Economi

cAnalysi
s(5001)
Semest
er:Aut
umn2020

ASSI
GNMENTNo.1

Q.
1Expl
ainIsl
amicEconomicSy st
em.Discusst
hef
eat
uresofI
slami
cEconomi
cSy
stem ov
er
t
heCapi
tal
istandsoci
ali
stEconomies.

Pr
oper
ty

Int heIslami csyst

em, propert
yi satrust.TherealownerisAllah(SubhanahuWaTa’ al
a).Man’ s
disposalofwor ldl
ygoodsi sint hecapacityofav i
ceroyandat rust
ee.Hisr ight
sare,theref
ore,
circumscr ibedbyt helimitsAllahhaspr escri
bed,andshouldbeexer ci
sedt owardtheendsAl l
ah
hasdef ined.Unl i
kethecapi tal
istsystem, t
herighttopropert
yisnotabsolut ebuthasli
mi t
ati
ons
andqual i
ficati
onsenf orcednotbyt hepoweroft hegov er
nmentbutbyt hepowerofone' sfaith
anddesi retobeapi ousMusl im.Hence,t hecommon- goodandt hewelf areoffell
owMusl ims
arei nt
ernal i
zedinthedeci sionmakingpr ocessofev er
yMusl i
m.ItisSociali
sm withatthestate.

I
nv iewoft hepur posi
venatureofman' slifei
nt heI sl
amicwor l
dv i
ew,ev ent heseli
mi tedr ights
ofowner shipar enotdevoidofpur pose.Weal t
hi sani nstrumenti ntheef fecti
vedi schar geof
manr esponsibi
li
ti
esast hev i
cer oyofAl lah,andt heachi evementofwel lbeingi nt helifef or
himself,hisfell
ow Musli
msandf el
low humanbei ngs.Nowher ethisv i
ceroyshi pisdi splay ed
l
ikei ntheShar i
’ahlawsofi nher i
tance.Thesel awscl earl
yassumet hatoncet heindividuali s
dead,hisweal thgoesbackt ot heor i
ginalowner ,whospeci fiestowhom t heweal t
hshoul dgo.
Thel awsofi nheri
tancespecifywher eexact l
ythi swealthshoul dgo,r egar
dlessoft heappr ove
ortheconsentoft hedeceasedowner .Hei sper mitt
edt oendow onl y1/ 3ofhi sl
egacy .Ev en
then,suchendowmentshoul dnotgot oabenef i
ciary(oneal soisincludedint heinher i
tors)not
tousest hatarenotconsideredi sShari’
ahachar ity.

Di
str
ibut
ion

Becauseal-
adl(
justi
ceandfair
ness)isabasi cvalueoftheI
slamiceconomi cor
der,di
str
ibuti
ve
j
usticeisamaj orconcer
noft hesy st
em.Equi tabl
edist
ri
buti
onofi ncomeand weal this
ther
eforeanobjecti
vebyit
self
.Operational
l
y,thisisaccompli
shedthroughcertai
ninsti
tut
ions
whichformthebackboneofthesoci
al secur
it
yinIslam.Examplesareabound:

Zakah

Zakahist hethi
rdpi l
l
aroft heIslami cfait
h.I ti
sauni quesystem ofsoci
alsecuri
ty.Zakahisnot
ahand-outf r
om ther ichtothepoor .Itisar ightofthehavenotsi nt
hewealthofthehav es.I
tis
ameasur edesignedt odirectl
yt r
ansf erpar tofthewealthfrom thewell
-t
o-dotot hepoorand
nottot hegov ernment .Becauset hepur posei sredist
ri
buti
onofi ncomeandweal th,wit
hout
creat
ingacl asssoci etyzakahi sleviedonal mostev er
yone.Ev enthenotverywel ltodo,pay
zakah.Hemayt henr eceivethezakatofot hersatthesamet i
me.Zakahi sl
eviedannuallyonthe
wealthitsel
fandnotont heindivi
dualori ncome,atagener alrateof2½ %perannum.Thi sis
notall
.Zakahi sar equirement.Howev er,aMusl imisalwaysengagednott oconfinehischarit
y
tothatr
equi r
ementbygi vi
ngal ms( sadaqat ).
LawsofI
nher
it
ance

