I

MARKET STRUCTURE

1. Definition of Market

It is a situation of diffused, impersonal competition among sellers who compete to sell their goods
and among buyers who use their purchasing power to acquire the available goods in the market. It
can also be referred to as the area where buyers and sellers contact each other and exchange goods
and services

2. Definition of Market Structure

Refers to the characteristics of the market either organizational or competitive, describes the
nature of competition and the pricing policy followed in the market.
3. Determinants of market structure
3.1. The number and size of buyers and sellers
The number of individuals in a certain market who are potential buyers and/or sellers of a
product or service
3.2. Similarity or type of product brought and sold
The type of products brought and sold by sellers to potential buyers in a specific market.
A product can be a service or an item. It can be physical or in a virtual or cyber form.
3.3. Degree of mobility of resources
The transfer of resources in terms of use or in terms of geographical mobility.
3.4. Entry and exit of firms and input owners
It is the level of difficulty imposed on businesses upon their entry and exit in the market
3.5. Degree of knowledge of economic agents
The amount of information and skills possessed by the potential sellers and buyers in the
market
4. Types of Market Structures
Market
structures
4.1. Perfect Competition
4.2. Imperfect Competition
Perfect Imperfect
4.2.1. Monopoly Competition Competition

4.2.2. Monopolistic Competition

4.2.3. Oligopoly Monopoly
Monopolistic
Oligopoly
Competition

Fig1. Market Structures

 Monopolistic
Perfect Monopoly Oligopoly
Competition
Large number of Single seller or
Many small firms Few sellers
small firms producer
Either a homogenous
Homogenous
A unique product Differentiated product or differentiated
product
product
Very easy entry Impossible entry Easy market entry and
Difficult market entry
and exit into the market exit
Table 1. Differences of Market Structures

QUESTIONS
A. Fill in the blanks
1. is referred to as a place where buyers and sellers interact and have an
exchange of goods and services at any given monetary value.
2. Refers to the of the market either organizational or competitive,
describes the nature of competition and the pricing policy followed in the market.
3. The is the amount of information and skills possessed by the potential
sellers and buyers in the market.
B. True or False
1. The market structure is categorized into four.
2. The degree of knowledge of economic agents is the type of products brought and sold by
sellers to potential buyers in a specific market.

KEY TO CORRECTION
A. 1. Market
2. characteristics
3. degree of knowledge of economic agents
B. 1. False ( It is categorized in to two: perfect and imperfect competition)
2. False (It refers to the similarity or type of products.)
 II
Perfect Competition

1. Definition of Perfect Competition

It is a theoretical market structure where in there is a perfect degree of competition and single price
prevails. It is where firms has no choice regarding the price policy; each having a small share in the
market. The closest real-world examples are: Agricultural Markets , Street Food Vendors,
2. Characteristics of Perfect Competition
These are the characteristics that a perfect competition have.
2.1. Many buyers and sellers
There is a large number of buyers and sellers that none of them individually is in a position
to influence the price and output of the industry as a whole
2.2. Homogeneity of the product
Each firm produce and sell a homogenous or similar product in the market. There is no
differentiation between two products offered by two different firm, thus the buyers do not have
any preference for the product of any individual seller over the other. Most likely, it is because
the industries the falls into perfect competition is the agricultural market, wherein the products
offered are commodities.
2.3. Free entry and exit of Firms
The firms should be free to enter or leave the industry without any barrier. Any new
entrants is not discouraged to enter and any old firm can withdraw anytime from the industry
if there is a probability of not overcoming the phase of depression.
2.4. Zero advertisement
There is no marketing involved in selling. Firms is not involved in advertising their
products, but they also depend on the good relationship between buyers and sellers which we
call being a “suki” to have a repeat purchase.
2.5. Buyers and sellers have a perfect knowledge of the market
Buyers and sellers possess complete knowledge about the prices at which goods are being
bought and sold and knowledge about the products offered and sold.
2.6. Absence of government controls

2.7. All firms are price takers

3. Disadvantages of Perfect Competition Models

a. Absence of innovation.
b. Absence of advertising, which are considered to be the pillars of any profit-making enterprise.
c. Firms cannot set themselves apart by charging a premium for their product and services.

