UNIT-III

INTRODUCTION MARKETS, THEORIES OF THE FIRM AND PRICING POLICIES

Introduction: Market constitutes an important phase in the economic activity. All the goods and services
that are produced need to be sold to the consumer for a price. Market primarily provides possession utility
for the goods and services. In other words “the sellers sell the goods to the buyer and thus transfer the
ownership of the goods.

Definition: It is defined as it is a place or point at which buyer and sellers negotiate their exchange of well
defined products or services. It was referred to as a public place in a village or town where provisions and
other objects where brought for sale. Based on the locations, markets are classified as rural, urban, national
or world markets.

Nature of the market

1. It has the boundaries

2. Different organizations are their
3. Different products are available
4. Different prices
5. Competition

Size of Market: The size of market depends on many factors such as nature of products, nature of their
demand, tastes and preferences of the customers, their income level, state of technology, extent of
infrastructure namely telecommunications and information technology.

Market Structure: Market structure refers to the characteristics of a market that influence the behavior
and performance of firms that sell in that market.

The structure of market is based on its following features:

 The degree of seller Concentration: This refers to the number of sellers and their market share for a
given product or service in the market.
 The degree of buyer concentration: This refers to the number of buyers and their extent of purchases of
a given product or service in the market.

1
 The degree of product differentiation: This refers to the extent by which the product of each trader is
differentiated from that of the other. Product differentiation can take several forms as varieties, brands all
of which are sufficiently similar to distinguish them as a group, from other products eg: cars
 The conditions of entry into the market: There could be certain restrictions to enter or exit from the
markets. The degree with which one can enter the market or exit from the markets also determines the
market structure.

Types of Competition: Based on the degree of competition, the market can be divided into

1. Perfect market Competition

2. Imperfect market Competition

PERFECT MARKET COMPETITION

A market in which all firms in an industry are price takers and in which there is freedom of entry into and
exit from the industry. The business motive of the entire firm under perfect competition is profit
maximization. Each firm seeks to maximize its profit. The market with perfect conditions is known as
perfect market.

IMPERFECT MARKET COMPETITION

A Competition is said to be imperfect when it is not perfect. In other words when any or most of the above
conditions do not exist in a given market. It is referred to as imperfect market. Based on the number of
buyers and sellers, the imperfect markets are classified as explained below. The structure of market varies
as below.

THE VARIOUS IMPERFECT COMPETITIONS ARE:

 Monopoly
 Monopolistic Competition
 Oligopoly
 Duopoly

MONOPOLY

Monopoly refers to a situation where a single firm is in a position to control either supply or price of a
particular product/services. In monopoly the seller have rights to fix the price as he like.
2
Monopoly can be interpreted in to two ways. When there is a sole supplier it is a case of a pure monopoly.
In this case, the firm and the industry are one and the same. E.g.: RBI is the sole supplier of currency notes
in India. Another way is the firm supplying a half of the total market may have a greater market power, if
the rest of the market is shared by a number of small firms, when the remaining firms are equally big it
may face competition from the other firms.

MONOPOLISTIC COMPETITION

When large number of seller produces differentiated products, monopolistic is said to exist. A product is
said to be differentiated when its important features vary.

Eg: For “cameras”, the important features include Zoom lenses, focal length, memory, size of the camera,
flash, safety, digital day and so on. The products with better features are differentiated from the others and
they can be sold at higher prices. NIKON, KODAK, YASHICA and so on are the leading players among
the many in market.

OLIGOPOLY:

Oligopoly is a situation where a few large firms compete against each other and there is an element of
interdependence in the decision making of these firms. Another variety of imperfect competition is
oligopoly. If there is competition among a few sellers. Oligopoly is said to exist.

Eg: 1.Car manufacturing companies such as Maruthi Suzuki, Hindustan Motors, and Toyota so on. 2. News
papers (such as The Hindu, Indian Express, and Times of India).

OLIGOPSONY: Oligopoly was defined at that form of market organized, where there are few sellers of a
homogenous or differentiated product or oligopoly.

Two or more firms existing in an industry each with a significant market share can be called oligopoly.