Itwouldnotbepossi bl
et oguarant
eet hefunctioni
ngoft hesy stem f r
eef r
om inj
usticeswithout
abuilt-
in-mechanism topreventinj
usti
cer eproducingitsel
fgener ati
onaf tergenerati
on.Studies
show t hatoneoft hemaj orcausesofi nequalit
yi nincomedi str
ibutioni st
hedi stri
buti
onof
wealth.Onemaj oroutcomeoft heIslamiclawsofi nherit
ancei st opr eventconcentrati
onof
wealth.Thisisbecausel egacyisdist
ri
butedinpr e-setrati
oswhi cht akeintoconsiderati
onneed
andcl osenesstot hedeceased.Yetgi vi
ngt hedeceasedt her i
ghtt oassi gnpartofhi swealth
(notexceeding1/ 3)tocharit
abl
euses.

Economi
cFr
eedom

Freedom i sacor nerstonei nt heI slami ceconomi csy stem.I nf act,i

ti ssobasi ct hatthewhol e
messageofI slam camet of reemanf r
om al lkindofsl av er
y .Freewi l
lisanecessar ycondi tion
fort hev al
idityofal lcont r
act s.Thebasi chumanr ight swhi char enowi ncludedi nt hel awsof
civil
izedcount ri
eshasbeenapar tofl egalsy stem ofI slam si ncet hePr ophet( P.B.U.H).I nfact,
allthesocal l
edMagnaChar t
ahasbeenenj oyedast hebasi cindividualrightsi nI slam f or
cent ur i
es.Fur ther more,t o guar antee compet it
ion i nt he mar ketplace and f reedom of
transact ion,manymeasur eswer eadopt edbyt hePr ophet( P. B.
U.H) .Prohibit
ionofmonopol y
,
mani pulationofpr icesandr est r
ictingent ryt othemar ketar ebutaf ewoft hesemeasur es.The
Islami cEconomyi sI nterest-FreeToday ’
st radeandcommer cei nthewhol ewor ldi srunont he
basisofi nt erestbaseddebt .Ifwel ookatt hemoneyandcapi talmar ketsinanycount r
ywef ind
thatt heyar ebasi callymar ketsf orexchangi ngf i
nanci alobl igati
onsandr eceivables.I tisno
wondert hatj ustt hemer ethoughtt hatinterestratemaygoup( ordown)wi llbringhav oct oall
sector soft heeconomy .St andar deconomi canal y si
st ellst hatinterestratespl ayimpor tant
rolesi nt heeconomy .Fi rstly,thati tpr ovidesi ncent iv esf orsav i
ngs,andsecondl yt hati t
per f
or msanal locativef unctionwi thr egardt ocapi tal.Thear gumentgoesasf ollows:

1.Sav i
ngisessentialt
oanyeconomybecauseonwhi chdependst her ateofinvestment,and
hencet herateofgr owthoftheeconomyandt hepr opertyofi t
sci t
izens.Sinceeconomi c
developmentistheobject
iveofeverysoci
ety
,impr ovi
ngt henascentr at
eofsav i
ngbecomesa
basicrequi
rementf ort
heachievementofav i
ableandsust ai
nableeconomi cgr owth.Because
toomuchsav ingmaybej ustasunproduct
iveastool it
tl
e, i
nterestr
ates,furt
hermore,providea
toolforpol
icyasr egar
dssavingswherethisratei scontroll
edi nsuchawayast oat t
ainthe
ri
ghtmagnitudeofsav i
ngsasrequir
edbythegoingeconomi ccircumstances.