4. Determination of Price under Perfect Competition

a. Price is determined by the market forces of demand and supply.

b. All buyers and sellers are price takers and not price makers.
c. Buyer represents demand side in the market. Seller represents supply side in the market.
d. But at a common price, buyer is ready to demand a particular quantity of goods and seller is also
ready to supply exactly the same quantity of goods to buyer, such common price is called
Equilibrium Price and such quantity is called Equilibrium Quantity.
 QUESTIONS
TRUE OF FALSE
1. Perfect competition constitutes a market with infinite sellers and limited buyers.
2. Products in perfect competition are heterogeneous.
3. In perfect competition, buyers and sellers have no barriers to enter or leave the market.
4. The price in perfect competition is determined by the market forces of demand and supply.
5. Sellers in perfect competition are price makers, they can influence the market price of their
product.
6. There is an absence of innovation and advertising of products in perfect competition.
7. In perfect competition, firms cannot set themselves apart by changing a premium of their product
and services.
8. Perfect competition is a theoretical market structure where in there is a perfect degree of
competition and singles price prevails.
9. In perfect competition, sellers are compelled to adhere to market rules.
10. Agricultural markets can be a closest representation of perfectly competitive markets.

KEY TO CORRECTION
1. False
2. False
3. True
4. True
5. False
6. True
7. True
8. True
9. True
10. True
 III
MONOPOLISTIC COMPETITION

1. Definition of Monopolistic competition

Monopolistic competition is a market structure which combines elements of monopoly and

competitive markets. Essentially a monopolistic competitive market is one with freedom of
entry and exit, but firms can differentiate their products. Therefore, they have an inelastic
demand curve and so they can set prices. However, because there is freedom of entry,
supernormal profits will encourage more firms to enter the market leading to normal profits in
the long term.

2. Four key characteristics

2.1. Large number of small firms
A monopolistically competitive industry contains a large number of small firms, each
of which is relatively small compared to the overall size of the market. This ensures that
all firms are relatively competitive with very little market control over price or quantity.
In particular, each firm has hundreds or even thousands of potential competitors.
2.2. Similar but not identical products
Each firm in a monopolistically competitive market sells a similar product. Yet each
product is slightly different from the others. The term used to describe this is product
differentiation.
2.3. Resource Mobility
Monopolistically competitive firms, like perfectly competitive firms, are free to enter
and exit an industry. The resources might not be as "perfectly" mobile as in perfect
competition, but they are relatively unrestricted by government rules and regulations,
start-up cost, or other substantial barriers to entry. While some firms incur high start-up
cost or need government permits to enter an industry, this is not the case for
monopolistically competitive firms. Likewise, a monopolistically competitive firm is not
prevented from leaving an industry as is the case for government-regulated public
utilities.
Most important, monopolistically competitive firms can acquire whatever labor,
capital, and other resources that they need with relative ease. There is no racial, ethnic,
or sexual discrimination.
2.4. Extensive Knowledge
In monopolistic competition, buyers do not know everything, but they have relatively
complete information about alternative prices. They also have relatively complete
information about product differences, brand names, etc. Moreover, each seller also has
relatively complete information about the prices charged by other sellers so that they do
not inadvertently charge less than the going market price.
3. Product differentiation

There are relatively few options for sellers to differentiate their offerings from other firms.
There might be “discount” varieties that are of lower quality, but it is difficult to tell whether
the higher-priced options are in fact any better. This uncertainty results from imperfect
 information: the average consumer does not know the precise differences between the various
products, or what the fair price for any of them is.

Product differentiation is responsible for giving each monopolistically competitive a little

bit of a monopoly, and hence a negatively-sloped demand curve. Differences among products
generally fall into one of three categories: (1) physical difference, (2) perceived difference, and
(3) difference in support services.

