Market price and output determinantion

1. Pricing and Output Decision in Different
Markets
By
Udai Bhan Singh, PhD
ABS, AUR

2. 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

3. Type of Markets
• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

4. Q AR (P) TR MR
1 10 10 10
2 10 20 10
3 10 30 10
4 10 40 10
5 10 50 10
6 10 60 10
7 10 70 10
Average Revenue and Marginal Revenue –
Perfect Competition

6. AR and MR – Monopoly and Monopolistic
Competition
Q AR (P) TR MR
1 10 10 10
2 9 18 8
3 8 24 6
4 7 28 4
5 6 30 2
6 5 30 0

7. Monopoly
Monopolistic Comp.

8. AR & MR: Oligopoly

16. Market Sharing Under Perfect Competition
• Short Run
1. Profit (AR > AC)
2. Normal Profit (AR=AC)
3. Loss (AR < AC)
• Long Run
1. Normal Profit (AR=AC)

17. Industry – Firms Equilibrium Under Perfect
Competition – Short Run

18. Industry – Firms Equilibrium Under Perfect Competition
– Short Run

19. Monopoly
Features
• Single Seller
• Single Product
• No difference between Firm and industry
• Independent Decision making
• Restricted Entry

20. Reason for Monopoly
• Monopolies often arise as a result of barriers
to entry.
• Barrier to entry: anything that impedes the
ability of firms to begin a new business in an
industry in which existing firms are earning
positive economic profits.

21. Common Entry Barriers
Economies of scale
– When long-run average cost declines over a
wide range of output relative to demand for the
product, there may not be room for another
large producer to enter market
Barriers created by government
– Licenses, exclusive franchises

22. Input barriers
– One firm controls a crucial input in the
production process
Brand loyalties
– Strong customer allegiance to existing firms
may keep new firms from finding enough buyers
to make entry worthwhile
Consumer lock-in
– Potential entrants can be deterred if they
believe high switching costs will keep them from
inducing many consumers to change brands

23. Network externalities
– Occur when value of a product increases as
more consumers buy & use it
– Make it difficult for new firms to enter markets
where firms have established a large network of
buyers

24. Sources - Barriers to entry
– Ownership of a key resource.
– The government gives a single firm the
exclusive right to produce some good.
– Costs of production make a single producer
more efficient than a large number of producers

26. Types of Monopolies
• Natural monopoly: it is formed when the size of
the market is so small that it can accommodate
only one player.
• Local/Regional monopoly: a monopoly that
exists in a limited geographic area.
• Economic Monopoly: Created whenever
competition is eliminated due to economic
efficiency of other players or due to superior
efficiency of a particular player.
• Monopolization: an attempt by a firm to
dominate a market or become a monopoly.

27. Legal/Regulated monopoly :
It is created when the government restricts
entry of other players in particular market in
order to keep total control in hand.
A monopoly firm whose behaviour is overseen
by a government entity. – Public utility sector in
India

43. • Monopolistic Competition refers to those market structures
that fall between perfect competition and pure monopoly.
• Markets that have some features of competition and some
features of monopoly
• Concept of monopolistic competition – Prof Chamberlin's
theory of monopolistic competition.
• The basic assumptions of monopolistic competition is same as
perfect competition except homogeneity of product.
Monopolistic Competition

44. Attributes of Monopolistic Competition
• Large number of firms each satisfying a small , but not
microscopic. Share of market demand for a similar not
identical.
• Products are close (not perfect) substitutes- seller of each
product group can be considered competing firms within
industry.

45. • Market is monopolistic
– Product differentiation creates a degree of market power
• Market is competitive
– Large number of firms, easy entry
• Product Differentiation
– Each firm produces a product that is at least slightly different
from those of other firms.
– Rather than being a price taker, each firm faces a
downward-sloping demand curve.

46. • The firm in the market do not consider the reaction of rivals
when choosing their product prices or annual sales target.
• Relative Freedom of Entry or Exit
• Neither opportunity nor the incentive exists for the firm sin the
market to cooperate any ways that decrease competition.
• The number of firms in the market adjusts until economic
profits are zero.

47. Product Differentiation
• Product quality
• Services
• Location
• Advertising and Packaging

48. Price and output determination under monopolistic
competition
• Pricing and output decision similar to monopoly as
- It face a downward sloping demand function which is
because of
- a strong preference of a section of consumers for the product
and
- Quasi monopoly of the seller over supply
• Brand loyalty or strong preference of the consumer gives seller
the opportunity to raise price and yet retain some consumer.
• Since each product is a substitute for the other, the firm can
attract the consumer of other products by lowering price.

