Unit 4 Price and Output Decisions Under Different Market Structures
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Price And Output Decisions Under Different Market Structures
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Economics - Price and output in Different Market condition
Transcript of Unit 4 Price and Output Decisions Under Different Market Structures
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
Perfect Competition
Perfect Competition
• The concept of Perfect Competition was
introduced by Dr. Alfred Marshall.
• Sometimes referred to as "pure
competition".
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 sellers and buyers
• Homogeneous Products
• Free entry and exit of firms
• Perfect mobility of factors of production
• Independent Decision making
• Perfect knowledge
• Indifference among the buyer towards sellers
• No Transport cost
• Price-taker not a Price-Maker
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 pricing that attempts to
take away the entire consumer’s surplus.
• This is also known as “TAKE-IT-OR-LEAVE-
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 rate of
production of the product.
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 will make zero
economic profit
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 firm’s 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 long-term 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
• Marginal cost pricing
• Going rate pricing
• Peak-Load pricing
• Charm pricing
• Cyclical pricing
• Product-Tailoring
• Refusal Pricing
• Cost-plus pricing
• Target return pricing
• Value-based pricing
• Psychological pricing
• Loss-Leader Tactics • Pricing
• 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 such as
BOGOF (Buy One Get One Free).
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-on-
investment
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