 Physical Difference: This means that the product of one firm is physically different from the
product of other firms. The most popular product of Manny Mustard's House of Sandwich is,
for example, the Deluxe Club Sandwich. While many restaurants sell club sandwiches, Manny
makes his with barbecue sauce rather than mayonnaise. It is similar to other club sandwiches,
but slightly different.
 Perceived Difference: Product differentiation can also result from differences perceived by
buyers, even though no actual physical differences exist. For example, OmniGuzzle gasoline
is chemically identically to Bargain Discount Fuel gasoline. However, many buyers are
absolutely convinced that OmniGuzzle is a "higher quality" gasoline. This could be due to
years of intense OmniGuzzle advertising that has burned the OmniGuzzle brand name into
heads of the consuming public. Brand names, in fact, are a common method of creating the
perception of differences among products when none physically exist. However, perceived
differences work just as well for monopolistic competition as actual differences. In the minds
of the buyers, it matters not whether the differences are real or perceived.
 Support Service Difference: Products that are physically identical and perceived to be
identical, can also be differentiated by support services. This is quite common in retail trade.
For example, several independent stores might sell Master Foot brand athletic shoes. Buyers
know that Master Foot shoes are the same regardless of who does the selling. No physical nor
perceived differences exist. However, Bobby's Bunyon-Free Footware provides individual
service, money-back guarantees, extended warranties, and service with a smile. Bobby's
Bunyon-Free Footware sells buyers the perfect Master Foot brand athletic shoe that fits an
individual's lifestyles. Mega-Mart Discount Warehouse Super Center, in contrast, has self-
service shelves filled with Master Foot brand athletic shoes. Buyers must find their own sizes.
Bobby's Bunyon-Free Footware is thus able to differentiate its Master Foot brand athletic
shoe from those sold by Mega-Mart Discount Warehouse Super Center.

4. Decision-making

Monopolistic competition implies that there are enough firms in the industry that one firms’
decision does not set off a chain reaction.

5. Pricing power

Firms in monopolistic competition are price setters or makers rather than price takers.
However, the firms nominal ability to set their prices is effectively offset by the fact that demand
for their products is highly price elastic. In order to actually raise their prices, the firms must
 be able to differentiate their product from their competitors by increasing its quality, real or
perceived.

6. Demand elasticity

Due to range of similar offerings, demand is highly elastic in monopolistic competition. In

other words, demand is very responsive to price changes.

The law of demand says that when the price of a good increase the quantity demanded of
that good decreases. Elasticity measure the degree of change between price and quantity
demanded. If a good is highly elastic then even a small change in price creates a relatively larger
change in the quantity demanded of that good.

Goods that take a large share of individuals' income, and goods with many substitutes are
likely to have highly elastic demand curves.

ADVERTISING IN MONOPOLISTIC COMPETITION

Firms in monopolistic competition spend large amounts real resources on advertising and
other forms of marketing. When there is a real difference between the products of different firms,
which the consumer might not be aware of, these expenditures can be useful. However, if it is instead
the case that the products are near perfect substitutes, which is likely in monopolistic competition,
ten real resources spent on advertising and marketing represent a kind of wasteful rent-seeking
behaviour, which produces a deadweight loss to society.

Limitations of the model of monopolistic competition

 Some firms will be better at brand differentiation and therefore, in the real world, they will
be able to make supernormal profit.
 New firms will not be seen as a close substitute.
 There is considerable overlap with oligopoly – except the model of monopolistic
competition assumes no barriers to entry. In the real world, there are likely to be at least
some barriers to entry
 If a firm has strong brand loyalty and product differentiation – this itself becomes a barrier
to entry. A new firm can’t easily capture the brand loyalty.
 Many industries, we may describe as monopolistically competitive are very profitable, so
the assumption of normal profits is too simplistic.

Key difference with monopoly

In monopolistic competition there are no barriers to entry. Therefore in long run, the market will be
competitive, with firms making normal profit.
Key difference with perfect competition

In Monopolistic competition, firms do produce differentiated products, therefore, they are not price
takers (perfectly elastic demand). They have inelastic demand.

Examples of Monopolistic Competition

 Restaurants – restaurants compete on quality of food as much as price. Product

differentiation is a key element of the business. There are relatively low barriers to entry in
setting up a new restaurant.
 Hairdressers. A service which will give firms a reputation for the quality of their hair-
cutting.
 Clothing. Designer label clothes are about the brand and product differentiation
 TV programmes – globalisation has increased the diversity of tv programmes from
networks around the world. Consumers can choose between domestic channels but also
imports from other countries and new services, such as Netflix.

QUESTIONS

Fill in the blanks, Identification and enumeration.

1. __________ is market structure with freedom of entry and exit, but firms can differentiate their
products.
2. Firms in monopolistic competition are _____________________.
3. Demand is highly elastic in monopolistic competition. In other words, demand is very responsive
to ___________ changes.
4. A way of discerning one product from another product.
5. Four key characteristics of Monopolistic competition.
6. Give 1 example of Monopolistic competition.
7. Firms are price setters or price makers rather than price takers.