49. • Short run
 super normal profit
 Normal profit
 Loss
• Long run
 Normal Profit

50. Competition with differentiated products
• Short-run economic profits encourage new firms to enter
the market :
 Increases the number of products offered.
 Reduces demand faced by firms already in the market.
 Incumbent firms’ demand curves shift to the left.
 Demand for the incumbent firms’ products fall, and their
profits decline.

51. • Short-run economic losses encourage firms to exit the
market :
 Decreases the number of products offered.
 Increases demand faced by the remaining firms.
 Shifts the remaining firms’ demand curves to the right.
 Increases the remaining firms’ profits.

54. Normal Profit

56. Price and output determination in the long run
• The super normal profit in the long run attracts new firms into
the industry – loss of market share – normal profit
• Increasing number of firm intensifies the price competition
between them.
• Price competition increases – existing firm cut down price to
retain or regain market share – new firms lower to penetrate
the market
• Demand curve more elastic

58. Excess capacity in the monopolistic competition
• Each firm will be equilibrium at the fall in portion of AC not at
the minimum point
• Excess capacity theorem
• There is excess capacity with each firm- more output can be
produced at a lower cost

60. Advertising and Brand Name
The product differentiation inherent in monopolistic
competition leads to the use of advertising and brand names
 Critics argue that firms use advertising and brand names to take
advantage of consumer irrationality and to reduce competition.
 Defenders argue that firms use advertising and brand names to
inform consumers and to compete more vigorously on price and
product quality.

61. Impact of advertising and other cost of production and selling
 These types of cost incurred to sell more of a product without
reducing its price must be added to production costs to
compute the average cost and contribute to higher price.
 This leads to increase in average cost
 Consumer buys more of the advertised goods, however
resources are diverted from the production of other goods
to provide the advertising.

63. Non price competition – product innovation and
advertisement
Two common form of non-price competition is:
1. Product innovation
2. Advertisement
• Both go on simultaneously.
• Cost incurred on these-selling cost
• Increase in selling cost – ASC initially decreases but ultimately
increases – ASC is u shaped like AC curve
• Non price competition through selling cost leads all the firms
to an almost similar equilibrium.

64. Firm’s Group Equilibrium

65. Short Run Equilibrium

66. Long Run Equilibrium or Long-Run Adjustment

67. Critical appraisal of Chamberlin's theory
• Assumption of independent pricing and output decision – firms are
bound to get affected by decisions of rivals since their products are
close substitutes.
• Firms do not learn from past experience – difficult to accept
• Product group is ambiguous – each firm is an industry by virtue of
its specialized and unique product.
• Heroic assumption of identical cost and revenue curves are
questionable.
• Assumptions of free entry is considered incompatible with product
differentiation.
• It is difficult to find any example in the real world with all
characteristics of monopolistic competition to which this model is
relevant.

68. Oligopoly
• Oligopoly is the most realistic types of market and yet is
the most complicated to be defined as theory.
• It comes from Greek word “oligo” means few and ‘polo’
means sell – it means market with a few seller.
• Oligopoly is a market where a few dominant sellers sell
differentiated or homogeneous products under continuous
consciousness of rival’s action.

69. Characteristics of Oligopoly
• Interdependence
• Importance of advertising and selling cost
• Group Behaviour
• Indeterminateness of demand curve facing an oligopoly

70. • Only a few firms supply the entire market with a product that
may be standardized or differentiated.
• At least some firm have large market shares and thus can
influence the price of the product.
• The Firm is oligopolistic are aware of their interdependence
and always consider their rival’s reaction when setting prices,
output goals, advertising budgets and other business policies.

71. • Entry Barrier
- Huge investment requirement
- Strong consumer loyalty for existing brands
- Economies of scale

72. Non - Price Competition
- Oligopoly firms avoid price war because it will not benefit
firms only benefit consumers.
- They resort to other strategies like highly aggressive
advertisement, product bundling, influencing value
perception of consumers, branding and offering better
service packages.
- The extreme case of non price competition is the
formation of cartels.
- Firms also tacitly agree to sell their products in separate
market and at the same price.

73. Indeterminateness of the demand curve
• Demand is affected by own price, advertisement and quality
• Price of Rival’s product, their quality, packaging and
• Promotion
• Oligopoly firm face two demand curves, highly elastic, less
elastic – different types of reaction by rivals firm in response
to change in price

74. Duopoly
• Special case of oligopoly – only two players in the market
• During price war less efficient firm had to exit or the price reached
after the price war is so low that new firms do not find market
attractive or small firma may not able to survive due to high cost.
• The other possibility of duopoly that there are many small players,
but two large players are competing and created duopoly like
situation.
• Example –
• Jio and Airtel
• Pepsi and Coca cola

75. Equilibrium Price and output
• Due to interdependence, there is an uncertainty about the
reaction pattern of rivals.
• A wide variety of reaction pattern become possible and
accordingly a large variety of models of price output
determination may be constructed.
• The actual solution is therefore indeterminate unless there
is specification of particular reaction pattern of the rivals.

