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perfect competition, monopoly, monopolistic and oligopoly


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Price determination under different market structure and characterstics of all these market stractures along with graphical presentation of Perfect competition, Monopoly, Monopolistic and Oligopoly market structue

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perfect competition, monopoly, monopolistic and oligopoly

  1. 1. Average Revenue Concepts        It is defined as total revenue divided by total number of units sold i.e. AR = TR / q1 Where, AR stands for average revenue TR for total revenue Q1 for total output produced, If TR is 2000 and q1 is 20, the AR will be 100 i.e. (2000/20) Sandeep Kapoor MIET, Meerut
  2. 2. Average Revenue Concepts  The AR will be same as the price   But when seller sells different units of the product at different prices   If we assume that the same price is charged to every unit. Then average revenue will not be equal to price In actual life however, seller usually charges the same price for the different units of the product. Sandeep Kapoor MIET, Meerut
  3. 3. Average Revenue Concepts  Thus in Economics we use price & average price as synonyms    And since the buyer’s demand curve represents the quantities demanded at various prices. It also shows the average revenue at which the various amount of goods are sold by the seller. Therefore, the demand curve is generally called average revenue curve. Sandeep Kapoor MIET, Meerut
  4. 4. Average Revenue Concepts And any point on demand curve gives the average revenue realizable from the sale of that particular quantity per unit.  Again assuming that a single price is charged for all units sold.  Sandeep Kapoor MIET, Meerut
  5. 5. Equilibrium of the firm The term equilibrium implies a state of balance or a position of no change.  A firm is said to be in equilibrium when it has no motive:   To change it’s scale of production This state would be possible only when it is earning maximum net profits.  In short, a firm is in equilibrium when it is earning maximum net money profits.  Sandeep Kapoor MIET, Meerut
  6. 6. Tabular clarification Equilibrium of the firm Units TC Sales MC 100 800 1000 400 3600 4000 9.33 500 4800 5000 10 600 5900 6000 10.20 Sandeep Kapoor MIET, Meerut MR 10 10 10
  7. 7. Equilibrium of the firm  Assumptions   The firm behaves in a rational manner & tries to secure maximum net money profit out of it’s business. Through a series of experiments the firm discovers a level of output which gives maximum profits to it. Sandeep Kapoor MIET, Meerut
  8. 8.   Equilibrium of the firm Conditions  It’s marginal cost (MC) must be equal to it’s marginal revenue (MR).  It’s MC curve cut it’s MR curve from below. There are various market conditions such as:  Perfect competition  Monopoly  Monopolistic  Oligopoly  But before studying price determination under these market conditions. We need to understand these forms of market one by one Sandeep Kapoor MIET, Meerut
  9. 9.  Perfect Competition It has following characteristics:  There is a large number of buyers and sellers in the market.  Each buyer and seller has perfect information about prices & output.  The product being sold is homogenous i.e.  It is not possible to distinguish the product of one from that of other. Sandeep Kapoor MIET, Meerut
  10. 10. Perfect Competition There are no barriers to entry into or exit from the market.  All firms are price taker i.e.  No single firm is large enough to exert control over the product price  Perfect mobility of factors of production  Sandeep Kapoor MIET, Meerut
  11. 11. Price Determination under Perfect Competition  There are three periods namely: 1. Market Period 2. Short Period 3. Long Period Sandeep Kapoor MIET, Meerut
  12. 12. Price Determination under Perfect Competition Market Period  It may be only of a few days i.e. specially for  Perishable goods as milk, vegetables, rice and fruit or  Goods which are durable can be stored for sometimes as wheat, soap and oil etc.  As such the supply in this period can not be varied in response to change in demand.  The supply is taken as fix in this period.  The price in the market period is determined more by demand than supply. Sandeep Kapoor MIET, Meerut
  13. 13. Price Determination under Perfect Competition During Market period for perishable goods T D1 Price P1 D P M Quantity  In the graph D is the market demand.  Supply is fixed at TM  The market price will be P at fixed supply  If demand increases the price will also increase to P1. Sandeep Kapoor MIET, Meerut