KEY TO CORRECTION
1. Monopolistic Competition
2. Many
3. Price
4. Product differentiation
5. Large number of small firms, Similar but not identical products, Resource Mobility, Extensive
Knowledge
6. Restaurant, hairdressers, Clothing lines, TV programmes
7. Pricing Power
 IV
Monopoly
1. Demand and Revenue
In monopoly, there is only one producer of a product, who influences the price of the product by
making Change m supply. The producer under monopoly is called monopolist. If the monopolist
wants to sell more, he/she can reduce the price of a product. On the other hand, if he/she is willing
to sell less, he/she can increase the price.

As we know, there is no difference between organization and industry under monopoly.

Accordingly, the demand curve of the organization constitutes the demand curve of the entire
industry. The demand curve of the monopolist is Average Revenue (AR), which slopes downward.

Fig. 1: AR Curve under Monopoly

2. Monopoly Profit Maximization

Under monopoly, the slope of AR curve is downward, which implies that if the high prices are
set by the monopolist, the demand will fall. In addition, in monopoly, AR curve and Marginal
Revenue (MR) curve are different from each other. However, both of them slope downward.

 The marginal cost curves faced by monopolies are similar to those faced by perfectly competitive
firms.
 Marginal costs get higher as output increases. It is reflected in the upward-sloping portion of the
marginal cost curve.
 The marginal revenue curve for monopolies, however, is quite different than the marginal revenue
curve for competitive firms. Monopolies have downward-sloping marginal revenue curves that are
different than the good's price.
3. Profit Maximization Function for Monopolies

Monopolies set marginal cost equal to marginal revenue in order to maximize profit. Profits for
the monopolist, like any firm, will be equal to total revenues minus total costs. The pattern of costs
for the monopoly can be analyzed within the same framework as the costs of a perfectly
competitive firm—that is, by using total cost, fixed cost, variable cost, marginal cost, average cost,
and average variable cost. However, because a monopoly faces no competition, its situation and its
decision process will differ from that of a perfectly competitive firm.
 Challenge: To strike a profit-maximizing balance between the price it charges and the quantity
that it sells.

4. Marginal Revenue and Marginal Cost for a Monopolist

A monopolist can sell a larger quantity and see a decline in total revenue. When a monopolist
increases sales by one unit, it gains some marginal revenue from selling that extra unit, but also
loses some marginal revenue because every other unit must now be sold at a lower price. As the
quantity sold becomes higher, the drop in price affects a greater quantity of sales, eventually
causing a situation where more sales cause marginal revenue to be negative.

Table 1. Costs and Revenues of HealthPill

Cost Information Revenue Information

Qty Total Marginal Average Qty Price Total Marginal
Cost Cost Cost Revenue Revenue
1 1,500 1,500 1,500 1 1,200 1,200 1,200
2 1,800 300 900 2 1,100 2,200 1,000
3 2,200 400 733 3 1,000 3,000 800
4 2,800 600 700 4 900 3,600 600
5 3,500 700 700 5 800 4,000 400
6 4,200 700 700 6 700 4,200 200
7 5,600 1,400 800 7 600 4,200 0
8 7,400 1,800 925 8 500 4,000 –200

Profit-maximizing monopoly should follow the rule of producing up to the quantity where
marginal revenue is equal to marginal cost—that is, MR = MC.

Table 2. Marginal Revenue, Marginal Cost, Marginal and Total Profit

Marginal Marginal Marginal Total

Quantity
Revenue Cost Profit Profit
1 1,200 1,500 –300 –300
2 1,000 300 700 400
3 800 400 400 800
4 600 600 0 800
5 400 700 –300 500
6 200 700 –500 0
7 0 1,400 –1,400 –1,400
 A perfectly competitive firm will also find its profit-maximizing level of output where MR =
MC. The key difference with a perfectly competitive firm is that in the case of perfect competition,
marginal revenue is equal to price (MR = P), while for a monopolist, marginal revenue is not equal
to the price, because changes in quantity of output affect the price.

Why is a monopolist’s marginal revenue always less than the price?