DUOPOLY

If there are two sellers, then duopoly is said to exist. If Pepsi and Coke are the two companies in soft
drinks this market is called Duopoly.

3
 PERFECT COMPETETION:

A market in which all firms in an industry are price takers and in which there is freedom of entry into and
exit from the industry. The business motive of the entire firm under perfect competition is profit
maximization. Each firm seeks to maximize its profit. The market with perfect conditions is known as
perfect market.

Features: The following are features of perfect competition. In other words these are the assumptions
underlying perfect markets:

 Large number of buyers and sellers: There should be significantly large number of buyers and sellers
in the market. The number should be so large that it should not make any difference in terms of price or
quantity supplied even if one enters the market or one leaves the market.
 Homogenous products or services: The products and services of each seller should be homogeneous.
They cannot be differentiated from that of one another. It makes no difference to the buyer whether he
buys from firm X or firm Z.
 Freedom to enter or exit the market: There is no restriction on the part of the buyer and sellers to enter
the market or leave the market. There should not be any barriers. The buyer can enter the market or leave
the market whenever they want.
 Perfect information available to the buyer and sellers: Each buyer and seller has total knowledge of
the prices prevailing in the market at every given point of time, quantity supplied, costs, demand, nature
of product and other relevant information. There is no need for any advertisement expenditure as the
buyer and sellers are fully informed.
 Each firm is a price taker: An individual firm can alter its rate of production or sales without
significantly affecting the market price of the product. A firm in a perfect market cannot influence the
market through its own individual actions.
 Perfect Mobility of factors of production: There should not be any restrictions on the utilization of
factors of production such as Land, Labour, and Capital so on. In other words whenever capital or labour
is required it should instantly be made available.

4
PRICE OUTPUT DETERMINATION INCASE OF PERFECT COMPETETION

SHORT RUN: - The price and output of the firm are determined under perfect competition, based on the
industry price and its own costs.

The firms demand curve is horizontal at the price determined in the industry (MR=AR=Price).

The demand curve is also known as average revenue curve. This is because if all units are solid at the same
price, on an average, the revenue to the firm equals its price.

When the average revenue is constant, it will coincide with the marginal revenue curve, thus CC is the
demand curve representing the price.

The firm satisfies both conditions.

a) MR=MC
b) MC curve must cut the MR curve from below the firm attain equilibrium point D where
MR=MC

Here, OC=QD, Which is the price

OF=QE, which is the average cost

OQ=FE, which is the equilibrium output.

Here DE is the average profit and the areas CDEF is the total profit which constitute the supernormal
profits (or) abnormal profits.

5
PRICE OUTPUT DETERMINATION IN LONG RUN:-

Having been attracted by supernormal profit, more and more firms enter the industry, with the
result, there will be a scramble for scarce inputs among the competing firms pushing the input prices.
Hence the average cost increases. The entry of more and more firms will expand the supply pulling down
the market price. As a result the supernormal profits neither enjoyed by the firms get eroded.

In long run, the firms will be in a position to enjoy only normal profits but not supernormal profits.

It shows the long run equilibrium position of the firm under perfect competition. Two conditions
are to be fulfilled in large in the long run.

a) MR=MC
b) AR=AC, and AC must tangential to AR at its lowest price.

QE is the price and also the long run average cost (LAC). Long run marginal cost (LMC) Curve passes
through the minimum point of the average cost curve (AC) at E,

E is only equilibrium point of the firm

OQ units of output.

6
 MONOPOLY

Monopoly refers to a situation where a single firm is in a position to control either supply or price of an
particular product or service. It cannot control both the price and supply.

Feature of monopoly:

FEATURES OF MONOPOLY

 Single seller and large number of buyers

 There is no close substitute goods
 Price maker
 In monopoly there is no difference between company and industry
 In monopoly restrictions are more
 Demand is inelastic
 In monopoly the seller control both price and supply

PRICE OUTPUT DETERMINATION IN MONOPOLY: - Under monopoly the average revenue curve
for a firm is downward sloping one. It is because if the monopolistic reduces the price of his products the
quantity demand increases and vice versa.

In case of monopoly the marginal revenue (MR) is always less than the average revenue (AR) because of
quantitative discounts or concessions.