  14. 14. Price Determination under Perfect Competition During Market period for Durable goods S Price D1 P2 P1 P D2 D S M M1 M2 Quantity  In the graph the supply curve is shown as sloping upward.  But the maximum quantity industry can supply is OM2 beyond which the supply curve slopes vertically. Sandeep Kapoor MIET, Meerut
  15. 15. Price Determination under Perfect Competition During Short Period Short Period  It may be only of a few months.  The supply will be adjusted to the demand.  Short period price is determined at the intersection of supply and demand curves. D1 Price P2 D P1 P S M M1 Quantity Sandeep Kapoor MIET, Meerut S
  16. 16. Price Determination under Perfect Competition During Long Period It may be defined to long enough to enable an industry to adjust output to an increase in demand. In the long run the number of firms in a perfectly competitive industry is not fixed. A long period demand represents the various quantities which firms may be expected to demand of a product. Sandeep Kapoor MIET, Meerut
  17. 17. Price Determination under Perfect Competition During Long Period On the other hand long period supply refers to the schedule of total quantities that would be produced and supplied. In long run the supply will be adjusted to the demand not only with existing but with additional capital. Sandeep Kapoor MIET, Meerut
  18. 18. Price Determination under Perfect Competition During Long Period Long Period  For a firm to be in equilibrium in long run the following two conditions must be met: 1. MR = MC = AR (Price) means  MR = MC  MR = Price  Price = MC 1. But MC curve should cut MR curve from below. Sandeep Kapoor MIET, Meerut
  19. 19. Price Determination under Perfect Competition During Long Period MC Price AC P R Q O Quantity Sandeep Kapoor MIET, Meerut AR = MR
  20. 20. Price Determination under Perfect Competition During Long Period       In the above graph equilibrium is obtained at point R which is the point of lowest average cost. At ‘R’ MC intersects AC. MC curve cuts AC curve at the lowest point and MC curve cuts the MR curve from below. Therefore R indicates that the long period price is not only equal to MC but OQ is the optimum output for the competitive firm because it is the output at lowest average cost. Sandeep Kapoor MIET, Meerut
  21. 21.      Monopoly The word MONOPOLY is composed of two words i.e. Mono + Poly Mono means single Poly means seller Thus monopoly is a market situation:   In which there is a single seller of goods with no close substitute. Some examples of Monopoly:   Railways and Telephone were also in monopoly But now up to some extent Electricity and Water Sandeep Kapoor MIET, Meerut
  22. 22. Monopoly  1. 2. 3. 4. Some Characteristics of Monopoly There is one seller in the market There are no close substitutes Seller has considerable control over the price There are barriers to entry Sandeep Kapoor MIET, Meerut
  23. 23. Price Determination under Monopoly A monopolist will be in equilibrium when following two conditions are fulfilled i.e. 1. MC = MR 2. MC curve cuts MR curve from below. A monopolist is in equilibrium When he earns either maximum profit or suffers minimum losses. For this he needs to compare his MR with MC. Sandeep Kapoor MIET, Meerut
  24. 24. Price Determination under Monopoly If MR > MC the profits can be increased by increasing production. If MR < MC the losses can be minimized by reducing the production. So a monopolist is said to be in equilibrium when his MC = MR The monopoly price determination can be studied under two different time periods i.e. 1. Short Period 2. Long Period Sandeep Kapoor MIET, Meerut
  25. 25. Price Determination under Monopoly During Short Period Price MC B A D Abnormal Profits C R Q O AC AR MR Quantity  In the graph the firm in in equilibrium at output OQ.  OA or QB is the price.  CQ is the average total cost  The grey area ABCD represents monopoly profit.  Any other combination of price & output will yield less than Kapoor maximum possible profit. SandeepMeerut MIET,
  26. 26. Price Determination under Monopoly During Short Period MC B Price A Normal Profits R AR MR Q O AC Quantity  In the graph R is the point of equilibrium where MR = MC.  OQ is the equilibrium output.  The firm is earning normal profits in equilibrium situation as   At equilibrium output AR = AC And normal profits are included in short run average cost Sandeep Kapoor MIET, Meerut
  27. 27. Price Determination under Monopoly During Short Period Minimum Loss MC B Price A D AT C AVC C AR R O Q Quantity MR Sandeep Kapoor MIET, Meerut
