Pricing decisions

Market structures and barriers to entry. entry. Pricing under pure competition& monopoly. Pricing under monopolistic and oligopolistic competition. competition. Pricing strategies.

Market structures and barriers to entry

y Four Market Structures

y Pure Competition:
Market structure characterized by homogeneous products in which there are so many buyers and sellers that none has a significant influence on price
y Monopolistic Competition: Market structure involving a heterogeneous product and product differentiation among competing suppliers, allowing the marketer some degree of control over prices

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y Oligopoly Oligopoly: Market structure involving relatively few sellers and barriers to new competitors due to high start-up costs y Monopoly Monopoly: Market structure involving only one seller of a good or service for which no close substitutes exist 18-4 .

Factors determining the nature of competition y Effect of buyers negotiation across the table Production characteristics Product characteristics .

more commonly. y Barriers to entry are the source of a firm's pricing power the ability of a firm to raise prices without losing all its customers. barriers to entry are obstacles in the path of a firm that make it difficult to enter a given market y Barriers to entry protect incumbent firms from competition from newcomers. industry or trade grouping. refers to hindrances that a firm (or even a country) may face while trying to enter a market. .Barriers to entry y in the theory of competition. y The term refers to hindrances that an individual may face while trying to gain entrance into a profession or trade. Barriers to entry restrict competition in a market. It also.

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Firms Are Price Takers This means that the individual firm treats the market price of the product as given. 2. The Four Conditions For Perfect Competition Firms Sell a Standardized Product The product sold by one firm is assumed to be a perfect substitute for the product sold by any other. .PRICE DETERMINATION UNDER PERFECT COMPETITION y 1.

Free Entry and Exit With Perfectly Mobile Factors of Production in the Long Run 4.Firms and Consumers Have Perfect Information . 3.CONTD .

i. the perfect competitive firm takes the price of the product . e. y since all the firms products are homogeneous . y There is no reason to sell the product below the market price.PRICE DETERMINATION UNDER PERFECT COMPETITION y THE PRICE of the product is determined at the intersection of market demand curve and market supply curve of the product. y Perfect competitive firm is price taker. a firm cannot sell at a price higher than the market price of the product. .

..Contd .

a one producer of a specific product y No Close Substitutes .no reasonable alternative products y "Price Maker" . .the firm exercises considerable control over price because it is responsible for the quantity supplied.Price determination under monopoly Pure Monopoly y exists when a single firm is the sole producer of a product for which there are no close substitutes y Characteristics y Single Seller .

Contd . y Totally Blocked Entry . technological.. legal obstacles y Advertising .monopolies may or may not advertise y monopolist selling luxury good can advertise to increase demand y monopolist selling utilities/necessities will not advertise .no competitors because of economic.

Contd Examples ygas/electric companies ywater boards yIndian railways . .

.This implies that the monopolist cannot sell more without lowering the price.Price determination under monopoly Monopoly Demand Curve y The demand curve in a monopoly is down-sloping .

.Short run price output determination y Monopolist is not a price taker but can set the price at which it sells the product . y This means the monopolist can sell more units by lowering the prices. y We now going to understand how a monopolist sets price to maximize profits in short run. y Since monopolist is the sole seller for which there are no close substitutes. the monopolist faces the negatively sloped market demand curve.

y Because of this marginal revenue is smaller than the product price y Marginal revenue curve is below the demand curve.Contd . .

E .

y From the fig d is the market demand curve.MR is the corresponding marginal revenue curve.Contd . y Best level of output in the short run is given by point E.at which MR = MC y When MR > MC the total profit of the monopolist will increase by expanding output y When MC > MR total profit of monopolist will increase by reducing output. .

y The best level of output of monopolistically competitive firm in short run is given by the one at which marginal revenue is equal to marginal cost. provided that price exceeds average variable cost .Price determine under monopolistic competition y Since monopolistically competetitive market produces differentiated products . the demand curve is highly price elastic. the price elasticity is higher the smaller the product differentiation. y But there are many close substitutes for the products. then demand curve is negatively sloped.

13 MC ATC A F E D 9 7 P B 5 MR 0 3 4 6 9 Q .

And the total profit of the firm increases by reducing the output. y The best level of output of typically monopolistic competitive firm is 6 units. AT Q< 6 MR > MC and the total profit of the firm increases by expanding the output.Contd . At Q> 6 . MC>MR. At which MR=MC. . And is given by point E.

y AND AFBP = RS 12 IN TOTAL. monopolist also incur losses. the monopolistic competitor earns the profit of rs 2 per unit. y As in the perfect competitive market .E. . (6units) the firm charges the price rs9 per unit (point a on d curve) y Since at q=6. profits& breakeven in short run.CONTD y To sell the best level of output i. (point F on figure) . ATC = rs7.