The marginal revenue curve for a monopolist always lies beneath the market demand curve.
To understand why, think about increasing the quantity along the demand curve by one unit, so that
you take one step down the demand curve to a slightly higher quantity but a slightly lower price. A
demand curve is not sequential: It is not that first we sell Q1 at a higher price, and then we sell Q2 at
a lower price. Rather, a demand curve is conditional: If we charge the higher price, we would sell
Q1. If, instead, we charge a lower price (on all the units that we sell), we would sell Q2.

So when we think about increasing the quantity sold by one unit, marginal revenue is affected
in two ways. First, we sell one additional unit at the new market price. Second, all the previous
units, which could have been sold at the higher price, now sell for less. Because of the lower price
on all units sold, the marginal revenue of selling a unit is less than the price of that unit—and the
marginal revenue curve is below the demand curve. Tip: For a straight-line demand curve, MR and
demand have the same vertical intercept. As output increases, marginal revenue decreases twice as
fast as demand, so that the horizontal intercept of MR is halfway to the horizontal intercept of
demand. You can see this in the Figure 6.

Fig 6. The Monopolist’s

Marginal Revenue Curve
versus Demand Curve.
Because the market demand
curve is conditional, the
marginal revenue curve for a
monopolist lies beneath the
demand curve.
 QUESTIONS
A. Identification
1. In monopoly, when output increases, the price ___________.
2. What is the rule of producing up to the quantity in Profit –Maximizing monopoly?
3. What is the marginal revenue curve for monopolies?
4. Give one factor that restricts the entry of other sellers in the market.
B. Modified True or False
1. In a monopoly market, the seller faces competition, as he is the sole seller of goods with no close
substitute.
2. Due to the lack of competition, a firm can charge a set price above what would be charged in a
competitive market, thereby maximizing its revenue.

KEY TO CORRECTIONS
Test A.
1. Decreases
2. MR=MC
3. Downward-Sloping Marginal Revenue Curve
4. Government license, ownership of resources, copyright and patent and high starting cost
Test B
1. False
2. True
 V
OLIGOPOLY

1. Etymology

The term oligopoly is derived from two Greek words: ‘oligi’ means few and ‘polein’ means to
sell.

2. Definition of Oligopoly
Oligopoly is a market structure in which there are only a few sellers (but more than two) of the
homogeneous or differentiated products. So, oligopoly lies in between monopolistic competition and
monopoly.
Oligopoly refers to a market situation in which there are a few firms selling homogeneous or
differentiated products. Oligopoly is, sometimes, also known as ‘competition among the few’ as there
are few sellers in the market and every seller influences and is influenced by the behaviour of other
firms.
3. Example of Oligopoly
In India, markets for automobiles, cement, steel, aluminium, etc, are the examples of oligopolistic
market. In all these markets, there are few firms for each particular product.

DUOPOLY is a special case of oligopoly, in which there are exactly two sellers. Under duopoly,
it is assumed that the product sold by the two firms is homogeneous and there is no substitute for it.
Examples where two companies control a large proportion of a market are: (i) Pepsi and Coca-Cola
in the soft drink market; (ii) Airbus and Boeing in the commercial large jet aircraft market; (iii) Intel
and AMD in the consumer desktop computer microprocessor market.

