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Price And Output

Decisions Under
Different Market
Structures

Market
Market is a system in which buyers and
sellers bargain for price of the product,
settle the price and transact their
business-buy and sell a product

Market does not necessarily mean a place.

Consumer Markets
A. Fast-moving consumer goods (FMCG's) News Papers
B. Consumer durables
i.

White

goods

(e.g.

fridge-freezers;

cookers;

dishwashers; microwaves)
ii. Brown goods (e.g. DVD players; games consoles;
personal computers)
iii. Soft goods - clothes, shoes
iv. Services - hairdressing, dentists, childcare

Industrial Markets
(Sale of Goods Between Businesses)
Selling

Finished

Goods

furniture,

computer

systems

Selling Raw Materials Or Components - steel, coal,


gas, timber

Selling Services To Businesses - waste disposal,


security, accounting & legal services

Market Structure

Market Structure

The competitive environment in which


the buyer and sellers of the product
operate.

Classification of the Market


Structure
Depending on the number of sellers and the degree of
Competition

Perfect Competition
Monopoly Competition
Monopolistic Competition
Oligopoly Competition

erfect
ompetition

Perfect Competition
The concept of Perfect Competition was
introduced by Dr. Alfred Marshall.
Sometimes
competition".

referred

to

as

"pure

Perfect Competition
Perfect degree of competition and single
price prevails

No buyer or seller has market power.

No single firm has influence on the price of


the product it sells.

Characteristics of Perfect
Competition
Large number of Independent
sellers and buyers
Decision making
Homogeneous
Products

Perfect knowledge

Indifference among
Free entry and exit
the buyer towards
of firms
sellers
Perfect mobility of No Transport cost
factors
of
production
Price-taker not a PriceMaker

Perfect Competition
Perfect competition is a theoretical market structure.

It is primarily used as a benchmark against which

other market structures are compared.

The industry that best reflects perfect competition in


real life is the agricultural industry

Perfect Competition
Perfect Competition is an Unrealistic
phenomenon
Examples
Share market
Securities and bond market
Agricultural markets
Local Vegetable market

Does Perfect Competition Exist In The


Real World?
Most products have some degree of differentiation
Many industries also have significant barriers to entry
Consumer awareness has increased with the information

age
Nothing is 100% perfect in this world.

So, this states that perfect competition is only a


theoretical possibility and it does not exist in reality

Price-Output Determination
Given
the
conditions
of
perfect
competition,
the
market
price
is
determined by the market forces (Market
demand and Market Supply)
The firm in a perfectly competitive market
is a Price-taker not a Price-Maker

Price Determination Rule

MC = MR
MC curve must cut MR curve
from below

Price-Output Determination
Price-Output Determination is analyzed
under perfect competition in two time
periods

A. Short Run
B. Long Run

Pricing in the Short-run


(Super normal Profit Equilibrium)

In the short-run, it is possible


for an individual firm to make a
profit.

Pricing in the Short-run


(Super normal Profit Equilibrium)

Pricing in the Short-run


(Loss Equilibrium)

Loss

Pricing in the Long-run


(Normal Profit Equilibrium)
In the long period, positive profit cannot be sustained.

The arrival of new firms or expansion of existing firms in

the market causes the (horizontal) demand curve of each


individual firm to shift downward, bringing down at the
same time the price, the average revenue and marginal
revenue curve.

Pricing in the Long-run


(Normal Profit Equilibrium)

The final outcome is that, in the long run,


the firm will make only normal profit (zero
economic profit).

Its horizontal demand curve will touch its


average total cost curve at its lowest point.

Pricing in the Long-run


(Normal Profit Equilibrium)

Normal Profit

Short-run & Long-run Equilibrium of Perfectly competitive firms

Long-run Equilibrium

Monopoly

Monopoly
Monopoly is the anti-thesis of Competition

In monopoly market there is a single seller,


there are no close substitutes for the
commodities and there are barriers to entry

Reasons for Monopoly


Legal Restrictions (Indian Railways)
Control over raw materials (Diamond company)

Efficiency
Patent over inventions
High cost of establishing an efficient plant

Characteristics of Monopoly
Single seller and a number of buyers
Absence of Competition
No close substitutes
Cross elasticity of demand is zero

Difficult to enter
Control over the supply of the commodity

Monopoly Pricing And


Output Decision
Short-run (Super Normal Profit)

Super
normal
Profit

Monopoly Pricing And


Output Decision
Long-run (Normal Profit)

Normal
Profit

Monopoly Equilibrium
(Supernormal Profit & Normal Profit)

Price Discrimination
seller price discriminates when it charges
different prices to different buyers.

The ideal form of price discrimination, from


the seller's point of view, is to charge each

buyer the maximum that the buyer is willing


to pay.

Degrees of Price Discrimination


First Degree Price Discrimination
Second Degree Price Discrimination
Third Degree Price Discrimination

First Degree Price Discrimination


The

discriminatory

attempts

to

take

pricing

away

the

that
entire

consumers surplus.
This is also known as TAKE-IT-ORLEAVE-IT

Second Degree Price


Discrimination

It is practiced when there are many


customers with different tastes and

with varying income levels.

