CBSE Class 12 Economics Market And Price Determination Notes

UNIT – IV

FORMS OF MARKET AND PRICE DETERMINATION

Market : Market is a place in which buyers and sellers come into contact for the purchase and sale of goods and services.

Market structure: refers to number of firms operating in an industry, nature of competition between them and the nature of product.

Types of market
a) Perfect competition.
b) Monopoly.
c) Monopolistic Competition
d) Oligopoly.

a) Perfect competition: refers to a market situation in which there are large number of buyers and sellers. Firms sell homogeneous products at a uniform price.

b) Monopoly market: Monopoly is a market situation dominated by a single seller who has full control over the price.

c) Monopolistic competition: It refers to a market situation in which there are many firmswh o sell closely related but differentiated products.

d) Oligopoly: is a market structure in which there are few large sellers of a commodity and large number of buyers.

Features of perfect competition:
1. Very large number of buyers and sellers.
2. Homogeneous product.
3. Free entry and exit of firms.
4. Perfect knowledge.
5. Firm is a price taker and industry is price maker.
6. Perfectly elastic demand curve (AR=MR)7. Per
fect mobility of factors of production.
8. Absence of transportation cost.
9. Absence of selling cost.

Features of monopoly:
1. Single seller of a commodity.
2. Absence of close substitute of the product.
3. Difficulty of entry of a new firm. 
4. Negatively sloped demand curve(AR>MR)
5. Full control over price.
6. Price discrimination exists
7. Existence of abnormal profit.

Features of monopolistic competition
1. Large number of buyers and sellers but less than perfect competition.
2. Product differentiation.
3. Freedom of entry and exit.
4. Selling cost.
5. Lack of perfect knowledge.
6. High transportation cost.
7. Partial control over price.

Main features of Oligopoly.
1. Few dominant firms who are large in size
2. Mutual interdependence.
3. Barrier to entry.
4. Homogeneous or differentiated product.
5. Price rigidity.

Features of pure competition
1. Large number of buyers and sellers.
2. Homogeneous products.
3. Free entry and exit of firm.

DETERMINATION OF PRICE UNDER PERFECT COMPETITION

Equilibrium: It means a position of rest, there is no tendency to change.

Market equilibrium:It means equality between quantity demanded and quantity supplied ofa commodity in the market.

Equilibrium price:This is the price at which market demand of a commodity is exactly equal to the market supply.

Market demand: It refers to the sum total demand for a commodity by all buyers in the market.

Market supply:It refers to supply of a comm

Very short answer questions

Question. Define perfect competition.

Answer : Perfect competition is a market with large number of buyers and sellers , selling homogeneous product at same price.

Question. Define monopoly.

Answer : Monopoly is a market situation dominated by a single seller who has full control over the price.

Question. Define monopolistic competition.

Answer : It refers to a market situation in which many buyers and sellers selling differentiated product and have partial control over the price.

Question. Under which market form firm is a price maker?

Answer : Monopoly

Question. What are selling cost?

Answer : Cost incurred by a firm for the promotion of sale is known as selling cost. (Advertisement cost)

Question. What is oligopoly?

Answer : Oligopoly is defined as a market structure in which there are few large sellers who sell either homogenous or differentiated goods.

Question. In which market form is there product differentiation?

Answer : Monopolistic competition market and oligopoly market.

Question. What is product differentiation?

Answer : It means close substitutes offered by different producers to show their output differs from other output available in the market. Differentiation can be in colour, size packing, brand name etc to attract buyers.

Question. What do you mean by patent rights?

Answer : Patent rights is an exclusive right or license granted to a company to produce a particular output under a specific technology.

Question. What is price discrimination?

Answer :- It refers to charging of different prices from different consumers for different units of the same product.

Question. What is the shape of marginal revenue curve under monopoly?

Answer : Under monopoly market MR curve is downwards sloping curve form left to right and it lies below the AR curve.

Question. What do you mean by abnormal profits?

Answer : It is a situation for the firm when TR > TC.

Question. Why AR is equal to MR under perfect competition?

Answer : AR is equal to MR under perfect competition because price is constant.

Question. What are advertisement costs?

Answer : Advertisement cost are the expenditure incurred by a firm for the promotion of its sales such as publicity through TV , Radio , Newspaper , Magazine etc.

Question. What is short period?

Answer : Short period refers to that much time period when quantity of output can be changed only by changing the quantity of variable input and fixed factors remaining same.