4. Types of Oligopoly
4.1. Pure or Perfect Oligopoly
If the firms produce homogeneous products, then it is called pure or perfect oligopoly.
Though, it is rare to find pure oligopoly situation, yet, cement, steel, aluminum and chemicals
producing industries approach pure oligopoly.
4.2. Imperfect or Differentiated Oligopoly
If the firms produce differentiated products, then it is called differentiated or imperfect
oligopoly. For example, passenger cars, cigarettes or soft drinks. The goods produced by
different firms have their own distinguishing characteristics, yet all of them are close substitutes
of each other.
4.3. Collusive Oligopoly
If the firms cooperate with each other in determining price or output or both, it is called
collusive oligopoly or cooperative oligopoly.
Cartel- association of independent firms within the same industry which follow the common
policies relating to price, output, sale, profit maximization, and distribution of products.
4.4. Non-collusive Oligopoly
If firms in an oligopoly market compete with each other, it is called a non-collusive or non-
cooperative oligopoly.
5. Features of Oligopoly
The main features of oligopoly are elaborated as follows:
5.1. Few firms
Under oligopoly, there are few large firms. The exact number of firms is not defined. Each
firm produces a significant portion of the total output. There exists severe competition among
different firms and each firm try to manipulate both prices and volume of production to
outsmart each other. For example, the market for automobiles in India is an oligopolist structure
as there are only few producers of automobiles.
The number of the firms is so small that an action by any one firm is likely to affect the rival
firms. So, every firm keeps a close watch on the activities of rival firms.
5.2. Interdependence
Firms under oligopoly are interdependent. Interdependence means that actions of one firm
affect the actions of other firms. A firm considers the action and reaction of the rival firms
while determining its price and output levels. A change in output or price by one firm evokes
reaction from other firms operating in the market
For example, market for cars in India is dominated by few firms (Maruti, Tata, Hyundai, Ford,
Honda, etc.). A change by any one firm (say, Tata) in any of its vehicle (say, Indica) will induce
other firms (say, Maruti, Hyundai, etc.) to make changes in their respective vehicles.
5.3. Non-Price Competition
Under oligopoly, firms are in a position to influence the prices. However, they try to avoid
price competition for the fear of price war. They follow the policy of price rigidity. Price
rigidity refers to a situation in which price tends to stay fixed irrespective of changes in demand
and supply conditions. Firms use other methods like advertising, better services to customers,
etc. to compete with each other.
If a firm tries to reduce the price, the rivals will also react by reducing their prices. However,
if it tries to raise the price, other firms might not do so. It will lead to loss of customers for the
firm, which intended to raise the price. So, firms prefer non- price competition instead of price
competition.
5.4. Barriers to Entry of Firms
The main reason for few firms under oligopoly is the barriers, which prevent entry of new
firms into the industry. Patents, requirement of large capital, control over crucial raw materials,
etc, are some of the reasons, which prevent new firms from entering into industry. Only those
firms enter into the industry which is able to cross these barriers. As a result, firms can earn
abnormal profits in the long run.
5.5. Role of Selling Costs
Due to severe competition ‘and interdependence of the firms, various sales promotion
techniques are used to promote sales of the product. Advertisement is in full swing under
oligopoly, and many a times advertisement can become a matter of life-and-death. A firm under
oligopoly relies more on non-price competition.
Selling costs are more important under oligopoly than under monopolistic competition.
5.6. Group Behaviour
Under oligopoly, there is complete interdependence among different firms. So, price and
output decisions of a particular firm directly influence the competing firms. Instead of
independent price and output strategy, oligopoly firms prefer group decisions that will protect
 the interest of all the firms. Group Behaviour means that firms tend to behave as if they were a
single firm even though individually they retain their independence.
5.7. Nature of the Product
The firms under oligopoly may produce homogeneous or differentiated product.
i. If the firms produce a homogeneous product, like cement or steel, the industry is
called a pure or perfect oligopoly.
ii. If the firms produce a differentiated product, like automobiles, the industry is
called differentiated or imperfect oligopoly.

QUESTIONS
A. True or false
1. One example of a homogenous product under oligopoly is Softdrinks
2. Group behavior means that firms tend to behave as if they were a multi firm even though
individually they retain their independence.
3. Competitions are more important under oligopoly than monopolistic competition
4. Firms in oligopoly follows the concept of price rigidity.
5. Under monopoly, it is assumed that the product sold by the firms si homogenous and
there is no substitute for it.
6. Under oligopoly, every seller influences and is influenced by behavior of the firms
B. Identification
1. Give the 4 types of oligopoly
2. ______ prevents entry of new firms into industry.
3. Firms can earn ______ profits in the long run.
4. _______ refers to a situation in which price tends to stay fixed irrespective of changes in
demand and supply conditions.
5. ______ is in full swing under oligopoly.
6. _____ comes from the 2 greek words oligi and polein
7. Oligopoly is sometimes also.known as_______
8. Features of Oligopoly

KEY TO CORRECTIONS
Test A
1. False
2. False
3. False
4. True
5. False
6. True
Test B
1. Pure or perfect, Imperfect or differentiated , Collusive, Non-Collusive
2. Barriers
3. Abnormal
4. Price rigidity
5. Advertisements
6. Oligopoly
7. Competition among the few
8. Few firms, interdependence, non-price competition, barriers to entry of firms, roles of selling costs,
group behaviour, nature of the product
 VI
Pricing Decisions
1. Definition of Price
Price is the value paid for a product or service in the market, it is a key element in the marketing-
mix and one that generally is the only variable that can be quickly changed to react to market changes
such as competitor actions or demand variations.
Price is the value that is put for a product or represents the products value.
2. Definition of Pricing Decisions
Decisions faced by top management and marketing managers. Pricing decisions is the choices
businesses make when setting prices for their products or services. How much to charge for a product
or service depends on a multitude of factors such as competition, cost, advertising, and sales
promotion.

