Chap 5 -- ME

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Chapter 5: Pricing under variousMarkets

Managerial Economics

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Meaning of Market

A place / region where Sellers and buyers areinteracted with goods and service by selling and

purchasing at a given price. It is considered as a Process

Goods and service Buyers and sellers

A place or region

Given price

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Perfect Competition Market

Classification of Market

Markets Form

Perfect Competition Imperfect Competition

Monopolistic Competition

Oligopoly

Duopoly

Monopoly

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Meaning of Perfect Competition Market

A Market situation in which a large number of

producers or sellers producing and sellinghomogeneous product.

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A Market situation in which a large number of

producers or sellers producing and sellinghomogeneous product.

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Main features of Perfect Competition Market

Each sellers sell a small portion total

Single sellers has no influence on market

Sellers are price taker

Large no. of buyersand sellers

Identical product

Same price and costHomogeneousproduct

There is no government or other controlFree entry andexit

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Main features of Perfect Competition Market

Perfect knowledge about the prevailing price.Perfect knowledgeabout market

Large no. of firm, so no transport or sellingcost

Homogeneous product, so no advt. needed

Absents of sellingcost and Advt.cost

Price is determined in the industry .A single price ofproduct

Example: Agricultural products

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Price determination Under PC

Equilibrium of the Industry:

When the total output of the industry is equal to

the total demand

Price prevailing is the equilibrium price

No buyer goes dissatisfied who wanted to buy at

that price and none of the sellers is dissatisfied

that he could not sell his goods at that price If price changes or the quantity changes the firm

wont remain in equilibrium

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Price determination in the industry

Price

Output

Demand Curve

Supply Curve

Excess supply

Excess Demand

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Equilibrium of the Firm:

When it maximizes its profit

The output which gives maximum profit is called

equilibrium output

In equilibrium state the firm has no incentive to

increase or decrease its output.

Firms are price takers because of presence of large no

of firms in the market with identical or homogeneousproducts

They have to accept the price fixed by the industry as

a whole

Price determination Under PC

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Nature of demand and AR, MR Curve of a firm

Out put Price TR AR MR

1 10

2 10

3 10

4 10

5 10

6 10

7 10

8 10

Price

Output

Price=AR=MR

Demand and AR, MR Curve of a firm

Out put Price TR AR MR

1 10 10 10 10

2 10 20 10 10

3 10 30 10 10

4 10 40 10 10

5 10 50 10 10

6 10 60 10 10

7 10 70 10 10

8 10 80 10 10

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Price determination in the industry

Price

Output

Price=AR=MR

Firm ( is a Price Taker)

Price

Output

Industry

Demand Curve

Supply Curve

First Condition for maximization of profit > MR= MC

Second Condition for maximization of profit > MC curve cut MR curve

from below

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The firms equilibrium(Out put determination)

Price

Output

Price=AR=MR

Firm ( is a Price Taker)

Price

Output

Industry

Demand Curve

Supply CurveMC

O M

MC=MR

EE0

First Condition for maximization of profit is MR= MC

Second Condition for maximization of profit is MC curve cut MR curve

from bellow

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Short run equilibrium of a firm with abnormal /super

normal profit

Profit

Price

Output

Price=AR=MR

Firm with Profit

MC

O M

MC=MR

E

AC

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Short run equilibrium of a firm with No profit No Losses

Price

Output

Price=AR=MR

Firm with Profit

MC

O M

MC=MR

E

AC

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Short run equilibrium of a firm with Losses

Losses

Price

Output

Price=AR=MR

Firm with Profit

MC

O M

MC=MRE

AC

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Long run equilibrium of a firm with Normal Profit

Price

Output

Price=AR=MR

Firm with Profit

LMC

O M

MC=MR

E

LAC

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Introduction

Monopolyis a market structure in which a

single firm makes up the entire market.

Monopolies exist because of barriers to entry

into a market that prevent competition.

18

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The Monopolists Price and Output

Graphically

The marginal revenue curve is a graphical

measure of the change in revenue that occurs

in response to a change in output.

It tells us the additional revenue the firm will

get by expanding output.

19

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MR = MCDetermines the Profit-

Maximizing Output

If MR > MC, the monopolist gains profit by

increasing output.

If MR < MC, the monopolist gains profit by

decreasing output.

If MC = MR, the monopolist is maximizing

profit.

20

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The Price a Monopolist Will Charge

The MR = MCcondition determines the

quantity a monopolist produces.

The monopolist will charge the maximum

price consumers are willing to pay for that

quantity.

That price is found on the demand curve.

21

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The Price a Monopolist Will Charge

To determine the profit-maximizing price

(where MC = MR), first find the profit

maximizing output.

22

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Determining the Monopolists Price

and Output

MC

$36

3024

18

12

6

0

6

12

Price

1 2 3 4 5 6 7 8 9 10

D

MR

Monopolistprice

23

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Comparing Monopoly and Perfect

Competition

Equilibrium output for both the monopolist

and the competitor is determined by the MC

= MRcondition.