Third Degree Price


Discrimination
Under this form, different prices are charged
for

the

same

homogeneous

good

for

different customers, depending upon various

factors (age, gender)

When Price Discrimination is


Possible?
If there is an imperfection in the market
Different elasticity of demand in the market
Different nature of the product (haircut)
Distance and frontier barriers

Monopolistic Competition
Monopolistic competition is a common market
form.
Monopolistic competition is a situation which
a large number of firms are offering similar
but not identical products.

It is a blend of Competition and Monopoly.

Monopolistic Competition

Monopolistic Competition
Many

markets

can

be

considered

monopolistically competitive, often including


the markets for restaurants, clothing, shoes

and service industries in large cities.

Characteristics of Monopolistic
Competition
Almost the same as in perfect competition,
with

the

exception

of

heterogeneous

products
Great deal of non-price competition (based
on slight product differentiation).

Characteristics of Monopolistic
Competition
Large number of sellers
Product differentiation
Non-price competition (More importance to Advertisements)
Free entry and exit
Independent behavior (independent pricing policy)
Producers have a degree of control over price

Short-run Pricing Equilibrium in Monopolistic


Competition
(Super Normal Profit)

A monopolistically competitive firm


acts like a monopolist in that the firm is
able to influence the market price of its
product

by

altering

the

production of the product.

rate

of

Short-run Pricing Equilibrium in


Monopolistic Competition
(Super Normal Profit)
Unlike in perfect competition, monopolistically
competitive firms produce products that are not
perfect substitutes.
As such, brand X's product, which is different
from all other brands' products, is available from
only a single producer.

Hence in the short-run a monopolistically


competitive firm may get profit or loss.

Short-run Pricing Equilibrium in


Monopolistic Competition
(Super Normal Profit)

In the short-run, the monopolistically


competitive
firm
can
exploit
the
heterogeneity of the market to reap
positive economic profit

Short-run Pricing Equilibrium in


Monopolistic Competition

(Super Normal Profit)

Short-run equilibrium of the firm


under monopolistic competition -

Loss

Long-run equilibrium of the firm under


monopolistic competition Normal Profit
In the long-run, one firm to reap
monopoly profits will be duplicated by
competing firms.
In the long-run, the monopolistically
competitive

firm

economic profit

will

make

zero

Long-run equilibrium of the firm


under monopolistic competition

Normal Profit

Oligopoly

Oligopoly
An oligopoly is a market form in which a market or

industry is dominated by a small number of sellers.

An oligopoly is competition among the few.

An oligopoly selling either homogeneous or


differentiated products.

Unique Characteristics of An
oligopoly
Few Sellers ( to 5 to 10)
Lack of uniformity in the size of the firm
More importance for Advertisement and Selling cost
Uncertainty in the rival behavior

Interdependence in price fixation


Constant war between firms on price

Outcome of the Unique


Characteristics of An oligopoly
Because there are few participants in this type of
market, each oligopolist is aware of the actions
of the others.

The decisions of one firm influence, and are


influenced by the decisions of other firms.
oligopolists always consider the responses of
the other market participants (Competitors).

Behavior Of An Oligopoly In Price


And Output Determination
The rival firms do not follow the leader if they
increase the price

The rival firms are forced to follow the leader if they


decrease the price

Kinked Demand curve and Rigid Prices in the


Industry

Kinked Demand curve of An


oligopoly
Above the kink, demand is
relatively elastic because all
other firms prices remain
unchanged.

Below the kink, demand is


relatively inelastic because all
other firms will introduce a
similar price cut, eventually
leading to a price war.

Therefore, the best option for


the oligopolist is to produce at
point E which is the equilibrium
point and the kink point.

Price And Output Determination In


Oligopoly Competition
The kinked demand curve
theory suggests that there will
be price stickiness in these
markets and that firms will rely
more on non-price competition
to boost sales, revenue and
profits.

If marginal costs (MC) fall in the


gap of the MR curve P* will
remain the profit maximizing
price and Q* will be the profit
maximizing output.

Other Market Models


Duopoly
Monoposony
Bilateral Monopoly
oligoposony

Duopoly

Duopoly

Two Sellers agree to share the


market to avoid price war

Monoposony

Monoposony
There is a single firm that buys
the entire market supply of an
output.