In other words the marginal revenue curve lies below the average revenue curve.

He can continue to sell as long as the marginal revenue exceeds marginal cost. At point F, where MR=MC,
profits will be maximized profits will diminished if the production is continued beyond its profit.

OQ is the equilibrium output

OA is the equilibrium Price

QC is the average cost.

BC is the average profit.

The monopolist will be in equilibrium at output OQ where MR=MC and profits are maximum.

7
 MONOPOLISTIC COMPETITION

Monopolist competition is said to exist when there are many firms and each one produces such goods and
services that are close substitutes to each other. They are sustain but not identical.

Ex: In the hotel industry some hotels have long and spacious pools, attached gymnasium, beauty parlors,
separate restaurants for vegetarians and non vegetarians cultural programmed and so on.

Features of Monopolistic Competition:

 Large Number of Buyers and Sellers:

 Product Differentiation:
 Selling Cost:
 Lack of Perfect Knowledge:
 Less Mobility:
 More Elastic Demand:
Price output determination in monopolistic competition: the products are differentiated the demand curve
has a downward slope. In other words each firm’s has limited control over price.

SHORT-RUN:

In the short run, firms may experience supernormal or normal profits or even losses. When there is fall in
costs or increases in demand. The firms may enjoy supernormal profits. In other words if the firm satisfies
the following two conditions, it may make supernormal profits.

8
 (a) Where marginal cost is equal to marginal revenue (MC=MR)
(b) Where average revenue is less than average cost (AR<AC)

It reveals that the demand curve is a downward sloping curve because of product differentiation.

At F marginal cost (MC) is equal to marginal revenue (MR).

OQ= Equilibrium output

OA=QB=Equilibrium price.

QC=Average cost

BC=Average profit.

ABCD represents the supernormal profits earned by a firm under monopolistic competition short run.

LONG RUN: More and more firms will be entering the market having been attracted by supernormal
profits enjoyed by the existing firms in the industry. As a result, competition becomes intensive on one
hand. Firms will compete with one another for acquiring scarce inputs pushing up the prices of factor
inputs.

The entry of new firms continue till the supernormal profits of the firms completely get eroded and
ultimately firms in the industry will earn only normal profits. Thus in the long run every firm in the
monopolists competitive industry will earn only normal profits, which are just sufficient to stay in the
business.

9
In the long run in order the achieve equilibrium position the firm has to fulfill the following two conditions.

a) MR=MC
b) AR=AC at equilibrium level of output.

OLIGOPOLY:

Oligopoly was defined at that form of market organized, where there are few sellers of a homogenous or
differentiated product or oligopoly.

Two or more firms existing in an industry each with a significant market share can be called oligopoly.

Oligopoly is of two kinds (a) Homogeneous oligopoly

(b)Differentiated oligopoly

Homogenous oligopoly: it consists of mostly agricultural products, such as oil & wheat, a few wholesale
oil merchants may control the entire supply of oil. Homogeneous oligopoly is also called Pure oligopoly.

Differentiated oligopoly:- It is found in the case of manufactured products. Oligopoly firms manufacture
most of the consumer durables.

Ex: the automobile industry, throughout the world as well as in India, paper & pulp, refrigerators, soaps
and detergents.

10
The following are some of the characteristics features of an oligopoly:

Only a few sellers: the number of sellers in an oligopoly industry in only few.

Inter-dependence: in this each firm closely watches the moves of the other firm and reacts carefully to their
moves. The firms may frequently anticipate the moves of the rival and out accordingly.

Price rigidity: Generally prices once established in an oligopoly industry, remain relatively stable unlike in
the case of perfect competition. Prices are more or less rigid and a firm in an oligopoly may change their
price upward and downwards.

Price leadership: one of the firms in the industry has the highest market share and therefore is called
dominant price leadership.

Advertising and selling cost: firms in an oligopoly market in incur heavy expenditure on advertising and
other promotional activities. Advertising is one way which existing firms try to prevent the entry of new
firms.

Innovations: oligopoly firms continually innovate and improve the quantity of the product, reduce the cost
of production and improve the brand image customer care etc.

Non-Price competition: Because price competition is easy to imitate and leads to price wars oligopoly
firms indulge in non-price competition.