  28. 28. Price Determination under Monopoly During Short Period  In the graph the firm in in equilibrium at output OQ  where MR=MC.  OD or QC is the price and  BQ is the average total cost  The grey area ABCD represents loss area.  But here the loss is minimum because AR = AVC.  Thus loss is limited to fixed cost.  The monopolist will suffer this loss even if he closes down the production.  If the price of monopolist falls below the QC he would prefer to close down the production in short term period. Sandeep Kapoor MIET, Meerut
  29. 29. Price Determination under Monopoly During Long Period Long period is period which is long enough: To fully adjust the supply to the changes in demand of a product. In this period all factors of the production are variable. Monopolist firm in the long run also is in equilibrium at a point where MR = MC. In short run we observed that a firm can earn profits as well as losses. Sandeep Kapoor MIET, Meerut
  30. 30. Price Determination under Monopoly During Long Period But in long fun, a monopolist firm earns only profits. If price is less than long run average cost The monopolist would like to close down the unit rather than suffer the loss. Monopoly firm in the long run is not satisfied with normal profits. It is in a position to earn supernormal profits. Sandeep Kapoor MIET, Meerut
  31. 31. Price Determination under Monopoly During Long Period The long period equilibrium of a monopolist firm is same as that of during short run (Abnormal Profits). Sandeep Kapoor MIET, Meerut
  32. 32. It MONOPOLISTIC may be defined as a combination of both perfect competition and monopoly. It is a middle point of the two extreme situations. It refers to that market situation: In which large number of producers produce goods which are close substitutes of each other. These goods are similar, but not exactly identical or homogenous. But their use is the same. Thus product differentiation is the hallmark of monopolistic Sandeep Kapoor MIET, Meerut
  33. 33. MONOPOLISTIC This product differentiation is found due to difference in Name, brand, trademark, color, quantity, packing design, fragrance etc. Many firms producing a variety of soaps such as Margo, Lux, Lifebouy, Dettol, Nirma etc. are the example of monopolistic competition. Moreover in cities, medical stores, retail general stores, restaurants, dry cleaners, hair dressers are good examples of monopolistic competition Sandeep Kapoor MIET, Meerut
  34. 34. MONOPOLISTIC Some important characteristics of Monopolistic Competition are as follows: 1. 2. 3. 4. 5. 6. 7. 8. Large number of firms Product Differentiation Free entry and exit of firms Selling costs (As high advertising cost) Non price competition No Collusion among firms Consumer’s attachment Firm is price maker not taker Sandeep Kapoor MIET, Meerut
  35. 35. Price Determination under Monopolistic Competition The monopolistic price determination can be studied under two different time periods i.e. 1. Short Period 2. Long Period Short Run The price determination under the short run is same as that of Monopoly i.e. 1. Abnormal Profits 2. Normal Profits 3. Minimum Losses Sandeep Kapoor MIET, Meerut
  36. 36. Price Determination under Monopolistic Competition But in practical life a monopolistic firm may earn abnormal profits Because other firms are not in a position to bring out closely related products. Nor can new firms enter the group during short period. The short run analysis of price & output determination under monopolistic competition Is similar to as under monopoly i.e. the case of abnormal profits. Sandeep Kapoor MIET, Meerut
  37. 37. Price Determination under Monopolistic Competition Long Run  As we know that long run is a time when firm can change all factors of production. In this period, each firm will produce up to that limit where LMR = LMC.  In long run firms earn normal profits only.  Sandeep Kapoor MIET, Meerut
  38. 38. Price Determination under Monopolistic Competition Long Run      No firm earns abnormal profits in the long run because of following reasons: If firm earns abnormal profits, then several new firms will enter the market as entry is free. In order to create demand for their products, the new firms will fix the price at a low level. Thus in long run monopolistic firm earns only normal profits The price determination is same as that of monopoly i.e. the case of normal profits. Sandeep Kapoor MIET, Meerut
  39. 39. Assignment What is the history of price discrimination & what are the latest practices of price discrimination?  What is the difference between perfect competition, Monopoly and Monopolistic competition.   Maximum length of the solution 4 pages (one side written) Sandeep Kapoor MIET, Meerut
