Economics

1. ECO 501.1; ECO 501.2
MANAGERIAL ECONOMICS
Fall Semester, 2022
BRAC University
Week 9: Introduction to Markets

2. WEEK 9: Markets- Introduction
• Topic 1: What is a market?
• Topic 2: Perfect Competition
• Topic 3: Assumptions:
Homogenous Good
• Topic 4: Assumptions:
Information Sets
• Topic 5: Assumptions:
Independent Decisions
• Topic 6: Assumptions: Entrance
and Exit.
• Topic 7: Some Types of Markets
• Reference: McGuigan. Chap 10

3. Topic 1: What is a market?
• A market is a meeting place
where a single buyer and a
single seller meet for transaction
• Market analysis economics
looks at ALL the transactions in
the industry (all the firms and
consumers).
• It is important to distinguish the
two before further analysis.
• How are markets defined?
• 1: No of sellers: Product markets
Monopoly- Duopoly- Oligopoly-
Monopolistic Competition
• 2: No of buyers: Factor markets
Monopsony- duopsony-
oligopsony.
• Economics analyses markets by
no of sellers. Group 1 above

4. Topic 1: What is a market?
• A firm’s decision has two
influences.
1: Does a firm’s decision to
produce more or less influence
itself and other firms?
2: What impact does that have
on the industry?
• Our analysis will then be based
on the above two questions
• Market analysis starts with
Perfect Competition, or Pure
Competition.
• Perfect Competition (PC) is used
as a benchmark to compare
other real world market
scenarios. It is a benchmark like
the body temperature of 98.4
degree Fahrenheit or BP of
80/120.

5. Topic 2: Perfect Competition
• PERFECT (PURE) COMPETITION:
• Assumptions
1. Many buyers and many sellers
2. Homogenous, identical
product in the eyes of the
consumer
3. Independent decisions
4. Symmetric information
5. Easy entrance and exit
• IMPLICATION OF PERFECT
(PURE) COMPETITION
• 1. A commodity market
2. Each unit identical to all
buyers & sellers
3. each unit sells at same price.
4. No buyers or no sellers can
influence market price or quality
5. Market forces (dd and ss)
determine outcome

6. Topic 2: Perfect Competition
• PC does not exist in reality. The
assumptions of PC gives an
insight to how firms in different
contexts may or may not be able
to exercise market power.
• Market power: Can a firm
through its output decision
influence the price at which a
good will sell at?
• By producing less or more, if a
firm can influence price, the firm
has market power.
• By charging a higher or lower
price, a firm can exercise market
power.
• There are other ways of gaining
market power. We will discuss
these later.

7. Topic 2: Perfect Competition
• What is competition?
• Market-share is defined as a
firm’s percentage of the total
demand in a market (industry).
• Let a market sell 10,000 units
per time period.
• If there are many firms, where
no single firm’s market-share can
influence the outcome, then
that market is competitive.
• Perfect competition: This arises
when there is competition as
defined above, plus the market-
share of each firm is
insignificant. No firm can
influence other firms or the
industry by selling more or less.

8. Topic 2: Perfect Competition
• Price-taking behaviour
• Sellers try to charge a price as
high as possible if they can. Or
else, they accept the market
price to be given. Buyers try to
offer a price a low as possible if
they can. Or else, they accept
the market price to be given.
They are then known as price-
takers.
• When sellers and buyers are
price-takers, they have no
market power.

9. Topic 3: Assumptions:
Homogenous Goods
• Homogenous Goods
Buyer’s Perspective:
1: Homogenous good: identical
in the eyes of consumers.
2: If two goods sold by two
sellers are identical in your eyes,
you will offer the same price to
both sellers.
3: If not, then you would offer a
higher price to the one you
prefer more.
• Seller’s Perspective:
1: If the seller knows buyers
offer the same price for the
same good, sellers cannot
charge a higher price. Charging a
lower price is not rational.
• When goods are homogenous,
they sell at a competitive price.
This does not depend on the
number of sellers.

10. Topic 3: Assumptions:
Homogenous Goods
• Example of Homogenous Goods
1: Crude oil. The crude oil that
Bangladesh buys is the same
crude oil sold by different
petroleum exporting countries.
Because of competition, it sells
at the same price.
2: Prices of Bananas. The same
breed of bananas sell at the
same price.
• Paradox of Homogenous Goods
1: Homogenous goods selling at
same price is not related to the
number of sellers.
2: Two sellers (or many sellers)
in a region selling a homogenous
good is expected to be sold at a
competitive price.
3: When goods are viewed
identically, they will command
the same price

11. Topic 3: Assumptions:
Homogenous Goods
• Eggs in Dhaka City
1: There are 22 million+ people
in Dhaka. If 50% of the people of
Dhaka eats one egg daily, the
daily demand is 11 million+.
• There are many sellers and
buyers. No seller (or groups) can
exercise control over market
price.
• Eggs sell at a competitive price
• 2: If tomorrow, there is a strike,
the total no of eggs available in
Dhaka city will fall. This will raise
prices. Opposite will happen if
there is a sudden increase in
Dhaka city.

12. Topic 4: Assumptions:
Information Sets
• Information Set:
What information set do the
buyer and seller have about
a: quality of the product?
b: performance of the product?
• First the quality of the product.
• Symmetric Information: When
the buyer and the seller have
same set of information about
the quality of the product.
• Whatever the buyer knows
about the actual quality, the
seller knows the same.
• Implication:
1. Good quality products sell at a
high price and low quality at a
low price.
2. Both good and low quality will
be available. There will be
product choice on the market.

