The PPT discusses the basic concept of a market in Economics and also the assumptions underlying the perfectly competitive market. It also discusses the concept of costs in the traditional theory of the firm. It is not an advanced lecture and would be useful for those not familiar with the basics. The reference is 'Modern Microeconomics' by Koutsoyiannnis'

1. Markets

2. • Students,
• You have learned about consumer
behavior and Producer behavior
• I will now talk to you about markets.
• What do you know about markets?

3. What do you understand by markets?
Does it mean only places like Ima Market, Thangal Bazaar,
Paona Bazaar?
If not, then what does it mean?

4. • Meaning of Market:
• In common usage, by market, we mean a place
where commodities are bought and sold.
• Thus, a market place is thought to be a place
consisting of a number of big and small shops,
stalls and even hawkers selling various types of
goods.
• In economics, that’s not all.

5. Market in Economics
In Economics however, the
term “Market” does not
refer to a particular place as
such but it refers to a
market for a commodity or
commodities.
It refers to an arrangement
whereby buyers and sellers
come in close contact with
each other directly or
indirectly to sell and buy
goods

6. Does a buyer have
to personally meet
a seller?

7. Types of Market
Structures
• Perfect Competition
• Monopoly
• Monopolistic competition
• Oligopoly:- 1. Collusive Oligopoly and 2.
Non-collusive Oligopoly.
• Today let us start with Perfect Competition

8. • Perfect competition is a market structure characterised by a complete absence of rivalry
among the individual firms.
• Thus perfect competition in economic theory has a meaning diametrically opposite to
the everyday use of this term.
• In practice businessmen use the word competition as synonymous to rivalry. In theory,
perfect competition implies no rivalry among firms.

9. Assumptions
• The model of perfect competition is based on the
following assumptions
• 1. Large numbers of sellers and buyers
• The industry or market includes a large number of
firms (and buyers), so that each individual firm,
however large, supplies only a small part of the
total quantity offered in the market. The buyers are
also numerous so that no monopsonistic power
can affect the working of the market. Under these
conditions each firm alone cannot affect the price
in the market by changing its output.

10. 2. Product homogeneity:
• The industry is defined as a group of firms producing a homogeneous
product. The technical characteristics of the product as well as the
services associated with its sale and delivery are identical.
• There is no way in which a buyer could differentiate among the products
of different firms.
• If the product were differentiated the firm would have some discretion
in setting its price.
• The assumptions of large numbers of sellers and of product
homogeneity imply that the individual firm in pure competition is a
price-taker: its demand curve is infinitely elastic, indicating that the firm
can sell any amount of output at the prevailing market price.
• The demand curve of the individual firm is also its average revenue and
its marginal revenue curve

12. 3. Free entry and exit of firms
• There is no barrier to entry or exit from the industry.
• Entry or exit may take time, but firms have freedom of movement in and out of the
industry.
• This assumption is supplementary to the assumption of large numbers.
• If barriers exist the number of firms in the industry may be reduced so that each one of
them may acquire power to affect the price in the market.

13. 4. Profit
Maximization Goal
• Profit maximisation :
• The goal of all firms is profit maximisation.
No other goals are pursued.

14. 5. No Government
regulation
• No government regulation
• There is no government intervention in the market
(tariffs, subsidies, rationing of production or demand and
so on are ruled out).
• The above assumptions are sufficient for the firm to be a
price-taker and have an infinitely elastic demand curve.
• The market structure in which the above assumptions are
fulfilled is called pure competition.
• It is different from perfect competition, which requires
the fulfilment of the following additional assumptions.

15. Additional Assumptions for Perfect
Competition
• 6. Perfect mobility of factors of production
• The factors of production are free to move from one firm to another throughout the
economy.
• It is also assumed that workers can move between different jobs, which implies that
skills can be learned easily.
• Finally, raw materials and other factors are not monopolised and labour is not unionised.
• In short, there is perfect competition in the markets of factors of production.

16. 7. Perfect Knowledge:
• Perfect knowledge
• It is assumed that all sellers and buyers have complete knowledge of the conditions of the market.
• This knowledge refers not only to the prevailing conditions in the current period but in all future periods
as well.
• Information is free and costless.
• Under these conditions uncertainty about future developments in the market is ruled out.
• Under the above assumptions we will examine the equilibrium of the firm and the industry in the short
run and in the long run.

