PRICING & OUTPUT

DECISION
- Market Structure
 Chapter Organization
• Introduction to Market Structure
• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly
 Market Structure
Determinants of market structure
• Freedom of entry and exit
• Nature of the product-
homogeneous, differentiated
• Control over supply/output
• Control over price
• Barriers to entry
 Classification of market based
on nature of competition
MARKET

Perfect competition Imperfect Competition

Pure Perfect Monopoly Oligopoly Monopolistic

 Perfect Competition
Assumptions
• Large number of Buyers & Sellers.
• Homogeneous product.
• Free entry & exist to industry.
• No govt. regulation.
• Price takers
• Perfect Knowledge of market conditions.
• Perfect mobility of factors of production.
• A perfectly competitive market is where
agents in the market (buyer&seller) are
price taker.
• Price taking behaviors: agents believe
that the market price is given and their
actions do not influence the market
price.
• Examples of Perfect Competition
- Financial markets - (stock exchange,
currency market), agriculture
FIRM-PRICE TAKER
 Equilibrium of firm in short run
(A) TR and TC approach TC
TR
C
R

XA XB X
(B) MR and MC approach
P

MC

P0 e P=AR=MR

0 Xe X
Profit Maximization for a Perfectly
Competitive Firm

• All firms maximization for a Perfectly

Competitive Firm
MR = MC
•Since the perfectly competitive firm is a
price taker, marginal revenue equals price.
MR = P
•Therefore, profits will be maximized where
MR (= P) = MC or P = MC
 Profit Maximization
All firms can maximize profits (or minimize
losses) by comparing marginal revenue (MR)
with marginal cost (MC)

• If MR > MC, profits are increasing

• If MR < MC, profits are decreasing
• Therefore, profits must be maximized where
MR=MC
• Since the perfectly competitive
firm is price taker, marginal
revenue equals price.
MR= P

• Therefore, profits will be

maximized where
MR (=P) = MC or P = MC
 Is the firm making a profit?

For a price taker, price is also equal to

the average revenue and we need to
compare average total cost with price in
order to tell whether the firm is making
a profit.
• If P > ATC , the firm is making a profit
that is , it is selling its output at mere
than its cost.
 •If P < ATC, the firm is losing money

MC
Price ,Cost, Revenue

ATC
E D
Loss C
F P=AR = MR

0
Quantity
 •If P > ATC, the firm is having super normal profits

MC
Price ,Cost, Revenue

ATC
P0 E P=AR = MR
Super Normal Profit
A B

0 Xe
Quantity
 •If P = ATC, the firm is having normal profits.
Price ,Cost, Revenue

MC ATC
C
B P=AR = MR

0
Quantity
Shut down point
What if the Firm is Losing
Money?

• If a firm is losing money, it has to decide whether

to operate at a loss or shut down.
• If a firm shuts down, its loss will be equal to the
amount of its total fixed costs.
• But, if a firm can cover its variable costs, it should
continue to operate even though it’s losing money.
The Shut-Down Condition
•If P < AVCmin , the firm should shut down.
Why? Because it’s not covering its variable costs.

•If P > AVCmin , the firm should continue to

operate at a loss.
Why? Because it will cover its variable costs

•The minimum of average variable cost is called

the shutdown price.
Short run equilibrium of industry
Long Run Equilibrium - Firm
Long Run Equilibrium- Industry