13. Topic 4: Assumptions:
Information Sets
• Symmetric Information
If both buyer and seller can
identify different quality mobile
phones credibly there will not be
fraudulent behavior.
1: Buyer cannot offer lower price
for either product– seller cannot
charge higher price either.
2: Low quality and high quality
sell at their competitive prices
• Asymmetric Information
Seller knows more:
In used car markets, sellers know
more about the true quality of a
car. Sellers will have an incentive
to hide true quality from buyers.
Buyer knows more:
In a life insurance market, the
buyer of insurance will have an
incentive to hide information of
their true health.

14. Topic 4: Assumptions:
Information Sets
• Asymmetric Info: Used Car
Market. Seller knows more
1. A good car sells at Tk 200; and
a bad car at Tk 100.
2. Buyers cannot credibly
distinguish quality.
3. Good and bad cars are
randomly distributed.
4. The probability of getting a
good and bad car is 50:50.
• 5. As a buyer, what price would
you offer? With the above
information, you would offer
6. ½(200+100)= Tk 150.
7. What will happen if the
average price persists in the
presence of info asymmetry?
8. Good quality cars will sell less.
Only bad cars will be sold. The
market will have only one
product.

15. Topic 4: Assumptions:
Information Sets
• Asymmetric Info: Insurance
Market. Buyer knows more
1. The buyer of a health
insurance knows if they are
healthy (good) or sick (bad).
2. Using same info as used cars
market: healthy & sick patients
are randomly distributed with a
probability of 50:50 selecting
any of the two types.
• 5. As a seller of insurance, what
premium would you offer?
6. If you offer avg premium, sick
patients will buy more health
insurance.
7. If only sick patients buy health
insurance, this could lead to NO
INSURANCE if situation persists
for too long.

16. Topic 4: Assumptions:
Information Sets
• Is Asymmetric Information a
Sustainable Outcome?
With asymmetric information,
fraudulent behavior prevails.
Some sellers or buyers can make
gains.
• This will not be sustainable.
Once others start to know of this
fraudulent behavior, markets will
correct themselves.
• Asymmetric information on
quality is also known as:
Adverse selection; Hidden
characteristics; Hidden
preferences.
• We shall discuss these later on

17. Topic 4: Assumptions:
Information Sets
• Asymmetric Information About
Performance:
Once a good is sold, and once
adverse selection has been
addressed then comes the que:
1: How well will the good
perform?
2: What is life-span of the good?
• Before a transaction these
cannot be determined credibly
• After hiring a worker, que:
1: How well will the worker
perform?
2: Will the worker shirk?
• These are known as:
Moral hazard- hidden actions.
• We shall discuss these later on, if
time allows.

18. Topic 5: Assumptions:
Independent Decisions
• Independent Decisions:
• When my decision to produce
more or less DOES NOT AFFECT
your decision to do so
• AND
• Your decision to produce more
or less DOES NOT AFFECT my
decision to do so
• Both have to hold at same time
• If I cannot influence your
decisions in a market with my
decisions, and you cannot also
do the same, Then
• I will try to do the best I can–
AND You will do the same
• The Eggs Example: You and I try
to sell as many eggs as we can.

19. Topic 5: Assumptions:
Independent Decisions
• Inter-dependent Decisions:
• My decision depends on WHAT
You are doing
• AND
• Your decision depends on WHAT
I am doing.
• When decisions are inter-
dependent, we will use game
theory.
• We will discuss inter-dependent
equilibrium later.
• We will discuss it under game
theory, and the concept of the
Nash equilibrium

20. Topic 6: Assumptions:
Entrance and Exit
• Two determinants that
influence a firm's decision to
enter a market:
First:
1. What is the avg profitability of
firms in the industry?
2. Is the market exhausted?
• If 1 and 2 above are favourable,
then a firm may be interested to
enter a market.
• Second:
1. How costly is it to enter? This
cost is determined by fixed
costs.
• Rule of Thumb:
1. If FC to enter a market is low,
then exit decision is easy.
2. If FC to enter a market is high,
then exit decision is difficult.

21. Topic 6: Assumptions:
Entrance and Exit
• Rule of Thumb:
• 3. The FC to enter a monopoly
market will be the highest. As
the number of firms that
operate in an industry increases,
the FC of entrance will tend to
fall.
4. Geographical and other
constraints also determine the
ease or difficulty of entrance.
• Fixed Cost is a Sunk Cost
1. Once a decision to enter a
market has been made and the
fixed cost has been paid, it
becomes a Sunk Cost.
2. Only when the Sunk Cost has
been recovered, and the firm
can no longer recover operating
costs, can the firm think of
exiting from the market

22. Topic 7: Some Markets
• Commodity Markets: buyers &
sellers meet to transact a
standardized good.
• Buyers & Sellers do not need to
know each other, i.e., do not
need to match
• Examples: Think
• Matching Markets: Buyers &
sellers meet certain conditions
for a transaction.
• Examples: Think
• Markets defined by sellers– not
by buyers.
Monopoly; Duopoly; Oligopoly
etc

23. Topic 7: Some Markets
Relevant Market:
Group of firms belonging to the
same strategic group of
Consumers.
Example: The grocery in your
neighbourhood has market power
in the neighbourhood.
Think due to what factors?
• Concentrated Market:
A relevant market with majority
of total sales occurring in the
largest four firms.
• Example: There are many
groceries in Dhanmondi, but the
relevant market is dominated by
few large superstores.
Think due to what factors?

24. Topic 7: Some Markets
• Fragmented Market:
A relevant market whose market
shares are small.
• Example: Groceries in
Dhanmondi. Fragmented into
few large groceries, and many
small corner shops.
Think due to what factors?
• Consolidated Market:
A relevant market whose
number of firms has declined
over time through acquisition,
merger, and buy outs.
• Example: Telecom carriers;
Cigarette and tobacco.
Think due to what factors?