here, TR = Total revenue, P = Price per unit of output, and Q = Quantity (or

units) of output.)

Average revenue Curve

However, as output increases the average revenue (AR) curve slopes downwards. The AR

curve is also the firm’s demand curve.

AR = TR/Q or AR = (P x Q)/Q [Since TR= P x Q] AR = P

Marginal revenue Curve

The marginal revenue (MR) curve also slopes downwards, but at twice the rate of AR. This

means that when MR is 0, TR will be at its maximum. Increases in output beyond the point

where MR = 0 will lead to a negative MR.

 MR = ΔTR/ΔQ = TRn – TRn-1

The relationship between TR, AR, and MR

In order to understand the basic concepts of revenue, it is also important to pay attention to

the relationship between TR, AR, and MR. When the first unit is sold, TR, AR, and MR are

equal.

Therefore, all three curves start from the same point. Further, as long as MR is positive, the

TR curve slopes upwards.

However, if MR is falling with the increase in the quantity of sale, then the TR curve will

gain height at a decreasing rate. When the MR curve touches the X-axis, the TR curve

reaches its maximum height.

Further, if the MR curve goes below the X-axis, the TR curve starts sloping downwards.

Any change in AR causes a much bigger change in MR. Therefore, if the AR curve has a

negative slope, then the MR curve has a greater slope and lies below it.

Similarly, if the AR curve has a positive slope, then the MR curve again has a greater slope

and lies above it. If the AR curve is parallel to the X-axis, then the MR curve coincides with

it.

Here is a graphical representation of the relationship between AR and MR:

In the left half, you can see that AR has a constant value (DD’). Therefore, the AR curve

starts from point D and runs parallel to the X-axis. Also, since AR is constant, MR is equal to

AR and the two curves coincide with each other.

TR
In the right half, you can see that the AR curve starts from point D on the Y-axis and is a

straight line with a negative slope. This basically means that as the number of goods sold

increases, the price per unit falls at a steady rate.

Similarly, the MR curve also starts from point D and is a straight line as well. However, it is a

locus of all the points which bisect the perpendicular distance between the AR curve and the

Y-axis. In the figure above, FM=MA.

Various forms of Market

The market is presented as a form that is for the cultural advantage of the general public. The

market structure comprises different types of markets, and the structures are portrayed by the

nature and the level of competition that exists for the goods and services in the market. The

forms of the market, both for the products market and the factor market or the service market,

is to be decided by the idea of rivalry that is winning in a specific kind of market.

Meaning of a Market: A market can be characterised as where a couple of parties can meet,

which will expedite the trading of products and services. The parties involved in the market

activities are the sellers and the buyers. A market is an actual structure like a retail outlet,

where the dealers and purchasers can meet eye to eye, or in a virtual structure like an internet-

based market, where there is the truancy of direct, actual contact between the purchasers and

vendors.

The Market structure is an expression that is resultant for the quality or the adequacy of the

market competition that is winning in the market. There are seven primary market structures:

 Monopoly
 Oligopoly
 Perfect competition
 Monopolistic competition
 Monopsony
 Oligopsony
  Natural monopoly

Types of the market:

Monopoly:

A monopolistic market is a market formation with the qualities of a pure market. A pure

monopoly can only exist when one provider gives a specific service or a product to numerous

customers. In a monopolistic market, the imposing business organisation, or the controlling

organisation, has the overall control of the entire market, so it sets the supply and price of its

goods and services. For example, the Indian Railway, Google, Microsoft, and Facebook.

Oligopoly:

An oligopoly is a market form with a few firms, none of which can hold the others back from

having a critical impact. The fixation or concentration proportion estimates the piece of the

market share of the biggest firms. For example, commercial air travel, auto industries, cable

television, etc.

Perfect competition:

Perfect competition is an absolute sort of market form wherein all end consumers and

producers have complete and balanced data and no exchange costs. There is an enormous

number of makers and customers rivalling each other in this sort of environment. For

example, agricultural products like carrots, potatoes, and various grain products, the

securities market, foreign exchange markets, and even online shopping websites, etc.

Monopolistic competition:

Monopolistic competition portrays an industry where many firms offer their services and

products that are comparative (however somewhat flawed) substitutes. Obstructions or

barriers to exit and entry in monopolistic competitive industries are low, and the choices

made of any firm don’t explicitly influence those of its rivals. The monopolistic competition

is firmly identified with the business technique of brand separation and differentiation. For

example, hairdressers, restaurant businesses, hotels, and pubs.

Monopsony:

A monopsony is a market situation wherein there is just a single purchaser, the monopsonist.

Just like a monopoly, a monopsony additionally has an imperfect market condition. The

contrast between a monopsony and a monopoly is basically in the distinction between the

controlling business elements. A solitary purchaser overwhelms a monopsonist market while

a singular dealer controls a monopolised market. Monopsonists are normal to regions where

they supply most of the locale’s positions in the regional jobs. For example, a company that

collects the entire labour of a town. Like a sugar factory that recruits labourers from the entire

town to extract sugar from sugarcane.