Question. Define long period.

Answer : Long period refers to that much time period available to a firm in which it can increase its outputs by changing its fixed and variable inputs.

Question. What is market period?

Answer : Market period is defined as a very short time period in which supply of commodity cannot be increased.

Question. What is meant by normal profit?

Answer : Normal profit is the minimum amount of profit which is required to keep an entrepreneur in production in the long run.

Question. What is break-even price?

Answer : In a perfectly competitive market, break- even price is the price at which a firm earn normal profit (Price=AC). In the long run, Break- even price is that price where P=AR=MC

Short Answer Questions: 

Question. Explain any four characteristics of perfect competition market.

Answer :
i) Large number of buyers and sellers : The number of buyers and sellers are so large in this market that no firm can influence the price.

ii) Homogeneous products: Products are uniform in nature. The products are perfect substitute of each other. No seller can charge a higher price for the product. Otherwise he will lose his customers.

iii) Perfect knowledge: Buyers as well as sellers have complete knowledge about the product.

iv) Free entry and exit of firm: Under perfect competition any firm can enter or exit in the market at any time. This ensures that the firms are neither earning abnormal profits nor incurring abnormal losses.

Question. Explain briefly why a firm under perfect competition is a price taker not a price maker?

Answer : A firm under perfect competition is a price taker not a price maker because the price is determined by the market forces of demand of supply. This price is known as equilibrium price. All the firms in the industry have to sell their outputs at this equilibrium price. The reason is that, number of firms under perfect competition is so large. So no firm can influence the price by its supply. All firms produce homogeneous product

Question. Which features of monopolistic competition are monopolistic in nature?

Answer : i) Product differentiation

ii) Control over price

iii) Downward sloping demand curve

Question. What are the reasons which give emergence to the monopoly market?

Answer : i) Patent Rights: Patent rights are the authority given by the government to a particular firm to produce a particular product for a specific time period.

ii) Formation of Cartel: Cartel refers to a collective decision taken by a group of firms to avoid outside competition and securing monopoly right.

iii) Government licensing: Government provides the license to a particular firm to produce a

Question. Explain the process of price determination under perfect competition with the help of schedule and a diagram.
Answer : Equilibrium price is that price which is determined by market forces of demand and supply. At this price both demand and supply are equal to each other. Diagrammatically it is
determined at the point where demand curve and supply curve intersect each other. At this point price is known as equilibrium price and quantity is known as equilibrium quantity.

Question. When will equilibrium price not change even if demand and supply increase?
Answer : When proportionate increase in demand is just equal to proportionate increase in supply. Equilibrium price will not change. It can be shown in the following diagrams. In the above diagram increase in demand is just equal to increase in supply. Demand curve shift from D to D1 and supply curve shift from S to S1 which intersect at point E. Thus equilibrium price remain unchanged at OP though equilibrium quantity increased from OQ to OQ1.

Question. How does increase in price of substitute goods in consumption affect the equilibrium price of a good? Explain with a diagram.
Answer : An increase in price of substitute goods (coke) will cause increase in demand for its related goods (Pepsi) . The demand curve for Pepsi will shift to the right side. The supply
curve of Pepsi remains the same. It will lead to an increase in equilibrium price of Pepsi and increase in quantity also. 

Result: Price increases from OP to OP1.Quantity demand increases from OQ to OQ1

Question. How does the equilibrium price of a normal commodity change when income of its buyers falls? Explain the chain effects.
Answer :
· When income falls demand falls
· Supply remaining unchanged .There is excess supply at a given price
· This leads to competition among sellers to reduce the price.
· As a result demand starts rising and supply starts falling.
· These changes continue till a new equilibrium price is established where demand equal supply.
· Equilibrium price falls.

Question. Why is the demand curve facing monopolistically competitive firm likely to be very elastic?
Answer : It is because the product produced by monopolistically competitive firms are close substitute to each other. If the products are closer substitutes to each other the elasticity of demand is high which makes the firm demand curve is elastic.

Question. Show with the help of diagram the effect on equilibrium price and quantity when supply is perfectly inelastic and demand increases and decreases?
Answer : When supply is perfectly inelastic and demand increases. Demand curve shift to towards right. The new demand curve D1 intersects the supply curve at point E1.
Result : Price increases from OP to OP1 and quantity demand remains unchanged.
In the above diagram demand curve shift left wards from D to D1 Price falls from OP to OP1 ,but quantity remains same.