2.Asr egardst hedi st

ributivef uncti
onofi nterest
,itisbel ievedt hatinterestr at
epl aysa
yardstick( benchmar k)f orev al uat i
ngt hef easibil
it
yofi nvestmentpr oject
sandot herusesof
scarcer esources.Si ncecapi tal isscarce, t
heeconomyneedsat oolthr oughwhi cht hi
sr esource
i
sdi rectedt othebestuse, i
.e.t heonet hatpr oducest hehighestr eturns.Withoutsuchat ool,i
t
i
squi tepossi bletoseecapi tal goi ngtor el
ativelypoorprojects,whilet hesoundonesar eleftout
ofinvest mentcapi tal.Witht het ool ofinterestr at
e,expectedpr ofi
tsar ealway scompar edt othe
rat
eofi nterest.Sincet hel attermeasur est hecostofcapi t
al,onlyt hesepr ojectswhi chmake
mor er eturns than “ cost ”wi llbe f i
nanced.Ev en self-f
inancing wi llbe subj ectt o such a
benchmar k since i nterestpl ays an “ al
ter nati
ve”t o any i nvestmentoppor tunit
y( i
.e.an
oppor t
uni t
ycost ).

Q.
2Expl
ainl
awofDemand.Cr
it
ical
lydi
scusst
hel
awofdemandandi
tspr
act
icali
mpl
icat
ions
ont
hecommonper
sonoft
hesoci
ety
.

Thel awofdemandi soneoft hemostf undament alconcept si neconomi cs.Itwor kswi tht he
l
awofsuppl yt oexpl ainhowmar keteconomi esal l
ocat eresour cesanddet er
mi net hepr icesof
goodsandser vicest hatweobser veinev er y
dayt ransactions.Thel aw ofdemandst at
est hat
quant i
typurchasedv ariesinverselywi thprice.Inot herwor ds, thehighert hepr i
ce, thelowert he
quant i
tydemanded.Thi soccur sbecauseofdi minishingmar ginalutili
ty.Thatis,consumer suse
thef i
rstunitsofaneconomi cgoodt heypur chaset oserv et heirmostur gentneedsf i
rst,and
useeachaddi ti
onaluni tofthegoodt oser vesuccessi v
elyl owerv al
uedends.•Thel aw of
demandi saf undament alpr
incipleofeconomi cswhi chstat est hatathi gherpr iceconsumer s
willdemandal owerquant i
tyofagood.•Demandi sder i
v edf r
om t hel aw ofdi mini shing
mar ginaluti
l
ity,thef actthatconsumer suseeconomi cgoodst osat isfytheirmostur gentneeds
fi
rst.•Amar ketdemandcur v
eexpr essest hesum ofquant i
tydemandedateachpr i
ceacr ossal l
consumer sint hemar ket.•Changesi npr icecanber efl
ect edi nmov emental ongademand
curve,butdonotbyt hemsel vesi ncreaseordecr easedemand.•Theshapeandmagni tudeof
demandshi ftsinr esponset ochangesi nconsumerpr eferences,i ncomes,orr elatedeconomi c
goods, NOTt ochangesi npri
ce.

