1. How a firm identifies the type of market in which they sell their output (perfectly
competitive or imperfectly competitive)
A firm identifies the type of market in which they are selling their output on the basis of
following factors
a. No of buyers and sellers

Perfectly Competitive – Many sellers each of whom produce a low percentage of market output
and cannot influence the prevailing market price. Many individual buyers, none has any control
over the market price. The implication of this feature is that the share of each seller in the total
market is small that no single seller can influence the price. Hence it has no option but to sell the
product at the price given by the industry. It is because at this position that each firm is said to
be a price taker in perfect competition.
Imperfectly Competitive – There are three kinds of imperfect markets, Monopoly, Monopolistic
and Oligopoly. A monopoly has a single seller which can exploit the buyers by charging almost
any price because of exclusive control over the product. It has a large number of buyers who
cannot influence the price in the market. In Monopolistic competition there are a large no. of
buyers and sellers and each seller has its own monopoly in its own product. In an Oligopoly,
there are few firms controlling the market where each firm produces a substantial part of the
total output of the industry. Each seller knows that he can influence the price by his own action
b. Nature Of Product
 Perfectly Competitive – All firms produce homogeneous products which makes
sure there is no difference in the product of the two firms regarding color, design
quality, size etc. Such a product is sold in the market at uniform price and firm
has no control over the price because if any firm charges a higher price, it will
lose all its buyers to another firm which is producing the same product at a lower
price.
 Imperfectly Competitive – In a Monopoly there are no close substitutes of the
product which implies that the consumer will have to buy the commodity or go
without it altogether. Monopolistic firms produce differentiated products which
are close substitutes of one another thereby implying that each seller has
monopoly in its own product and can therefore he can charge different prices in
the market, keeping in mind the prices of the rival firm. An Oligopoly firm
produces both homogeneous and differentiated products.
c. Entry and Exit of Firms –
 Perfectly Competitive – There are no restrictions or barriers on entry or exit of
new firms and during the short run it is not possible for a firm to expand or
decrease its scale of production. This implies that there are no abnormal profits
for the firms as abnormal profits if any will attract new firms which will increase
the supply and bring the price down.
 Imperfectly Competitive – In a Monopoly, there are restrictions on the entry of
new firms which enables firms to earn abnormal profits in the long run due to
blocked entry of new firms. In a monopolistic market there are is free entry and
exit of firms as firms can enter when they anticipate profit and quit when they
anticipate losses. In an Oligopoly the entry is largely difficult.
d. Selling Cost - Selling cost helps in increasing the sale under monopolistic competition
because in this competition products are differentiated whereas under perfect
competition there is no need of selling cost as products are homogeneous and in case of
monopoly there is no fear of competition.
1.1 How the type of market assists in understanding the characteristics of the demand for their
product?
A household’s decision about what quantity of a particular output, or product, to demand depends
on a number of factors including:
■
The price of the product in question – There is an inverse relationship between price of
the product and the quantity demanded. An increase in Price causes the quantity demanded to go
down and vice versa.
■
The income available to the household - The sum of all a household’s wages, salaries,
profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow
measure.
■
The household’s amount of accumulated wealth - The total value of what a household
owns minus what it owes. It is a stock measure
■
The prices of other products available to the household – There are substitutes and
complementary goods that can influence the demand for the product .
Substitutes are goods that can serve as replacements for one another: when the price of one
increases, demand for the other goes up.
Complements, complementary goods. Goods that “go together”: a decrease in the price of one
results in an increase in demand for the other, and vice versa
■
The household’s tastes and preferences - Changing tastes and preferences can have
a significant effect on demand for different products. Persuasive advertising is designed to
cause a change in tastes and preferences and thereby create an increase in demand.
■
The household’s expectations about future income, wealth, and prices.
Change in price of a good or service leads to Change in quantity demanded (movement along the
demand curve).
Change in income, preferences, or prices of other goods or services leads to Change in demand
(shift of the demand curve).
f. How a firm classifies its short run costs,
There are three types of costs in the short run
1. Fixed cost - Any cost that does not depend on the firm’s level of output. These costs are incurred
even if the firm is producing nothing. There are no fixed costs in the long run.
2. Variable cost A cost that depends on the level of production chosen.
3.Marginal cost (MC) The increase in total cost that results from producing one more unit of output.
Marginal costs reflect changes in variable costs.
These are further classified into the following.
Total cost (TC) Fixed costs plus variable costs.
Total fixed costs (TFC) or overhead The total of all costs that do not change with output, even if
output is zero.
average fixed cost (AFC) Total fixed cost divided by the number of units of output; a
per-unit measure of fixed costs.
total variable cost (TVC) The total of all costs that vary with output in the short run
g. How to identify the profit maximizing outcome in the short run,
The profit maximization conditions are determined by the marginal revenue and marginal cost
functions of the firm.
Total revenue (TR) The total amount that a firm takes in from the sale of its product: the price per
unit times the quantity of output the firm decides to produce (P x q).
Marginal revenue (MR) The additional revenue that a firm takes in when it increases output by one
additional unit. Inperfect competition, P = MR.
A firm maximizes its profits by choosing to supply the level of output where its marginal revenue
equals its marginal cost. When marginal revenue exceeds marginal cost, the firm can earn
greater profits by increasing its output. When marginal revenue is below marginal cost, the firm
is losing money, and consequently, it must reduce its output. Profits are therefore maximized
when the firm chooses the level of output where its marginal revenue equals its marginal cost.
f.
how this outcome differs for a perfectly competitive firm and an imperfectly competitive firm
with a graphical illustration and
Perfectly Competitive Firm
In the short run, a competitive firm faces a demand curve that is simply a horizontal line at the market
equilibrium price. In other words, competitive firms face perfectly elastic demand in the short run.
As long as marginal revenue is greater than marginal cost, even though the difference between the two is
getting smaller, added output means added profit. Whenever marginal revenue exceeds marginal cost, the
revenue gained by increasing output by one unit per period exceeds the cost incurred by doing so.
The profit-maximizing perfectly competitive firm will produce up to the point where the price of its output
is just equal to short-run marginal cost—the level of output at which P* = MC.
The profit-maximizing output level for all firms is the output level where MR = MC.
Imperfectly Competitive Firm
All firms, including monopolies, raise output as long as marginal revenue is greater than marginal cost.
Any positive difference between marginal revenue and marginal cost can be thought of as marginal profit.
The profit-maximizing level of output for a monopolist is the one at which marginal revenue equals
marginal cost: MR = MC.
A monopoly firm has no supply curve that is independent of the demand curve for its product.
A monopolist sets both price and quantity, and the amount of output that it supplies depends on both its
marginal cost curve and the demand curve that it faces.
A monopoly’s marginal revenue curve shows the change in total revenue that results as a firm moves along
the segment of the demand curve that lies directly above it.
g. a scenario that would result in the individual firm increasing P*.
Perfect competition – In case of perfect competition,an increase in the price of a
commodity by an individual firm will not affect the market demand for the
commodity as an individual has no control over price and output in perfect
compettion and a firm is a price taker whereas an industry is price maker.
Whereas in any other scenario(imperfect) an increase in the price of the commodity
will have negative affect on the quantity demanded and demand curve will contract
i.e. quantity demanded will decrease.