Question. Explain the implication of free entry and free exit of a firm in perfect competitive market.
Answer :- If there is free entry and free exit of firms, then no firm can earn abnormal profit in the long run (firm earn zero abnormal profit). Each firm earns just normal profit.

LONG ANSWER QUESTIONS (6 MARKS)

Question. Equilibrium price may or may not change with shifts in both demand and supply curve. Comment.
Answer : There can be 3 situations of a simultaneous right wards shift of supply curves and demand curves.
i) When demand increases more than supply price and quantity both will increase. 

When increase in demand is more than increase in supply price increases from OP to OP1.
Quantity increases from OM to OM1. Increase in price is less than increase in quantity.
ii) When demand increases less than supply, price will fall but quantity will rise. 

When supply increases more than demand price falls from OP to OP1 and quantity demand increases from OM to OM1. Decrease in price is less than increase in quantity. i) When demand and supply increases equally then equilibrium price remain same. 

When increase in demand is equal to increase in supply price remains unchanged at OP. Quantity exchanged increases from OQ to OQ1.

Question. Distinguish between collusive and non-collusive oligopoly. Explain the following features of oligopoly.
a) Few firms.
b) Non-price competition.
Answer : Collusive oligopoly is one in which the firm cooperate with each other in deciding price and output.
Non collusive oligopoly is one in which firms compete with each other.
Few firms: There are few sellers of the commodity and each seller sells a substantial portion of the output of the industry. The number of firm is so small that each seller knows that he can influence the price by his own action and that he can provoke rival firms to react.
Non price competition: The firms are afraid of competition through lowering the price because it may start price war. Therefore they complete through the non price factors like advertising, after sales service etc.

Question. With the help of demand and supply schedule explain the meaning of excess demand and its effects on price of a commodity.
Answer : (Image 11) The above schedule shows market demand and market supply of the commodity at different
prices. At the price of 7 and 6 the market demand is greater than market supply. This is the situation of excess demand. There will be competition among the buyers resulting in a rise in price. Rise in price will result in fall in market demand and rise in market supply. This reduces the excess demand. These changes continue till the price rises to Rs. 8 at which
excess demand is zero. The excess demand results in a rise in price of the commodity.

Question. Market for a good is in equilibrium. There is increase in demand for the goods.
Explain the chain effect of this change. 
Answer : · Increase in demand shift the demand curve from D to D1 to right leading to excess demand E E1 at the given price OP.
· There will be competition among buyers leading to rise in price.
· As price rise supply starts rising (along S) demand starts falling.
· These changes continues till D=S at a new equilibrium at E1
· The quantity rises to OM to OM1 and price rises OP to OP1

Question. Distinguish between monopoly and monopolistic competition.
Answer : i) Under monopoly there is single seller / producer of the commodity. Whereas under monopolistic competition there are large numbers of sellers, so the firm under monopoly has greater influence over price than under monopolistic competition.
ii) There is freedom of entry of new firms under monopolistic competition where as there is no such freedom under monopoly. As a result a monopolist can earn abnormal profit in the long run.
iii) Under monopolistic competition the product is heterogeneous while under monopoly there is no close substitute of the product.
iv) Demand curve in a monopoly market is less elastic than the demand curve under monopolistic competition because under monopoly there is no close substitute of the product.

HOTS

Question. How much loss a firm can bear in the short run?
Answer : A firm can bear losses up to its total fixed cost in the short run.

Question. The firms are earning abnormal profits. Will the number of firms in the industry change?
Answer : If firms are getting abnormal profit new firms will enter the industry.

Question. If firms are making abnormal losses will the number of firms in the industry change?
Answer : When firms are suffering losses, the number of firms in the industry will decrease as some firms may exit from the industry.

Question. Why is demand curve facing a monopolistic competition firm likely to be more elastic?
Answer : In monopolistic competition market the demand curve of a firm is likely to be more elastic, the reason behind this is that all the firm in the industry produce close substitute of each other. If close substitute of any good is available in the market then elasticity of demand is very high because whenever there is a hike in price the consumer will shift to its
substitutes. That is why a firm’s demand curve under monopolistic competition is more elastic.