  40. 40. OLIGOPOLY It is a imperfect market where there are a few sellers in the market. They are producing identical products. Products are close but not perfect substitutes of each other. Some examples are  Steel, Cement, Cigarette, Automobiles, Soft Drinks, providers etc. Sandeep Kapoor MIET, Meerut Aluminum, Tyres, Telephone service
  41. 41. OLIGOPOLY It is also known as limited competition, incomplete monopoly or the theory of games. It is a competition among few firms. There is great deal of interdependence among them. Each firm formulates its policies regarding price or output with an eye to their effect on its rivals. A firm’s price or output affects the sales & profits of the competitors. Sandeep Kapoor MIET, Meerut
  42. 42. OLIGOPOLY Because of their interdependence they face a situation: In which the optimal decision of one firm depends on what other firms decide to do The main features of oligopoly are as follows: 1. A few sellers 2. Lack of Uniformity (size of the firm) 3. Homogenous or Differentiated Product 4. Huge Advertisement Expenditure 5. Interdependence 6. Price rigidity Sandeep be Kapoor 7. Objective of the firm may Meerut non profit MIET,
  43. 43. Classifications of OLIGOPOLY On the basis of product differentiation: If products are homogenous it is known as pure or perfect oligopoly If products are heterogeneous, it is termed as differentiated or imperfect oligopoly On the basis of entry of firms: If entry is open to the new firms, it denotes open oligopoly. It free entry is restricted it becomes closed oligopoly Sandeep Kapoor MIET, Meerut
  44. 44. Classifications of OLIGOPOLY On the basis of Agreement: If the rival firms, instead of competing, follow a common price policy is known as collusive oligopoly If the collusion is in the form of an agreement it is called open collusion If the collusion is in the form of an understanding, it is known as tacit collusion. If the rival firms, act independently, then it is called non-collusive oligopoly. Sandeep Kapoor MIET, Meerut
  45. 45. Classifications of OLIGOPOLY On the basis of price leadership: If a firm dominates and fixes the price policy and the other firms simply follow. Then it is called partial oligopoly. If no firm is dominant enough to assume the role of price leader Then it is called full oligopoly. Assignment What are the reasons for the emergence of oligopoly?  Length of solution one pageKapoor Sandeep maximum. MIET, Meerut
  46. 46. Non Collusive model of OLIGOPOLY Non collusive models assume that there is no collusion between the firms i.e. There is no explicit or implicit understanding or agreement between sellers regarding Price fixation, market sharing or leadership and firms compete with each other for profits. Sweezy’s kinked demand curve model is regarded as most important model of this category. Sandeep Kapoor MIET, Meerut
  47. 47. Price rigidity under Non Collusive model of OLIGOPOLY Paul M Sweezy noticed something quite significant about oligopolies i.e. For relatively long period of times, prices seemed to remain more or less fixed. This observed stuckiness of oligopolistic prices gave rise to the theory of Kinked Demand Curve. The theory to explain price rigidity in oligopoly Was developed by American Economist of Harward University Paul M. Sweezy in 1938. Sandeep Kapoor MIET, Meerut
  48. 48. Price rigidity under Non Collusive model of OLIGOPOLY Assumption of the Kinked Demand curve Each firm assumes its competitors will follow a reduction in price, but will not follow a price rise.  There is an established prevailing price. Sandeep Kapoor MIET, Meerut
  49. 49. Price rigidity under Non Collusive model of OLIGOPOLY The simplest version of the theory supposes that There are a number of similar-sized firms producing a homogeneous product. All firms set the same price. Naturally, if they all set a high price they sell relatively little, whilst at low price, consumers buy more in total. Thus, the relationship between a firm's sales and price, when all firms set the same price, has downward slope i.e. Sandeep Kapoor MIET, Meerut
  50. 50. Price rigidity under Non Collusive model of OLIGOPOLY Price D1 D2 Output Sandeep Kapoor MIET, Meerut
  51. 51. Price rigidity under Non Collusive model of OLIGOPOLY If all firms are currently selling at point ‘P’ Price D1 The P D2 Output individual firm believes that if it reduces the price the competitors will also reduce the price. Thus its sales, for price reduction below point ‘P” is given by ‘D1D2’ curve. On the other hand if firm raise the prices, it is believed that competitors will not follow it So if the price is increased above point ‘P’ the firm will lose its customers faster than indicated by curve ‘D D ’ Sandeep Kapoor MIET, Meerut