LawofDemand

Economi csinvolvest hest udyofhowpeopl eusel i

mi tedmeanst osat isfyunl i
mi t
edwant s.The
l
awofdemandf ocusesont hoseunl imi tedwant s.Nat ur all
y,peopl epr iorit
izemor eur gentwant s
andneedsov erlessur gentonesi nt hei reconomi cbehav ior,andt hi scar ri
esov erintohow
peopl echooseamongt hel imitedmeansav ail
ablet ot hem.Foranyeconomi cgood,t hef ir
st
unitoft hatgoodt hataconsumerget st hei rhandsonwi l
lt endt obeputt ouset osat isfyt he
mostur gentneedt heconsumerhast hatt hatgoodcansat isfy.Forexampl e,consi dera
cast awayonadeser tisl andwhoobt ainsasi xpackofbot tl
ed, freshwat erwasheduponshor e.
Thef ir
stbot tl
ewi llbeusedt osat isfyt hecast away 'smostur gent lyfeltneed,mostl i
kel y
drinki ngwat ertoav oiddy i
ngoft hir
st .Thesecondbot tl
emi ghtbeusedf orbat hingt ost av eof f
disease,anur gentbutl essi mmedi at eneed.Thet hirdbot t
lecoul dbeusedf oral essur gent
needsuchasboi li
ngsomef isht ohav eahotmeal ,andondownt ot hel astbot tl
e,whi cht he
cast awayusesf orar elativelyl ow pr iorityl i
kewat eri
ngasmal lpot tedpl antt okeephi m
companyont heisl and.I nourexampl e,becauseeachaddi tionalbot tl
eofwat erisusedf ora
successi velylesshi ghl yv aluedwantorneedbyourcast away ,wecansayt hatt hecast away
valueseachaddi tionalbot tlelesst hant heonebef ore.Si mi l
arly,whenconsumer spur chase
goodsont hemar keteachaddi tionaluni tofanygi v
engoodorser vicet hatt heybuywi llbeput
toal essv alueduset hant heonebef ore, sowecansayt hatt heyv alueeachaddi ti
onaluni tless
andl ess.Becauset heyv alueeachaddi ti
onaluni toft hegoodl ess,t heyar ewi lli
ngt opayl ess
fori t.Sot hemor euni tsofgoodconsumer sbuy ,thel esst heyar ewi l
lingt opayi nt ermsoft he
price.Byaddi ngupal ltheuni tsofagoodt hatconsumer sar ewi l
l
ingt obuyatanygi v
enpr i
ce
wecandescr i
beamar ketdemandcur ve, whichi salway sdownwar d-sloping, li
ket heoneshown
i
nt hechar tbelow.Eachpoi ntont hecur ve( A,B,C)r ef l
ectst hequant i
tydemanded( Q)ata
givenpr ice(P).Atpoi ntA, forexampl e, thequant it
ydemandedi sl ow( Q1)andt hepr i
cei shi gh
(P1) .Athi gherpr ices,consumer sdemandl essoft hegood,andatl owerpr ices,t heydemand
mor e.

Demandv
sQuant
it
yDemanded

I
neconomicthi
nki
ng,i
tisi
mportanttounder
standthedif
fer
encebetweenthephenomenonof
demandandthequanti
tydemanded.Inthechart
,theterm"demand"ref
erstothegreenli
ne
pl
ott
edthr
oughA,B,andC.I texpressest
her el
ati
onshi
pbetweentheurgencyofconsumer
want
sandthenumberofunitsoftheeconomicgoodathand.Achangei ndemandmeansa
shif
toft heposi ti
onorshapeoft hi
scur ve;itr
efl
ectsachangei nt heunder l
yi
ngpat t
ernof
consumerwant sandneedsv is-
a-v
isthemeansav ail
abletosatisfythem.Ont heotherhand,
the
ter
m" quantitydemanded"r efer
stoapoi ntalongwithhorizontalaxis.Changesinthequantit
y
demandedst ri
ctl
yr ef
lectchangesinthepr i
ce,wit
houtimpl yi
nganychangei nt hepatt
ernof
consumerpr eferences.Changesinquantit
ydemandedj ustmeanmov ementalongthedemand
curveit
selfbecauseofachangei npr i
ce.Thesetwoi deasar eof tenconfl
ated,butthisi
sa
commoner ror;ri
sing(orfall
i
ng)inpricesdonotdecr ease(ori ncr
ease)demand,t heychange
thequantit
ydemanded.