76. Price and output determination
 Collusive oligopoly
i. Cartel
ii. Price Leadership
 Non-Collusive oligopoly
i. Kinked Demand Curve
ii. Cournot’s Model of Duopoly
iii. Stackelberg’s Model

77. Cartel
• It imply direct agreement among competing Oligopolist with
the aim of reducing uncertainty.
• The aim of cartel is the maximization of joint profit.
• The firms appoint a central agency, to whom they delegate
authority to decide not only the total quantity and the price but
also the allocation of production among the members of the
cartel and the distribution of joint profits among them.
• The central agency has full information about the cost function
of the firms.
• It is assumed that all members produce identical products.

79. Price Leadership
Types of Price Leadership
1. By low cost firm
2. By dominant firm
3. Barometric price leadership
4. By aggressive price policy

80. Low cost price leadership: Price and output
determination
• Assumption:
1. There are two firms, A and B. The firm A has lower cost than
firm B.
2. Product is homogeneous.
3. Each of the two firm has equal share in the market.

82. Price leadership by dominant firm: Price and
output determination
• Oligopoly market is dominated by few firms among
which one may be the largest player.
• Example : Google, Intel, Nokia, IBM, Maruti, Godrej etc.
• The other firms acknowledge the leadership of the largest
firm for price determination.
• A dominant firm is a leader in term of market share or
presence in all segments, or just being the pioneer in
particular product category.
• Leader is very large in size and earns economies of scale,
produces optimum output at which it is able to maximize
returns.

83. • This dominant firm may be either a benevolent or an
exploitative firms.
• A benevolent firm allows other firm to exist by fixing a price
at which small firms may also sell.
• An exploitative leader fixes a price at which small inefficient
players may not survive and thus it gains a large share of the
market.

84. Price leadership by dominant firm: Price and output
determination

85. Non-Collusive Oligopoly
• Kinked Demand Curve
• Cournot’s Model of Duopoly
• Stackelberg’s Model

86. Sweezy’s kinked demand curve model of
Oligopoly
• Assume no cooperation or collusion among firms
• This model helps explain why the prices in some oligopolistic
markets change very slowly over time – individual firms are
basically afraid to change price because of what other firms
might do.

87. Assumptions
• If a firm raises prices, other firms won’t follow and the firm
loses a lot of business. So demand is very responsive or elastic
to price increases.
• If a firm lowers prices, other firms follow and the firm doesn’t
gain much business. So demand is fairly unresponsive or
inelastic to price decreases.

88. • If reduce price and competitors match the price cut then move along more
inelastic demand segment.
• If increase price and competitors do not follow then move along the more
elastic segment.

91. Conclusion
• This model provides a detailed description of firm under
oligopoly and explain various characteristics such as price
rigidity, indeterminate demand curve, non price competition
and interdependent decision makings.
• However this model fails to explain basic questions , how
price is determined.

92. Cournot’s Duopoly Model
• This model Illustrate the market situation under oligopoly with an
example of two firms engaged in production and sale of mineral
water. Each firms own a spring mineral water which is available free
from nature.
• In cournot model, it is assumed that an oligopolist thinks that his
rival will keep their output fixed regardless of what he might do.
That is, each oligopolist does not take in to account the possible
reactions of his rivals in response to his actions.
• The crux of this model is a situation in which firms ignore
independence and take decisions as if they are operating
independently in the market.

93. Assumptions:
 Two interdependent sellers selling homogeneous goods.
 Large number of buyers in the market
 Identical cost curves, each duopolist has a zero cost of production.
 Each duopolist makes an output plan during a period which cannot
be revised in that period.
 Neither of the duopolist sets the price but each accepts the price of
his product at which total planned output can be sold.
 Though each duopolist is aware of the mutual interdependence
between their output plans, each is quite ignorant of the direction
and magnitude of the revision in his rival’s plan that would be
induced by any given change in his own.

94. Cournot’s Approach to Equilibrium of the Duopolist
• Only the demand side of the market is analysed.
• Duopolist fully know the market demand for the mineral
water.
• Market demand for the product is assumed to be linear, that is
market demand curve facing the two producers is a straight
line.
• The duopolist amount of output will be most profitable for him
to produce in the light of his rival’s present output and
assumes that it will remain constant.

96. Conclusion
• As per cournot’s solution, equilibrium is stable and each firm
will be maximizing profit by selling equal amounts of output
at the same price.
• Equilibrium is reached when both the firms earn maximum
profit and have no tendency to change their output.