Question. Explain how the efficiency may increase if two firms merge.
Answer : i) When two firms merge then there combined efforts and efficiency brings more output to the firm. Increase in the sale of output and economies of scale can be availed. It leads to division of labour and can get advantage of the specialization. Use of better and advanced technology saves the cost of production.

FREQUENTLY ASKED QUESTIONS – CBSE BOARD EXAMINATION
One Mark Questions (1M)
1) In which market form can a firm not influence the price of the product?
2) What is equilibrium price?
3) Under which market form a firm is a price taker?
4) Define market equilibrium.
5) Define Monopoly.
6) State one feature of Oligopoly.
Three Marks Questions (3M)

Case Study Questions National Income and Its Measurement Class 12 Economics

“A multiplicity of manufacturing activities will make a kingdom or city abound in money when they are diverse and produce things necessary or useful or pleasing to people in quantities that exceed the needs of the country. There are four reasons why this is so.
First, there is greater certainty in manufacturing activity, for a manufacturer is more certain to earn from his work than a farmer or other person who tills the soil or deals in his agricultural ‘produce’, for the earnings of these people depend not just on human labour but on the weather-since the land sometimes needs rain and sometimes sun–as well as other conditions.
And if these conditions are not forthcoming or the weather is bad, their work is wasted and instead of making money they lose it. But a manufacturer’s earnings are always certain, provided that he keeps working. 
Second, in manufacturing activities it is possible to achieve a multiplication of products and therefore of earnings. The same cannot be done with agricultural produce, which is not subject to multiplication. If a given piece of land is only large enough to sow a hundred (bushels) of wheat, it is impossible to sow a hundred and fifty there. In manufacturing, by contrast production can be multiplied not merely twofold but a hundredfold and at a proportionately lower cost.
Third, the sale of manufactured products is more certain than that of agricultural produce and this certainty of sale means a greater certainty of profit.
For it is difficult to preserve agricultural produce, for a long time without its deteriorating, so it is risky to export from country to another one far away and so it is also risky to preserve it for the future, should it not be sold immediately, manufactured products, on the other hand, can easily be preserved even for long periods, so they can easily be exported to far off lands.
And since navigation–the only art in which the moderns surpass the ancients–has been so greatly facilitated that trade is carried on not merely between East and West, North and South, but even between one hemisphere and the other and goods can be easily transported from one to the other who will deny that the sale of manufactured products is more certain and more profitable than that of agric ultural produce?
Fourth and last, manufactured goods generally yield much higher earnings than agricultural produce… For all these reasons the accident of a multiplicity of manufacturing activities is more important than that of domestic agricultural surplus.”
Source (From Antonio Serra –A Short Treatise on the Wealth and Poverty of Nations, 1613)

Question. Manufacturing offers the possibility of more likely profit than agriculture because
(a) the variety of manufacturing products is greater than the variety of agricultural produce
(b) it used to be risky to export from one country to another country that is far away
(c) both storage and transport are easier for manufactured goods
(d) manufacturing products are diverse 

Answer: A 

Question. There is greater certainty in manufacturing activities than in agricultural because
(a) it is subject to increasing returns
(b) it relies only on human labour
(c) the manufacturing worker must always keep working
(d) manufacturing products are diverse

Answer: B 

Question. The significance of advances in navigation for Serra is that
(a) it enables improved transport of agricultural produce to make up for losses when the weather is bad
(b) it proves that themoderns have surpassed the ancients
(c) it gets rid of the difficulty of preserving goods for the future
(d) it makes profits from manufacturing more certain by expanding potential markets 

Answer: D

Question. Serra believed that
(a) agriculture and manufacturing are both subject to increasing returns
(b) only manufacturing is subject to increasing returns
(c) neither activity is subject to increasing returns no activity
(d) increasing returns are not relevant in a discussion of economic activity 

Answer: B

Question. Assertion (A) There exists a unidirectional relationship between certainty of sales and certainty of profits.
Reason (R) Higher revenues are often guaranteed from sale of manufactured goods than agricultural produce.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason
(R) is the correct explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are true, but Reason
(R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is false, but Reason (R) is true
(d) Both the statements are false 

Answer: B

Question. According to Serra, manufacturing
(a) generates higher value added than agriculture
(b) is desirable only when the quantities produced exceed the needs of the country
(c) is always in a multiplicity that exceeds the agricultural surplus
(d) always makes a kingdom or a city abound in money 