KINKED DEMAND THEORY OF OLIGOPOLY: Many economists observed that prices in an

oligopoly industry are surprisingly stable or rigid. paul sweezy explained very convincingly the reasons
for price rigidity in any oligopoly industry through his kinked demand curve model.
The model is based on two assumptions:
a) If an oligopoly firm increases the prices, its rivals will not increase the price because they believe that
they can gain more customers by keeping status quo.
b) In an oligopoly firm reduces the prices with an intention of increasing the volume of sales, other rival
firms also follows the same strategy.

The demand curve of oligopoly firms will slope downwards. It actually consists of two parts, one is
below the kink and another above the kink.

11
The firm somehow fixed the price originally and once the price is fixed, it remains stable or rigid at that
tlevel. The upper part of the demand curve is relatively elastic demand indicating that any small increases
in price will result in more than a proportionate fall in sales revenue.

MANAGERIAL THEORIES OF FIRM

WILLIAMSON’S APPROACH:

 Diver E.Williamson states that the firms exist because of certain assets they hold for production.
These assets are such that their specific to each other. This is popularly called assets specificity in
production. When usage of the assets extends over a long period. This may lead of increase in
transaction costs.
 Depending on the market conditions the user of the asset may propose for takeover or merger to
overcome the continued conflict of interest.
 Asset may imply human capital also.
 The labour threatens to call for a strike because there is no viable human capital alternative but the
firm also can resist this problem by issuing notice to fire.
 Every firm’s should follows smart methods of protecting their own reputations rather than, to legal
means including writing and enforcement of contracts.
 According to Williamson the normal tendency is that the size of the firm gets limited because of
increasing costs of delegation and there will not be any incentive for the entrepreneur to increase
the size of the firm the increase as the number of owners increase.
 In this most of the entrepreneur fixed small and fed expanding the size of firm up to a particular
point may be feasible and beyond that it is not there are also entrepreneur consider they cannot
really do big business if the size of business is kept limited.

12
  Every entrepreneur is very passionate to spread the business across the boundaries and get the work
done through competent workforce at different levels of management. The deciding factor in all
cases is the competence of the entrepreneur his ability to translate of the vision into action.

MARRIS GROWTH MAXIMIZATION THEORY:

According to marris the growth rate is determined by the growth rate for firm’s product in terms of demand
(GD), and growth rate of capital (GC) supply to the firm, These two growth rates are translated into two
utility functions.

(a) Utility function for manager (UM)

(b) Utility function for owner (Uo)

Um = F(S,P,Js,P,S) Where,

S= Salary
P=Power
Js= Job Security
P=Prestige
S= Status

Uo = F(O,C,Ms,P,Pe)

Where O=Output

C=Capital

Ms= Market Share

P=Profit

Pe=Public Esteem

 The utility for Manager (Um) is governed by salary, power, Job security, Prestige, status associated
with their respective job.
 The (Uo) is determined by the output, capital introduced market share, profit and public esteem.
 The Um and Uo are positively collected with the size of firm that is as the firm’s size increases the
Um and Uo also will increase and vice versa.

13
 CONCEPT OF PRICING

Introduction: Pricing is the process whereby a business sets the price at which it will sell its products and services, and
may be part of the business's marketing plan. In setting prices, the business will take into account the price at which it
could acquire the goods, the manufacturing cost, the market place, competition, market condition, brand, and quality of
product.

Definition: Price is the value that is put to a product or service and is the result of a complex set of calculations,
research and understanding and risk taking ability. A pricing strategy takes into account segments, ability to pay,
market conditions, competitor actions, trade margins and input costs, amongst others.

OBJECTIVES OF PRICING:

A. Maximum Current Profit:

B. Sales Growth:
C. Increase in Market Share:
D. To Face Competition:
E. To Remove Competitors from the Market:
F. To Satisfy Customers:
PRICING METHODS: Fixation of the price for the product is very important. Most often discounts,
concessions offered at the time of purchase. Sometimes certain schemes are introduced.

In consideration of pricing “Under pricing will result in losses and over pricing will make the customer
run away. So in order to determine the pricing, objectives, methods, policies and procedures are
implemented.