Fact
orsAf
fect
ingDemand

Sowhatdoeschangedemand?Theshapeandposi ti
onoft hedemandcur vecanbei mpacted
bysev er
alfactors.Risingincomest endt oincreasedemandf ornormaleconomi cgoods,as
peoplearewi l
li
ngt ospendmor e.Theav ailabi
li
tyofclosesubstitut
eproductsthatcompetewi t
h
agiveneconomi cgoodwi l
ltendtor educedemandf orthatgood,si ncetheycansat i
sfythe
same ki nds of consumer want s and needs. Conv ersel
y ,the av ail
abi
li
ty of closel
y
complement arygoodswi llt
endt oincreasedemandf oraneconomi cgood,becausetheuseof
twogoodst oget hercanbeev enmor ev aluabl
et oconsumer sthanusi ngthem separ
atel
y,li
ke
peanutbut t
erandj el
ly.Otherfactorssuchasf ut
ureexpect ati
ons,changesi nbackground
envi
ronment alconditi
ons,orchangei ntheact ualorpercei
vedqual i
tyofagoodcanchanget he
demandcur ve,becauset heyalt
erthepat ternofconsumerpr eferencesforhowt hegoodcanbe
usedandhowur gentlyiti
sneeded.

Q.3Cri
ti
cal
lydi
scusst
her
elat
ionshi
pbet
weenel
ast
ici
tyofdemandandt
her
evenuewi
th
exampl
es.

Priceel astici
tyofdemanddescr i
beshow changesi nt hepriceforgoodsandt hedemandf or
thosesamegoodsr el
ate.Ast hoset wov ar
iablesi nteract,t
heycanhav eanimpactonaf ir
m’ s
totalr evenue.Rev enuei stheamountofmoneyaf i
rm bringsi nfrom sales—i.
e.,thet otal
numberofuni tssoldmul t
ipl
iedbyt hepr iceperuni t.Therefore,asthepriceorthequant i
tysol d
changes,t hosechangeshav eadi recti mpactonr ev enue.Businessesseekt omaxi mi zetheir
profits,andpr i
ceisonet ooltheyhav eatt heirdisposalt oi nfl
uencedemand( andt herefore
sales) .Pickingt her i
ghtpr i
cei stricky ,though.Whathappenswi t
hapr i
cei ncrease?Wi l
l
cust omer sbuyonl yal i
ttleless,sucht hatthepr i
cei ncreaser ai
sesrevenues,orwilltheybuya
l
otl ess, suchthatthepr iceincreaselower srev enues?Mi ghtthecompanyear nmor ei fi
tlower s
pri
ces,orwi l
lthatjustleadt olowerr evenueperuni twi t
houtst i
mulati
ngnewdemand?These
arecr iti
calquestionsforev erybusiness.

Q.
4Explai
nj oi
ntst
ockcompany
.Cr
it
ical
lydi
scusst
headv
ant
agesofJoi
ntSt
ockCompany
ov
erpar
tnershi
pbusiness.

JointStock:WhatIsaJoi nt-
StockCompany?Themoderncorporationhasit
soriginsint
hej oint-
stockcompany .Ajoi
nt-
stockcompanyisabusinessownedbyi tsinvest
ors,witheachinvestor
owningashar ebasedont heamountofstockpur
chased.Joint-
stockcompaniesar ecr
eatedi n
ordertofinanceendeavorsthataret
ooexpensi
veforanindi
vidualorevenagov ernmenttof und.
Theowner sofajoint
-st
ockcompanyexpecttosharei
nitsprofi
ts.

Adv
ant
agesofJoi
ntSt
ockCompany
:

1.LargerCapi
tal
-Thehugecapitalrequir
edbymoder nenter
pri
seswoul
dnotbepossi bl
eunder
otherfor
msoforgani
zati
onslikesoleindi
vidualpr
oprietor
shi
pandeveninpar
tnershi
p.Thejoint
stockcompanybyi ts widespread appealt oinvestorsofallcl
assescan raise adequate
r
esour
cesofcapi
tal
requi
redbyl
arge-
scal
eent
erpr
ise.