THE FIRM BREAKS EVEN.THE FIRM EARN PROFITS.CONTD y IF AT THE BEST LEVEL OF OUTPUT P > ATC . y IF P < ATC THEN THE FIRM INCURRS LOSSES. y IF P=ATC .BUT MINIMISING THE LOSSES BY CONTINUING TO PRODUCE AS LONG AS P>AVC .

y Oligopoly differs from monopoly and monopolistic competition in this that in monopoly. in monopolistic competition.Price determination under oligopoly y Oligopoly is that market situation in which the number of firms is small but each firm in the industry takes into consideration the reaction of the rival firms in the formulation of price policy. there are only a small number of sellers. and in oligopoly. there is a single seller. y The number of firms in the industry may be two or more than two but not more than 20. . there is quite a larger number of them.

y The demand curve is drawn on the assumption that the kink in the curve is always at the ruling price. : .PRICE DETERMINATION MODELS OF OLIGOPOLY: y Kinky Demand Curve: The kinky demand curve model tries to explain that in non-collusive oligopolistic industries there are not frequent changes in the market prices of the products. The reason is that a firm in the market supplies a significant share of the product and has a powerful influence in the prevailing price of the commodity.

a firm has two choices y The first choice is that the firm increases the price of the product. it will lose most of its customers to its rival. Each firm in the industry is fully aware of the fact that if it increases the price of the product. the upper part of demand curve is more elastic than the part of the curve lying below the kink. . In such a case.Under oligopoly.

compete with one another on the basis of quality. y The second option for the firm is to decrease the price. y The oligopolists.Contd . If the rival firms make larger price cut than the one which initiated it. special offers. and try to sell their products at the prevailing market price. however. the firm which first started the price cut will suffer a lot and may finish up with decreased sales. These firms. y In case the firm lowers the price. discounts. after-sales services. product design. gifts. its total sales will increase. therefore avoid cutting price. but it cannot push up its sales very much because the rival firms also follow suit with a price cut. . warrantees. etc. advertising.

During this discontinuity the marginal cost curve is drawn. we shall notice that there is a discontinuity in the marginal revenue curve just below the point corresponding to the kink. . This is because of the fact that the firm is in equilibrium at output ON where the MC curve is intersecting the MR curve from below.Contd . y In the above diagram.

Its sales with a big price cut of Rs. its competitors in the industry will match the price cut. it loses a large part of the market and its sales come down to 40 units with a loss of 80 units. 10 per unit. 4 per unit. 6 increases the sale by only 40 units. When the price is Rs. .Contd y The demand curve is kinked at point B. If a firm decides to charge Rs. a firm sells 120 units of output. The firm does not gain as its total revenue decreases with the price cut. In case. the producer lowers the price to Rs. 12 per unit.

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for reasons not associated with costs. .Price discrimination y Most businesses charge different prices to different groups of consumers for what is more or less the same good or service! This is price discrimination and it has become widespread in nearly every market. y It is important to stress that charging different prices for similar goods is not pure price discrimination. y Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service.

. y We must be careful to distinguish between price discrimination and product differentiation differentiation of the product gives the supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service.Contd .

y Peak-load pricing is often used by electricity and telephone utilities as a means of reflecting the investment they have made to meet peak demand for their services. The most recent analysis of this pricing policy stems from American research in the 1960s and 1970s.Peak load pricing y Peak-load pricing is a policy of raising prices when the demand for a service is at its highest. .

a camera retailer may offer a discounted price when customers purchase both a digital camera and a how-to photography DVD that is lower than if both items were purchased separately. For buyers. In this example the retailer may promote this as: Buy both the digital camera and the how-to photography DVD and save 25%. the technique is often used to sell products that are complementary to a main product. For example.Bundling y bundle pricing. . the overall cost of the purchase shows a savings compared to purchasing each product individually.

Two part tariff y A two-part tariff is a pricing technique in which the price y y y y y of a product or service is composed of two parts. Examples of two-part tariffs include: "membership discount retailers" such as shopping clubs that charge an annual fee for admission to the point of sale and also charge for your purchases amusement parks where there are admission fees and also per-ride fees cover charge for bars combined with per drink fees credit cards which charge an anual fee plus a per-transaction fee loyalty cards or clubs .

Consumers of one product could be more price elastic than the consumers of the other product (and therefore more sensitive to changes in the product's price). . To begin with there are two demand curves.Pricing of joint products y Pricing for joint products is a little more complex than pricing for a single product. The characteristics of each demand curve could be different. Demand for one product could be greater than for the other product.

or they could be linked in the sense that they can be produced by the same inputs (referred to as substitutes in production). There are complexities in the production function also. because they are produced jointly. share a common marginal cost curve. production of the joint product could be in fixed proportions or in variable proportions.Contd y To complicate things further. Their production could be linked in the sense that they are biproducts (referred to as complements in production). . both products. Also.