3. Objectives in Setting the Price

3.1. Maximize profit
This is one of the objectives of firms and is also the objective used in setting prices because
in the first place the goal of the firm is to gain profit and not losses.
3.2. Meet target sales or market share
Every firm has goals for short and long term and it is not unusual to have a target sales to
be achieved at a certain time or period. In setting the prices, one need to consider that this target
is met.

3.3. Maintain a price that is stable in relation to competitors’ prices

In setting up a price, it is of concern that one should know the competitors’ price to have
comparisons and further analysis of its effect to your product or service and its price. Likewise
it also aims to influence the competitors
4. Factors Affecting Pricing Decisions
4.1. Internal Factors
These are the factors that is present inside the business or firm’s management
4.1.1. Organizational Factors
Pricing decisions occur on two levels in the organisation. Over-all price strategy is
dealt with by top executives. They determine the basic ranges that the product falls into in
terms of market segments. The actual mechanics of pricing are dealt with at lower levels
in the firm and focus on individual product strategies. Usually, some combination of
production and marketing specialists are involved in choosing the price.
*A market segment is a group of people who share one or more common characteristics.
* Firms may pursue a variety of value-oriented objectives, such as maximizing sales
revenue, maximizing market share, maximizing customer volume.
4.1.2. Marketing Mix
The marketing mix refers to the set of actions, or tactics, that a company uses to
promote its brand or product in the market. The 4Ps make up a typical marketing mix -
 Price, Product, Promotion and Place. However, nowadays, the marketing mix increasingly
includes several other Ps like Packaging, Positioning, People and even Politics as vital mix
elements.
4.1.3. Product Differentiation
The price of the product also depends upon the characteristics of the product. In order
to attract the customers, different characteristics are added to the product, such as quality,
size, colour, attractive package, alternative uses etc. Generally, customers pay more prices
for the product which is of the new style, fashion, better package etc. (ex. coke customize
name, packaging.)
4.1.4. Costs
The most important factor is the cost of production. In deciding to market a product, a
firm may try to decide what prices are realistic, considering current demand and
competition in the market. The product ultimately goes to the public and their capacity to
pay will fix the cost, otherwise product would be flapped in the market.
4.2. External Factors
4.2.1. Market Competition
The structure of the market plays a big role in the pricing decisions of a firm. If one’s
market structure is perfect competition, then he cannot decide on the price and rather need
to follow the market price. And if one is a monopoly, then he can decide the price how
much he wants. Hence, the competition in the market is a crucial factor in price
determination.
4.2.2. Legal Factors
There are existing rules and by laws that controls, balances and prohibits the pricing
done by businesses. As such, the most evident example is the Suggested Retail Price or
better known as SRP. There are also pricing methods that is prohibited by the law such as
predatory pricing, collusive pricing, and discriminatory pricing.
*Predatory pricing- setting prices so low to drive out competitors
*Collusive pricing- conspiration of companies to set very high prices
*Discriminatory pricing- charging different prices from different customers
4.2.3. Demand and Supply
Demand is the willingness of a customer to buy a product or avail a service at a given
price. While, supply refers to the quantity of goods that a seller is willing to offer for sale.
The relationship of demand and supply shows the movement of the price when the demand
goes up or the supply goes down and vice versa. Thus, this helps to forecast and maximize
the sales for a specific period.
5. Pricing Methods/ Strategies
Methods or strategies used to formulize and create a price that will help to maximize the
profits. It requires to consider many factors both internal and external.
5.1. Cost-based pricing
Price is set by adding a certain mark-up above the cost of producing and selling product.
*Mark-up- the amount added to the cost they made to create or buy the product

Price= Cost + Mark-up

= Cost + (Mark-up rate x Cost)