2.Li
mitedLiabi
li
ty-Li
abil
it
yoftheshareholder
sofacompanyi sl
imi
tedtot
hefaceval
ueofthe
shar
estheyhavepur chased.I
thasast i
mul at
ingef
fectoni
nvest
ment.Thepr
ivat
eproper
tyof
shar
eholderi
snotattachablet
orecov
ert heduesofthecompany.

3.Stabil
it
yofExi
stence-Theor
gani
zati
onofacompanyasasepar
atel
egalenti
tygi
vesi
ta
char
acterofper
manenceorconti
nui
ty.Asani
ncor
porat
edbody
,acompanyenjoysper
pet
ual
exi
stence.

4.EconomiesofScale-Sincethecompanyoper at
esonal ar
gescal
e,itwouldresul
tint
he
real
i
zati
onofeconomiesinpurchases,management,di
str
ibuti
onorsel
li
ng.Theseeconomi
es
wouldprov
idegoodst
ot heconsumeratacheaperpri
ce.

5.ScopeforExpansi
on-Asther
eisnorestr
ict
iontothemaxi
mum numberofmembersi
na
publ
iccompany,
expansi
onofbusi
nessi
seasybyissui
ngnewshar
esanddebent
ures.

6.Publi
cConf i
dence-For mationandwor ki
ngofcompaniesarewellregul
atedbythepr
ovisi
ons
oftheCompani esAct .Theprovi
sionsregardi
ngcompulsorypubli
cati
onofsomedocument s,
accounts,di
rector’
sr eport
,etc.
,creat
econf i
denceinpubli
c.Theiraccountsareaudi
tedbya
chart
eredaccount antandar etobepublished.Thi
screat
esconfidenceinthepubli
caboutthe
funct
ioningofthecompany .

7.Transferabi
li
tyofShar
es-Thesharehol
der
sofapubl i
ccompanyar
eenti
tl
edt ot
ransf
erthe
sharesheldbythem t
oother
s.Thesharesofmostj
ointst
ockcompani
esar
elist
edonthestock
exchangeandhencecanbeeasilysol
d.

8.Pr of
essi
onalManagement -Themanagementofacompanyv est
sinthedirect
orsduly
elect
edbyshar ehol
ders.Normally
,experi
encedpersonsareel
ectedasdir
ector
s.Thus,the
avail
abl
eskil
lisuti
li
zedfort
hebenef i
tofthecompany.Thecompanyor
gani
zati
on,t
heref
ore,i
s
l
ikeabr i
dgebetweentheski
llandcapit
al.

9.TaxBenef
its-Companypay
slowertaxonahigheri
ncome.Thi
sisbecauseoft
hereasont
hat
thecompanypay staxonthefl
atrates.Si
mil
arl
y,companygetssomet axconcessi
onsi
fit
establ
i
shesi
tselfi
nabackwar
darea.

10.RiskDi
ff
used-Themember shi
pofacompanyislar
ge.Thebusi
nessriskisdivi
dedamong
sever
almembersofthecompany.Thi
sencour
agesi
nvest
mentofsmalli
nvestors.

Di
sadv
ant
agesofJoi
ntSt
ockCompany
:

1.Di
ffi
cul
tyi
nformati
on-Thelegalfor
mal i
ti
esandprocedur
esr equiredintheformat
ionofa
companyaremany.Ithastoapproachl ar
genumberofpeopl ef oritscapit
alanditcannot
commencebusi
ness,unl
essithasobtainedacert
if
icat
eofi ncorporati
onandacer ti
fi
cat
et o
commencebusi
ness.

2.LackofSecrecy-Ever
yi ssueisdiscussedinthemeeti
ngoftheboar
dofdirect
ors.The
minut
esofmeetingandaccountsofthef i
rm’spr
ofi
tandl
osset
c.,
havetobepubl
i
shed.Inthi
s
si
tuat
ionmai
ntenanceofsecrecyi
sdif
ficul
t.