Oligopsony:

An oligopsony is a business opportunity for services and products that is influenced by a

couple of huge purchasers. The centralisation of market demand is in only a couple of parties

that gives each a generous control of its vendors and can adequately hold costs down. For

example, the supermarket industry is arising as an oligopsony with a worldwide reach.

Natural monopoly:

A natural monopoly is a kind of a monopoly that can exist normally because of the great

start-up costs or incredible economies of scale of directing a business in a particular industry

which can bring about huge barriers to exit and entry for possible contenders. An

organisation with a natural monopoly may be the main supplier of a service or a product in an

industry or geographic area. Normally, natural monopolies can emerge in businesses that
require the latest technology, raw materials, or similar factors to work. For example, the

utility service industry is a natural monopoly. It consists of supplying water, electricity, sewer

services, and distribution of energy to towns and cities across the country.

Price and Output Determination under Perfect Competition

Perfect competition refers to a market situation where there are a large number of buyers and

sellers dealing in homogenous products.

Moreover, under perfect competition, there are no legal, social, or technological barriers on

the entry or exit of organizations.

In perfect competition, sellers and buyers are fully aware about the current market price of a

product. Therefore, none of them sell or buy at a higher rate. As a result, the same price

prevails in the market under perfect competition.

Under perfect competition, the buyers and sellers cannot influence the market price by

increasing or decreasing their purchases or output, respectively. The market price of products

in perfect competition is determined by the industry. This implies that in perfect competition,

the market price of products is determined by taking into account two market forces, namely

market demand and market supply.

Demand under Perfect Competition:

Demand refers to the quantity of a product that consumers are willing to purchase at a

particular price, while other factors remain constant. A consumer demands more quantity at

lower price and less quantity at higher price. Therefore, the demand varies at different prices.

Figure-1 represents the demand curve under perfect competition:

As shown in Figure-1, when price is OP, the quantity demanded is OQ. On the other hand,

when price increases to OP1, the quantity demanded reduces to OQ1. Therefore, under

perfect competition, the demand curve (DD’) slopes downward.

Supply under Perfect Competition:

Supply refers to quantity of a product that producers are willing to supply at a particular

price. Generally, the supply of a product increases at high price and decreases at low price.

Figure-2 shows the supply curve under perfect competition:

In Figure-2, the quantity supplied is OQ at price OP. When price increases to OP1, the

quantity supplied increases to OQ1. This is because the producers are able to earn large
profits by supplying products at higher price. Therefore, under perfect competition, the

supply curves (SS’) slopes upward.

Equilibrium under Perfect Competition:

As discussed earlier, in perfect competition, the price of a product is determined at a point at

which the demand and supply curve intersect each other. This point is known as equilibrium

point. At this point, the quantity demanded and supplied is called equilibrium quantity.

Figure-3 shows the equilibrium under perfect competition:

In Figure-3, it can be seen that at price OP1, supply is more than the demand. Therefore,

prices will fall down to OP. Similarly, at price OP2, demand is more than the supply.

Similarly, in such a case, the prices will rise to OP. Thus, E is the equilibrium at which

equilibrium price is OP and equilibrium quantity is OQ.

Price and Output Determination under Monopoly

Monopoly refers to a market structure in which there is a single producer or seller that has a

control on the entire market.

This single seller deals in the products that have no close substitutes and has a direct demand,

supply, and prices of a product.

Therefore, in monopoly, there is no distinction between an one organization constitutes the

whole industry.

Demand and Revenue under Monopoly:

In monopoly, there is only one producer of a product, who influences the price of the product

by making Change m supply. The producer under monopoly is called monopolist. If the

monopolist wants to sell more, he/she can reduce the price of a product. On the other hand, if

he/she is willing to sell less, he/she can increase the price.

As we know, there is no difference between organization and industry under monopoly.

Accordingly, the demand curve of the organization constitutes the demand curve of the entire

industry. The demand curve of the monopolist is Average Revenue (AR), which slopes

downward.

Figure-9 shows the AR curve of the monopolist:

In Figure-9, it can be seen that more quantity (OQ2) can only be sold at lower price (OP2).

Under monopoly, the slope of AR curve is downward, which implies that if the high prices

are set by the monopolist, the demand will fall. In addition, in monopoly, AR curve and
Marginal Revenue (MR) curve are different from each other. However, both of them slope

downward.

The negative AR and MR curve depicts the following facts:

i. When MR is greater than AR, the AR rises

ii. When MR is equal to AR, then AR remains constant

iii. When MR is lesser than AR, then AR falls

Here, AR is the price of a product, As we know, AR falls under monopoly; thus, MR is less

than AR.

Figure-10 shows AR and MR curves under monopoly:

In figure-10, MR curve is shown below the AR curve because AR falls.

Table-1 shows the numerical calculation of AR and MR under monopoly:

As shown in Table-1, AR is equal to price. MR is less than AR and falls twice the rate than

AR. For instance, when two units of

Output are sold, MR falls by Rs. 2, whereas AR falls by Re. 1.

