Indian Stock Market: Does it Explain Perfect Competition? CASE STUDY SOLUTION

 Indian Stock Market: Does it Explain Perfect Competition? CASE STUDY SOLUTION

Indian Stock Market: Does it Explain Perfect Competition?

The stock market is one of the most important sources for corporates to raise capital. A stock

exchange provides a market place, whether real or virtual, to facilitate the exchange of securities

between buyers and sellers. It provides a real time trading information on the listed securities,

facilitating price discovery.

Participants in the stock market range from small individual investors to large traders, who can

be based anywhere in the world. Their orders usually end up with a professional at a stock exchange,

who executes the order. Some exchanges are physical locations where transactions are carried out

on a trading floor. The other type of exchange is of a virtual kind, composed of a network of

computers and trades are made electronically via traders.

By design a stock exchange resembles perfect competition. Large number of rational profit

maximisers actively competing with each other, trying to predict future market value of individual

securities comprises the main feature of any stock market. Important current information is almost

freely available to all participants. Price of individual security is determined by market forces and

reflects the effect of events that have already occurred and are expected to occur. In the short run it

is not easy for a market player to either exit or enter; one cannot exit and enter for few days in those

stocks which are under no delivery. For example Tata Steel was in no delivery from 29/10/07 to

02/11/07. Similarly one cannot enter or exit on those stocks which are in upper or lower circuit for

few regular trading sessions. Therefore a player has to depend wholly on market price for its profit

maximizing output (in this case stock of securities). In the long run players may exit the market if

they are not able to earn profit, but at the same time new investors are attracted by rise in market

price.

As on 01/11/07 total market capital at Bombay Stock Exchange (BSE) is $1589.43 billion (source:

Business Standard, 1/11/2007); out of this individual investors account for only $100bn. In spite of

the fact that individual investors exist in a very large number, their capital base is less than 7% of

total market capital; rest of capital is owned by foreign institutional investor and domestic

institutional investors (FIIs and DIIs), which are very small in number. Average capital owned by a

single large player is huge in comparison to small investor. This situation seems to have prompted Dr

Dash of BSE to comment ‘The stock market activity is increasingly becoming more centralised,

concentrated and non competitive, serving interest of big players only.” Table 2 shows the impact of

change in FII on National Stock Exchange movement during three different time periods.

Table 2: Impact of FIIs’ Investment on NSE

Wave

Date

Nifty

close

Change in

Nifty

Index

FLLS Net

Investment

(Rs.Cr.)

Change in Market

Capitalisation

(Rs.Cr.)

Wave 1

From

To

17/05/04

26/10/05

1388.75

2408.50

1019.75

59520

5,40,391

Wave 2

From

To

27/10/05

11/05/06

2352.90

3701.05

1348.15

38258

6,20,248

Wave 3

The Indian Institute of Business Management & Studies

Subject: Managerial Economics Marks: 100

8

From

To

12/05/06

13/06/06

3650.05

2663.30

-986.75

-9709

-4,60,149

By design, an Indian Stock Market resembles perfect competition, not as a complete description

(for no markets may satisfy all requirements of the model) but as an approximation.

Questions

1. Is stock market a good example of perfect competition? Discuss.

2. Identify the characteristics of perfect competition in the stock market setting.

3. Can you find some basic aspect of perfect competition which is essentially absent in stock

market?