3.Del
ayinDeci
sionMaking-I
ncompanyform oforgani
zat
ion,al
li
mpor t
antdecisi
onsaretaken
bytheboar
dofdirect
orsandshar
ehol
dersi
ngener almeet
ing.Hence,deci
sionmakingprocess
i
stimeconsumi
ng.Boardofdir
ect
orsi
tsel
fhasoftentobeatthemer cyofbureaucr
acy.
4.Concent r
ati
onofEconomi cPower-Thecompanyf orm ofor
ganizat
iongiv
esscopef or
concentr
ati
onofeconomi cpoweri naf ew hands.Itgiveseasyscopef ort
hef ormati
onof
combinati
onswhichresul
tsi nmonopol
y.Lar gej
ointstockcompani
estendt of
ormt hemselv
es
i
ntocombi nati
onsorassociati
onsexer
cisingmonopolisti
cpowerwhichmaypr ovedetri
mental
tootherfi
rmsinthesamelineortotheconsumer s.

5.LackofPersonalInt
erest-Incompanyform oforgani
zat
ion,theday-t
o-daymanagementis
vest
edwi t
hthesalari
edper sonsorexecuti
veswhodonothav eanyper sonalint
eresti
nthe
company.Thi
smayl eadtoreducedemployeemotivat
ionandresulti
ninef
fici
ency
.

6.Mor eGovernmentRestr
icti
ons-Theinternalworki
ngofthecompanyi
ssubjectt
ostat
utory
restri
cti
onsregardingmeet
ing,voti
ng,audi
t,etc.Theest
abli
shmentandr
unni
ngofacompany ,
therefore,would prov
eto bet roubl
esomeand bur densomebecauseofcompl i
cat
ed l
egal
regulati
ons.

7.Incapabl
eandUnscr upul ousManagement-Unscrupul
ousi ndi
vidual
smaybr ingeconomi c
rui
nt othecommunitybypr omoti
ngboguscompanies.Thefraudulentpromot er
smaybef ool
thepubli
ctocol
lectcapitalandmisusei
tfort
hei
rpersonalgai
n.Mi suseofpr opert
y,goodsand
moneybyt hemanager ialpersonnelmayharmthei nter
est
soft heshar ehol
dersandcr eat
e
panicamongtheinvest
ingpubl i
c.

8.UndueSpecul ati
onint heShar esoftheCompany -Il
legi
timatespecul
ationi
nt heval
uesof
sharesofacompanyl i
stedont hestockexchangeisinjuri
oust othei
nter
estofsharehol
ders.
Viol
entfl
uctuat
ionsi nthev al
uesofshar esasar esultofgambl i
ngont hestockexchange,
weakenstheconf i
denceofinvestorsandmayleadtofinanci
al cr
isi
s.

Q.
5Explai
nperfectmar
ket
.Cr
it
ical
lyev
aluat
etheassumpt
ionsandf
eat
uresofper
fectmar
ket
wi
thexamples.

Per
fectCompet
it
ion–aPur
eMar
ket

Wecant akesomeusef ulinsi

ghtsfrom studyingawor l
dofper fectcompeti
ti
onandt hen
compari
ngandcont rasti
ngwi thimperfect
lycompet it
ivemarket
sandi ndust
ri
es•Economi sts
havebecomemor einterestedinpurecompet i
ti
onpar tl
ybecauseofthegrowthofe-commer ce
asameansofbuy i
ngandsel l
i
nggoodsandser v
ices.Andalsobecauseoft hepopular
it
yof
aucti
onsasadeviceforallocati
ngscarceresourcesamongcompet ingends.Whatarethemai n
assumpti
onsforaper f
ectlycompeti
tiv
emar ket?