Monopoly Equilibrium:

Single organization constitutes the whole industry in monopoly. Thus, there is no need for

separate analysis of equilibrium of organization and industry in case of monopoly. The main

aim of monopolist is to earn maximum profit as of a producer in perfect competition.

Unlike perfect competition, the equilibrium, under monopoly, is attained at the point where

profit is maximum that is where MR=MC. Therefore, the monopolist will go on producing

additional units of output as long as MR is greater than MC, to earn maximum profit.

Let us learn monopoly equilibrium through Figure-11:

In Figure-11, if output is increased beyond OQ, MR will be less than MC. Thus, if additional

units are produced, the organization will incur loss. At equilibrium point, total profits earned
are equal to shaded area ABEC. E is the equilibrium point at which MR=MC with quantity as

OQ.

It should be noted that under monopoly, price forms the following relation with the MC:

Price = AR

MR= AR [(e-1)/e]

e = Price elasticity of demand

As in equilibrium MR=MC

MC = AR [(e-1)/e]

Exhibit-2:

Determining Price and Output under Monopoly:

Suppose demand function for monopoly is Q = 200-0.4Q

Price function is P= 1000-10Q

Cost function is TC= 100 + 40Q + Q2

Maximum profit is achieved where MR=MC

To find MR, TR is derived.

TR= (1000-10Q) Q = 1000Q-10Q2

MR = ∆TR/∆Q= 1000 – 20Q

MR = MC

1000 – 20Q = 40 + 2Q

Q = 43.63 (44 approx.) = Profit Maximizing Output

Profit maximizing price = 1000 – 20*44 = 120

Total maximum profit= TR-TC= (1000Q – 10Q2) – (100+ 40Q+Q2)

Price-output determination under Monopolistic Competition: Equilibrium of a firm

Under monopolistic competition, the firm will be in equilibrium position when marginal

revenue is equal to marginal cost. So long the marginal revenue is greater than marginal cost,

the seller will find it profitable to expand his output, and if the MR is less than MC, it is

obvious he will reduce his output where the MR is equal to MC. In short run, therefore, the

firm will be in equilibrium when it is maximising profits, i.e., when MR = MC.

(a) Short Run Equilibrium: Short run equilibrium is illustrated in the following diagram:

Diagram:

Monopolistic

Competition Short Run Equilibrium

In the above diagram, the short run average cost is MT and short run average revenue is

MP. Since the AR curve is above the AC curve, therefore, the profit is shown as PT. PT is the

supernormal profit per unit of output. Total supernormal profit will be measured by

multiplying the supernormal profit to the total output, i.e. PT × OM or PTT’P’ as shown in

figure (a). The firm may also incur losses in the short run if it is facing AR curve below the
AC curve. In figure (b) MP is less than MT and TP is the loss per unit of output. Total loss

will be measured by multiplying loss per unit of output to the total output, i.e., TP × OM or

TPP’T’.

 (b) Long Run Equilibrium: Under monopolistic competition, the supernormal profit in the

long run is disappeared as new firms are entered into the industry. As the new firms are

entered into the industry, the demand curve or AR curve will shift to the left, and therefore,

the supernormal profit will be competed away and the firms will be earning normal profits. If

in the short run firms are suffering from losses, then in the long run some firms will leave the

industry so that remaining firms are earning normal profits.

The AR curve in the long run will be more elastic, since a large number of substitutes will be

available in the long run. Therefore, in the long run, equilibrium is established when firms are

earning only normal profits. Now profits are normal only when AR = AC. It is further

illustrated in the following diagram:

Determination of Price and

Output In Oligopoly
There are various types of markets that exist and oligopoly is one of them. Oligopoly markets

are mostly dominated by suppliers on a small scale. These are oligopoly markets that are

found across the world in many sectors. Some of the oligopoly markets are competitive

whereas some are not that significant. The authorities for the competition are called upon to

supervise the coordinated actions as well as if there is low competition. Oligopoly markets

can exist between the extreme conditions of a market which is either a perfect competition

market or a monopoly market. It is the market where three are two or three firms that

dominate the market for a good or service. Marketing decisions of each company and other

companies affect one another thus; the oligopoly marketing decisions are interdependent in

an oligopoly market. Interdependence can be any decision e.g. pricing of a particular product

or service. This, in turn, will affect all the pricing of products and services of the other

companies associated with a company.

Price and Output Determination in Oligopoly

There are two conditions under which the price and output determination in an oligopoly can

be done. They are:

In the case of duopoly

In the case of fewer firms

In the case of duopoly, which means two companies that dominate the market in a sector and

the firms have similar products. In such cases, the two firms or companies will form a

collaboration with each other and have a joint profit. The firm which provides products with

lower prices will attract more people and have better client associations. This can cause
losses to the other company. On the other hand, if the companies have slightly different

products, the firm which provides products of better quality with a low price will gain large

profits.

In the case of fewer firms, each company is an essential player in that sector. Here, the

collaboration will help both the companies and there won’t be a loss for either of them. When

the products of the companies are different then they may increase or decrease the pricing

without having the fear of losing shares in the market.