Bilateral Monopoly

Bilateral Monopoly

Single seller faces a single


buyer

Oligoposony
Few firms purchase the entire market
supply

For example
Professional sports clubs

Pricing policy and Practices

Pricing policy and Practices


One of the four major elements of the marketing
mix is price.
Pricing is an important strategic issue because it
is related to product positioning.
Furthermore, pricing affects other marketing mix
elements such as product features, channel
decisions, and promotion

Pricing Objectives
The firm's pricing objectives must be identified in
order to determine the optimal pricing.
The pricing objective depends on many factors
including production cost, existence of
economies of scale, barriers to entry, product
differentiation, rate of product diffusion, the firm's
resources, and the product's anticipated

Pricing Objectives

Current profit maximization


Current revenue maximization
Maximize quantity
Maximize profit margin
Quality leadership
Partial cost recovery
Survival
Status quo (Price Stabilization)
Preventing competition
Maintain market share

Current profit maximization


It seeks to maximize current profit, taking
into account revenue and costs.
Current profit maximization may not be the
best objective if it results in lower longterm profits.

Current revenue maximization


It seeks to maximize current revenue with
no regard to profit margins.
The underlying objective often is to
maximize long-term profits by increasing
market share and lowering costs.

Maximize quantity

It seeks to maximize the number of units


sold or the number of customers served in
order to decrease long-term costs as
predicted by the experience-curve

Maximize profit margin

It attempts to maximize the unit profit


margin, recognizing that quantities will be
low.

Quality leadership

use price to signal high quality in an


attempt to position the product as the
quality leader.

Partial cost recovery

An organization that has other revenue


sources may seek only partial cost
recovery.

Survival
In situations such as market decline and
overcapacity, the goal may be to select a
price that will cover costs and permit the
firm to remain in the market.
In this case, survival may take a priority
over profits, so this objective is considered
temporary.

Price Stability

The firm may seek price stabilization in


order to avoid price wars and maintain a
moderate but stable level of profit.

Pricing Objectives For new


products
For new products, the pricing objective often is
either to maximize profit margin or to maximize
quantity (market share).
To meet these objectives, skim pricing and
penetration pricing strategies often are
employed.
Joel Dean discussed these pricing policies in his
article entitled, Pricing Policies for New
Products

Skim pricing
It attempts to "skim the cream"
off the top of the market by setting a high
price and selling to those customers who
are less price sensitive.
Skimming is a strategy used to pursue the
objective of profit margin maximization.

Penetration pricing

Penetration pricing pursues the objective of


quantity maximization by means of a low price

Pricing Methods

To set the specific price level that


achieves
their
pricing
objectives,
managers may make use of several
pricing methods.

Pricing Methods
Full cost pricing

Refusal Pricing

Marginal cost pricing

Cost-plus pricing

Going rate pricing

Target return pricing

Peak-Load pricing

Value-based pricing

Charm pricing

Psychological pricing

Cyclical pricing

Loss-Leader Tactics
Pricing

Product-Tailoring
Resale Price maintenance

Full Cost Pricing


Direct costs per unit of output
+ a markup to cover overhead
costs and profits.

Marginal Cost Pricing

The policy of setting the price of a good


or service equal to the marginal cost of
producing it.

Going-Rate-Pricing
Establishing the price for a product
or service based on prevalent
market prices.

Peak Load Pricing

It is a pricing strategy that implies price


will
be set at the highest level during times
when demand is at a peak.

Cyclical Price
A single cycle has an upside during
which prices rise to a peak and a
downside when prices fall to a bottom

Product-Tailoring
Tailoring Products to Customer
Preferences

customized products to specific


needs

Economy Pricing
This is a no frills low price. The cost of marketing
and manufacture are kept at a minimum.

Supermarkets often have economy brands for


soups, spaghetti, etc.

Product Line Pricing


Where there is a range of product or services the
pricing reflect the benefits of parts of the range.

For example car washes. Basic wash could be $2,


wash and wax $4, and the whole package $6.

Optional Product Pricing


Companies will attempt to increase the amount customer
spend once they start to buy.

Optional 'extras' increase the overall price of the product

or service.

For example airlines will charge for optional extras such


as guaranteeing a window seat or reserving a row of
seats next to each other.

Captive Product Pricing


Where products have complements, companies
will charge a premium price where the consumer
is captured.
For example a razor manufacturer will charge a
low price and recoup its margin (and more) from

the sale of the only design of blades which fit the


razor.

Product Bundle Pricing


Here sellers combine several products in
the same package.

This also serves to move old stock.


Videos and CDs are often sold using the
bundle approach.

Promotional Pricing
Pricing to promote a product is a very
common application.

There are many examples of promotional


pricing

including

approaches

BOGOF (Buy One Get One Free).

such

as

Geographical Pricing
Geographical pricing is evident where
there are variations in price in different

parts of the world.

For example scarcity value, or where


shipping costs increase price.

Value Pricing
This approach is used where external factors
such as recession or increased competition

force companies to provide 'value' products


and services to retain sales
e.g. value meals at McDonalds.

Pricing Methods
Cost-plus pricing
set the price at the production cost plus a certain
profit margin.

Target return pricing


set the price to achieve a target return-oninvestment

Pricing Methods
Value-based pricing
based the price on the effective value to the
customer relative to alternative products.

Psychological pricing
base the price on factors such as signals of
product quality, popular price points, and what the
consumer perceives to be fair

Refer notes for other points