Pricing objectives: It refers to the general and specific objectives. The various objectives are:

 To maximize profits.
 To increase sales.
 To increase market share.
 To satisfy customers and to meet the competition.

Pricing Methods:

 Cost based pricing methods.

 Competition oriented pricing.
14
  Strategy based pricing.
 Demand oriented pricing.
1. Cost Based Pricing: These are two types
A. Cost Plus pricing: This is also called as “Mark up” pricing. The average cost at normal capacity of
output is ascertained and then a conventional margin of profits is added to the cost to arrive at the
price. This method is suitable where the costs keep fluctuating from time to time. It is commonly
followed in departmental stores and other retail shops.
B. Marginal Cost pricing: In Marginal Cost pricing, selling pricing is fixed in such a way that it
covers fully the variables or marginal cost and contributes towards recovery of fixed costs fully or
partly depending up on the market situations. In stiff competition, marginal cost offers a guide line
or boundary line, how the selling prices are lowered. This is also called Break- Even Pricing or
Target profit pricing.
2. Competition Oriented Pricing: The pricing is a very complex task. The price of a product is set based on
the competition charges for a similar product. These are various types mainly:
A. Sealed Bid Pricing: This method is more popular in tenders and contracts. Each contracting firm
quotes its price in a sealed cover called “Tender”. All the tenders are opened on a scheduled date
and the person, who quotes the lowest price, is awarded the contract. Any price quoted less than the
marginal price results in loss.
B. Going rate pricing: The price charged by the firm is in tune with the price charged in the industry
as a whole. When one wants to buy and sell gold, the prevailing market rate at a given point of time
is taken as the basis to determine the price. Normally the market leaders keep announcing the
prevailing prices at a given point of time based on demand and supply positions.
3. Demand based pricing methods: Demand-based pricing, also known as customer-based pricing, is
any pricing method that uses consumer demand - based on perceived value - as the central element. These
include: 
A. Price discrimination: Price discrimination is the practice of charging a different price for the same
good or service. .
4. Strategy Based Pricing: The various types of pricing are
A. Market Skimming: when the product is introduced for the first time in the market, the company follows
this method. Under this method the company fixes High price for the product. The main idea is to change
the customer maximum possible. This strategy is mostly found in case of technological products. Eg:
when Sony introduces a particular TV model, it fixes a very high price.

15
B. Penetration price: This is exactly opposite to the market skimming method. The price of the product is
fixed at low price that the company can increase its market share. The company attains profits with
increasing volumes and increase in market share. The companies believe that it is necessary to dominate
the market in the long run than making profits in the short run.
C. Two-Part Pricing: The firms with market power can enhance profits by the strategy of two part pricing.
Under this strategy, a firm charges a fixed fee for the right to purchase its goods, plus a per unit charges
for each unit purchased.
D. Peak Load pricing: During seasonal period when demand is likely to be higher a firm may enhance
profits by peak load pricing. The firm’s philosophy is to charge a higher price during peak times.
LIMIT PRICING: limit pricing refers to the pricing by incubent firms to deter or inhibit the entry or the
expansion or the fringe firms.
Limit pricing implies that firms sacrifice current profits in order to deter entry of new firms and earn
future profits.

INTERNET PRICING MODELS:

The traditional pricing scheme of putting a postage stamp on every letter does not work with internet.
The internet pricing models are described as follows:
FLAT RATE PRICING:
The internet user is required to pay a fee to connect for a fixed period during which one is not charged
on the basis of bits sent or received each time.
USAGE SENSITIVE PRICING: This model looks like a two part tariff. That utilities have a part of the
bill is for the connection and the other part is a price per unit of bit sent or received.
We would have the peak user paying both parts and off peak user paying only one part.
The variable part could be based on connection time speed of connection etc.
TRANSACTION BASED PRICING: This model is a variant of the usage sensitive pricing.
In this model the pricing is transaction based and not usage based. In this we cannot distinguish between
different qualities of service.
PRIORITY PRICING:
In this model the users pay according to the quality of service chosen by them. This comes close to the
price discrimination model.
Ex: Electricity pricing where the user pays a fixed amount for the first block of units, a higher amount for
the next block and so on.

16