Answer: A 

Consumption, production and investment decisions of individuals, households and firms often affect people not directly involved in the transactions.
Sometimes these indirect effects are tiny. But when they are large they can become problematic—what economists call externalities. Externalities are among the main reasons governments intervene in the economic sphere. Most externalities fall into the category of so-called technical externalities; i.e., the indirect effects have an impact on the consumption and production opportunities of others, but the price of the product does not take those externalities into account. As a result, there are differences between private returns or costs and the returns or costs to society as a whole.
Externalities could be either positive or negative.
There is no valuation of it in the estimation of GDP.
Its impact (positive or negative) is not accounted in the index of social welfare in terms of GDP. To that extent, GDP as an index of welfare is not an appropriate index. It is either underestimated or overestimated the level of welfare.

Question. Smoke emitted by a chemical factory and causing air pollution is an example of 
(a) positive externalities
(b) negative externalities
(c) Either of the two
(d)Neither of the two 

Answer: B

Question. An externality can be defined as
(a) good or bad impact of an activity for which the other person is fully compensated
(b) production or consumption choices of one entity enters the production or utility function of other entity without that entity’s approval
(c) positive or negative impact of an activity, solely on the concerned individual 
(d) All of the above 

Answer: B 

Question. With every increase in the level of GDP, social welfare definitely increases in an economy.
The given statement is
(a) True, if increase in GDP is associated with disparities in the distribution of income
(b) True, if increase in GDP is associated with skewed distribution of income
(c) False, if increase in GDP is associated with disparities in the distribution of income
(d) False, if increase in GDP is associated with normality in distribution of income 

Answer: C

Question. Welfare of the people in an economy is measured in terms of ……… .
(a) availability of national income
(b) availability of goods and services per person
(c) overall price level and degree of profit maximisation
(d) overall price level in an economy 

Answer: B 

Question. Assertion (A) Mass vaccination, awareness about sanitisation and promoting cleanliness entails positive externalities.
Reason (R) These often accounts as part of economic development but does not count for economic growth.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is false, but Reason (R) is true
(d) Both the statements are false 

Answer: B

Question. (A) GDP cannot be considered as an appropriate index of welfare.
Reason (R) Non-monetary transactions,externalities, composition and distribution of GDP are some of the reasons which makes it an inappropriate index of welfare.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A)
(c) Assertion (A) is true, but Reason (R) is false
(d) Assertion (A) is false, but Reason (R) is true 

Answer: A

It is not that countries which are endowed with a bounty of natural wealth-minerals or forests or the most fertile lands are naturally the countries with high national income. In fact, the resource rich Africa and Latin America have some of the countries with lowest national income in the world, whereas many countries with high national income have scarcely any natural wealth.
There was a time when possession of natural resources was the most important consideration but even then the resources have to be transformed through a production process.
The economic well-being of a country thus does not necessarily depend on the mere possession of resources; the point is how these resources are used in generating a flow of production and how, as a consequence, income and wealth are generated from that process.

Question. Possession of natural resources and growth of national income are ……… related.
(a) directly
(b) inversely
(c) constantly
(d) Can’t comment 

Answer: D

Question. Assertion (A) The economic well-being of a country doesn’t directly depend upon the possession of natural resources.
Reason (R) Distribution of income generated in the growth process is an important indicator of countries level of development.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A)
(c) Assertion (A) is true, but Reason (R) is false
(d) Assertion (A) is false, but Reason (R) is true 

Answer: A

Question. GDP cannot be considered as a good indicator of development due to which of the following reasons?
(a) It ignores non-tradable goods
(b)It gives no information regarding the distribution of income
(c) It ignores the side-effects of undertaking production activities
(d)All of the above 

Answer: D 

Question. Growth and development of a country are ………related.
(a) positively
(b) negatively
(c) Not related at all
(d) None of these 

Answer: A

Question. Countries of ............. are rich in natural resources.
(a) Africa
(b) Latin America
(c) Both (a) and (b)
(d) Asia 

Answer: C

Question. Which of the following statements is/are correct?
(i) Inequitable distribution of resources is the inequality in the social conditions of daily living shaped by deeper social structures and processes.
(ii) The inequality is systematic, produced by social norms, policies and practises that tolerate or promote unfair distribution of power, wealth and other necessary social resources.
Alternatives
(a) Both are true
(b) Both are false
(c) Only (i) is true, but (ii) is false
(d) Only (ii) is true, but (i) is false  

Answer: A 

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