24

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Competition

Because the monopolists marginal revenue is

below its price, price and quantity will not be

the same.

The monopolists equilibrium output is less

than, and its price is higher than, for a firm

in a competitive market.

25

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Competition

$36

30

24

18

12

60

6

12

PriceMC

1 2 3 4 5 6 7 8 9 10

D

MR

Monopolistprice

Competitive price

26

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Profits and Monopoly

Draw the firm's marginal revenue curve.

Determine the output the monopolist will

produce by the intersection of the MCand MR

curves.

27

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Determine the price the monopolist will

charge for that output.

Determine the average cost at that levelof output.

28

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Determine the monopolist's profit (loss) by

subtracting average total cost from average

revenue (P) at that level of output and

multiply by the chosen output.

29

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The monopolist will make a profit if price

exceeds average total cost.

The monopolist will make a normal returnif price equal average total cost.

The monopolist will incur a loss if price is

less than average total cost.

30

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A Monopolist Making a Profit

A monopolist can make a profit.

31

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A Monopolist Making a Profit

Price

ATC

MC

Quantity

PM

0

MR D

QM

Profit

CM

A

B

32

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A Monopolist Breaking Even

A monopolist can break even.

33

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A Monopolist Breaking Even

PriceMC

Quantity

PM

0

MR D

QM

ATC

34

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A Monopolist Making a Loss

A monopolist can make a loss.

35

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A Monopolist Making a Loss

Price ATCMC

Quantity0

MR D

QM

LossPM

CMB

A

36

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Cartels

Cartels can be defined as the formal organization ofgroup of firms that tries to act as if it is one firm in

the industry. Cartels appoint a central agency to deal

with the day to day affairs and to regulate the price.

Example: Organization of Petroleum Exporting

Countries (OPEC) is perhaps the best known cartel

worldwide. OPEC restricts the production of oil to

create the scarcity of oil in the international market.It was between 1972 and 1974, when the price of oil

rose from $3 to $12. It was due to the restrictions on

the oil production by the member countries.

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Cartels are of two types,

Joint profit maximization cartels

cartels aimed at market sharing.

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Cartels Aimed at Joined Profit

Maximization

The aim of such a cartel is to maximize

the industry profit.

Firms enter into a direct agreement withthe aim of reducing the uncertainty as a

result of the mutual interdependence.

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Market Sharing Cartels

As the name suggests in this form of cartel,

firms share the market, keeping a considerable

degree of freedom concerning the style of their

output, their selling activities and otherdecisions.

There are two methods for sharing the market:

non-price competition agreements and

determination of quotas.

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Non-price competition agreements

In this type of cartel, firms agree on a price, atwhich each of them can sell any quantity

demanded.

Prices are set by hard bargaining. Cost structureof the firm plays an important role. The firm with

low cost structure would like to go for lower

price, whereas the firms with high cost structure

pressing for high prices.

Firms maintain freedom of advertising and selling

policies

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Sharing of the market by agreement

on quotas

Here firms agree on a specific quantity of

quota to be sold in the market at an agreed

price.

In this type of cartels too, cost structure of the

firm plays an important role. Based on the cost

structure firms decide on the output that each

firm can produce.

If the cost structure is same for all the firms,

they produce the same quantity.

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Measurement of Monopoly Power

Consumers has less choice of product & price

If the product of monopolists are input to

other firm, the situation poses a great risk from

security point of view as well as from the

macro economic point of view

Any trouble within the monopoly firm, if the

production stops, the entire economy is thrownout of gear

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Governments have often sought to control

monopolies

Monopolies & Restrictive Trade Practices Act

(MRTP) in India is an example.

So the consideration of measuring monopoly

power come into existence

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Main Measure are:

1)Number of firms criterion: counting the

number of firms in an IndustryMany a times

Oligopoly is deemed to be monopolist

Limitation : Size of the firm

2) Concentration Ratio: measures the percentage

share of one firm or a group of the largest firm in

the total Industry outputLimitation: No consideration of Unused/idle capacity

Local/National Difference Not Considered

) f d h

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3)Excess Profit Criterion: J.S. Bain Promoted this

method

If a firms profit rate continuously remains higher than

all opportunity costs necessary for keeping the firm in

the industry, it should be construed that the firm is

making excess profits.

Lerners Measure: MP = P - MC

P

Where, MP is Monopoly Power, P is Price and MC is marginal

cost

Limitation: Any firm can earn super-normal profit in a short run

Statistical Data regarding marginal cost can hardly be available

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4) Cross Elasticity Criterion:

Prof. R. Triffin has suggested this method.

The lower the cross elasticity of the product, the

greater would be the degree of the producers

monopoly and vice-versa

Limitation: only relative measure and not single

usable index of monopoly power.

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Chap 5 -- ME

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