1.Manyseller
sint hemarket-eachofwhom producealowper
cent
ageofmar
ketoutputand
cannoti
nfl
uencetheprevai
li
ngmar ketpr
ice–eachfi
rmi
nt hi
smar
keti
sapri
cet
aker-i
.e.i
thas
totaket
hemar ketpri
ce

2.Manyi
ndi
vi
dual
buy
ers-nonehasanycont
rol
overt
hemar
ketpr
ice

3.Perf
ectfreedom ofent
ryandexitf
rom t
heindustr
y.Fir
msfacenosunkcostsandentr
yand
exi
tfrom themar ketisfeasi
blei
nthelongr un.Thi
sassumpti
onmeanst hatallf
ir
msi na
per
fectl
ycompet i
ti
vemarketmakenormalprof
itsi
nthelongr
un

4.Homogeneouspr
oductsaresuppl
iedt
othemarket
sthatareper
fectsubst
it
utes.Thi
sleads
toeachf
ir
msbeing“pr
icetaker
s"wi
thaperf
ect
lyel
ast
icdemandcur
vef ort
hei
rproduct

5.Perf
ectknowledge– consumershaveallreadi
l
yav ai
labl
einfor
mati
onaboutpr
icesand
pr
oductsf
rom competi
ngsuppli
ersandcanaccesst
hisatzerocost–inot
herwor
ds,
ther
eare
fewtransact
ionscost
sinv
olvedi
nsearchi
ngfortherequir
edi
nfor
mat
ionaboutpr
ices.Li
kewi
se
sel
ler
shav eperf
ectknowl
edgeaboutt
heircompeti
tors.

6.Perf
ectl
ymobi
l
efact
orsofproduct
ion–l
and,labourandcapi
talcanbeswit
chedinr
esponse
tochangingmar
ketcondi
ti
ons,pri
cesandincenti
ves.Weassumet hatt
ranspor
tcostsare
i
nsigni
fi
cant

7.Noext
ernal
i
tiesar
isi
ngf
rom pr
oduct
ionand/
orconsumpt
ion.

Under
standi
ngt
her
ealwor
ldofi
mper
fectcompet
it
ion!

Itisoftensaidthatper
fectcompeti
ti
oni
samar ketst
ruct
urethati
soutdat
ednotworthyof
study!Clear
lyt
heassumptionsofpur
ecompet
it
iondonothol
dinthevastmaj
ori
tyofr
eal
-wor
ld
mar ket
s.

•Suppli
ersmayexer
tcont
rolov
ert
heamountofgoodsandser
vicessuppl
i
edandexpl
oitt
hei
r
marketpower

•Onthedemand-
side,
consumersmayhavemonopsonypoweragai
nstt
hei
rsuppl
i
ersbecause
t
heypur
chaseahi
ghper cent
ageoft
otal
demand.

•Inaddi
ti
on,ther
eareal
wayssomebarr
ierstothecontest
abi
li
tyamarketandfarfrom bei
ng
homogeneous;mostmar
ket
saref
ull
ofheterogeneouspr
oduct
sduetoproductdi
ff
erent
iati
on

•Consumer
s hav
eimper
fecti
nfor
mat
ion and pr
efer
ences ar
einf
luenced by per
suasi
ve
mar
ket
ing

•Inever
yindust
rywecanfindexampl
esofasymmet r
icinf
ormati
onwher
ethesell
erknows
moreaboutqual
i
tyofgoodt
hanbuyer–af
requent
lyquotedexampl
eist
hemarketf
orsecond-
handcar
s!

•Ther ealworl
disoneinwhi
chnegat
iveandposi
ti
veext
ernal
iti
esfr
om bot
hproduct
ionand
consumptionar
enumerous–bot
hofwhichcanl
eadtoadi
vergencebet
weenpri
vat
eandsocial
costsandbenefi
ts.

•Fi
nal
lyther
emaybei mperfectcompet
it
ioni
nrel
atedmar
ket
ssuchast
hemar
ketf
orkeyr
aw
mater
ial
s,l
abourandcapi
tal
goods.