5.2. Value-based pricing
Price is set based on the buyer’s perceived value, and on the benefits provided by the
product. It is applicable where individual quotes are given to individual order or jobs. It is
sometimes the reverse of cost-plus pricing and uses target costing, wherein the price is first
stated based on the perceived value then the business creates a target cost that would limit the
expenses made to ensure profit. However, it has a condition that customer satisfaction must not
be sacrificed.
5.3. Competition-based pricing
Price is set based on the competitors’ prices for similar product. Focuses on information from
the market rather than production costs and products perceived value. It has no complex
computation, however, additional efforts must be made like aggressive advertising, better
customer support and market saturation.
*Higher price means higher profit, low sales

Higher price *Lower price means less profit, more sales

benchmark
Lower price *Benchmark is the market price or common price
among firms with similar product or service

5.4. Penetration pricing

This method is used for new products. This is a pricing method that involves setting low
prices with the intention of quickly introducing a new product to the market. It aims to attract
customers away from competitors by offering lower prices initially. Once the product has been
accepted and has established its brand in the market, prices may increase to yield greater profits.
Example: Bonux
5.4.1. Advantages of Penetration pricing
The product is diffused quickly in into the market. Low prices may cause low profit
per unit but it can be compensated with the high volume of sales. It can help to establish
market dominance.
5.4.2. Disadvantages of Penetration pricing
The low prices may cause the customers to question the quality of the product and
once the price increases, buyers may not be willing to make repeat purchase anymore.
5.5. Price Skimming
This method is also used for new products but its process is the reverse of penetration
pricing. Likewise, it is mostly used in the technological sector where repeat purchase is
uncommon. Price skimming involves setting high initial prices to recover costs and make
huge profits in the early stages of the products life cycle.
High prices is afforded by the upper class market and as time goes by the price is
lowered to serve a larger clientele.

Upper class market →lowered price→ lower class market

Results in a larger market share and continuous sales

 QUESTIONS
A. IDENTIFICATION
1. It refers to the characteristics of the market either organizational or competitive, that
describes the nature of competition and the pricing policy followed in the market.
2. Decisions faced by top management and marketing managers about much to charge for a
product.
3. The value that is put or paid for a product or service in the market.
4. A group of people who share one or more common characteristics.
5. Refers to the set of actions, or tactics, that a company uses to promote its brand or product in
the market.
6. Refers to the expenses made or incurred by the business during the production.
7. It is the amount added to the expenses made or incurred in the creation of products.
8. It refers to the rules and by laws that controls, balances and prohibits the pricing done by
businesses.
9. This method is based on the competitors’ prices for similar product.
10. It is mostly used in the technological industry.
B. TRUE OR FALSE
1. Pricing Decisions consider only one factor in charging the product or service?
2. Price is the only variable that can be quickly changed to react to market changes.
3. Product Differentiation means that the price of the product also depends upon the
characteristics of the product.
4. Competition is a crucial factor in price determination.
5. The demand for a product can be controlled by the firm.
6. Pricing decisions occur on two levels in the organisation.
7. The most important factor in pricing is the cost of the product.
8. Scarcity or abundance of the raw materials is not considered in pricing.
C. ENUMERATION
1. Give the three external factors that affects pricing decisions
2. Give at least two internal factors in pricing decisions
3. Five Pricing Methods
4. The three objectives in setting the price
D. ESSAY
1. Explain why it is difficult for a company to just set any price and have the factors to be
considered.
 KEY TO CORRECTIONS

TEST A

1.) Market structure

2.) Pricing decisions
3.) Price
4.) Market segment
5.) Marketing mix
6.) Cost
7.) Mark-up
8.) Legal Factors
9.) Competition-based pricing
10.) Price Skimming

TEST B

1) FALSE
2.) TRUE
3.) TRUE
4.) TRUE
5.) FALSE
6.) TRUE
7.) TRUE
8.) FALSE

TEST C

1) a. Market Competition, b. Legal Factors, c. Demand and Supply

2) Organizational Factors, Marketing Mix, Product Differentiation, Costs
3) Cost-based pricing, Value-based pricing, Competition-based pricing, Penetration Pricing,
Price Skimming

TEST D

1) –The price and sales is needed to gain profit. The factors could dictate the rise and fall of the
firm and its sales. Without proper knowledge about the factors and without considering it, it
could be considered as very difficult to achieve the firm’s goal: to maximize profits.