17. Cost curves-basics
• Before we discuss equilibrium, we need to have some ideas about cost curves
• What are total costs?
• TC= TVC+TFC
• TVC= total variable costs
• TFC= Total Fixed Costs

18. • The fixed costs include: (a) salaries of administrative staff (b) depreciation (wear and
tear) of machinery (c) expenses for building depreciation and repairs (d) expenses for
land maintenance and depreciation (if any). Another element that may be treated in the
same way as fixed costs is the normal profit, which is a lump sum including a percentage
return on fixed capital and allowance for risk.
• The variable costs include: (a) the raw materials (b) the cost of direct labour (c) the
running expenses of fixed capital, such as fuel, ordinary repairs and routine maintenance.

19. TFC
•The total fixed cost
is graphically
denoted by a
straight line parallel
to the output axis
(figure 4.1).

20. TVC
• The total variable cost in the traditional theory of the firm has broadly
an inverse-S shape (figure 4.2) which reflects the law of variable
proportions.

21. Law of Variable Proportions
• According to this law, at the initial stages of production with a given
plant, as more of the variable factor(s) is employed, its productivity
increases and the average variable cost falls.

22. • This continues until the optimal combination of the fixed and variable factors is reached.
• Beyond this point as increased quantities of the variable factor(s) are combined with the fixed
factor(s) the productivity of the variable factor(s) declines (and the AVC rises).
• By adding the TFC and TVC we obtain the TC of the firm (figure 4.3)
• From the total-cost curves we obtain average-cost curves.
• The average fixed cost is found by dividing TFC by the level of output:
• AFC=
TFC
X

23. • Graphically the AFC is a rectangular hyperbola, showing at all its
points the same magnitude, that is, the level of TFC (figure 4.4).
• The average variable cost is similarly obtained by dividing the TVC
with the corresponding level of output:
• AVC=
TVC
X

24. • Graphically the AVC at each level of
output is derived from the slope of a
line drawn from the origin to the point
on the TVC curve corresponding to the
particular level of output.
• For example, in figure 4.5 the AVC at X1
is the slope of the ray Oa, the AVC at X2
is the slope of the ray Ob, and so on.
• The slope of a ray through the origin
declines continuously until the ray
becomes tangent to the TVC curve at c.
• To the right of this point the slope of
rays through the origin starts increasing.

25. • Thus the SAVC curve falls
initially as the productivity
of the variable factor(s)
increases, reaches a
minimum when the plant
is operated optimally (with
the optimal combination of
fixed and variable factors),
and rises beyond that
point (figure 4.6).

26. • The ATC is obtained by dividing the TC by the corresponding level of
output: ATC=
TC
X
=
TFC+TVC
X
= AFC+AVC
• Graphically the ATC curve is derived in the same way as the SAVC.
• The ATC at any level of output is the slope of the straight line from the
origin to the point on the TC curve corresponding to that particular
level of output (figure 4. 7).
• The shape of the ATC is similar to that of the AVC (both being U-
shaped).

27. • Initially the ATC declines, it
reaches a minimum at the level
of optimal operation of the plant
(XM) and subsequently rises
again (figure 4.8).
• The U shape of both the AVC
and the ATC reflects the law of
variable proportions or law of
eventually decreasing returns to
the variable factor(s) of
production(More later)

29. • The marginal cost is defined as the change in TC which results from a unit change in
output.
• Mathematically the marginal cost is the first derivative of the TC function.
• Denoting total cost by C and output by X we have ac
• MC=
𝜕C
𝜕X

30. • Graphically the MC is the slope of the TC curve (which of course is the same at any point
as the slope of the TVC).
• The slope of a curve at any one of its points is the slope of the tangent at that point. With
an inverse-S shape of the TC (and TVC) the MC curve will be U-shaped.
• In figure 4.9 we observe that the slope of the tangent to the total-cost curve declines
gradually, until it becomes parallel to the X-axis (with its slope being equal to zero at this
point), and then starts rising.
• Accordingly we picture the MC curve in figure 4.10 as U-shaped.

31. Short Run Marginal Cost Curve(SMC)

32. • In summary: the traditional theory of costs postulates that in the short run the cost curves (A
V C, A TC and M C) are U-shaped, reflecting the law of variable proportions.
• In the short run with a fixed plant there is a phase of increasing productivity (falling unit costs)
and a phase of decreasing productivity (increasing unit costs) of the variable factor(s).
• Between these two phases of plant operation there is a single point at which unit costs are at
a minimum.
• When this point on the SATC is reached the plant is utilised optimally, that is, with the optimal
combination (proportions) of fixed and variable factors.

33. That’s all for
today