  52. 52. It Price rigidity under Non Collusive model of OLIGOPOLY can be suggested by drawing a flatter demand curve ‘dd’ D1 Price d P d D2 Output The idea is that a small increase in price will lead to large fall in sales. The above discussion implies that the demand curve is steeper for price reductions than For price increases, with a kink at the current price ‘P’ Thus the demand curve perceived by the individual oligopolist is labelled ddD2 Sandeep Kapoor MIET, Meerut
  53. 53. Price rigidity under Non Collusive model of OLIGOPOLY D1 Price d P d MC3 MC2 MC1 a b D2 MR Output Sandeep Kapoor MIET, Meerut
  54. 54. Price rigidity under Non Collusive model of OLIGOPOLY Price d P d MC3 MC2 MC1 MR Output Sandeep Kapoor MIET, Meerut
  55. 55. Collusive model of OLIGOPOLY These models assume that these is some kind of agreement between the sellers And they work under a cartel or leadership of some one of them. The price leadership defined as a situation where one firm in an industry sets a price which others follow. There are various models of price leadership as follows:Sandeep Kapoor MIET, Meerut
  56. 56. Barometric Price Leadership The price leader is a firm that responds more quickly than its rivals to changing cost and demand conditions In such circumstances the price leader acts as a barometer of market conditions for the rest of the industry. The price decisions are not forced upon others but others will accept it without any reservation. If the price leader sets the price that do not reflect with reasonable accuracy.  With the demand and supply conditions in the industry. It is not likely to continue its role as the barometric leader. A firm belonging to another industry may also be chosen as the barometric leader such as cement for construction. Sandeep Kapoor MIET, Meerut
  57. 57. Dominant Firm & competitive fringe Price Leadership A firm is said to be dominant when It has over half of the sales in the market. Twice the size of the next largest firm. Some assumptions of the dominant firm model are as:  The industry consists of one dominant firm & a competitive fringe of small firms.  The dominant firm sets the market price and allows the small firms to sell all as they wish at this price.  The market demand is assumed to be known to the dominant firm.  The small firms recognize their subordinate positions, and behave just like a firm in a perfectly competitive market.  They assume that their demand curve is horizontal. Sandeep Kapoor MIET, Meerut
  58. 58. As Dominant Firm & competitive fringe Price Leadership per the assumptions the market sharing between dominating firm and other firms can be seen by graph as: D S PRICE Small Firms P2 supply P A MC B P Leaders supply P1 Dl Dm O Q MR OUTPUT OUTPUT In this situation AB = OQ i.e. supply of the leader. Once the leader firm sets its price OP, the market demand curve for smaller firms is the horizontal price line PB. Sandeep Kapoor MIET, Meerut
  59. 59. Price Leadership by a low cost firm Assumptions:  The industry consists of two firms A and B.  The firm B has a lower cost of production than firm A.  The product is homogenous.  Each firm has en equal share in the market. In this type of situation  The firm B has the economies of scale its cost of production and price will be lower.  Since the product is homogenous, the firm A will be forced to accept the price charged by the firm B.  Therefore, firm B is the price leader and A is follower  The firm B can drive out the firm A by fixing a price lower than the AC of firm A. Sandeep Kapoor MIET, Meerut
  60. 60. Pricing      We have studied the price determination during various market conditions. We assumed that each firm do the pricing for profit maximization i.e. MR = MC. But in real situation firms have multiple objectives and profit maximization is one of them. While the firms have objectives other than profit maximization the marginal pricing system will not work. In such a situation there are various methods of pricing as given follows: Sandeep Kapoor MIET, Meerut
  61. 61.    Full Cost Pricing This is the most popular method, because it is simple to compute. It assumes profitable business. In this method the price is determined by   Adding a fix mark-up to the producing cost of the product. Size of Mark-up     The mark up should guarantee the seller a fair profit i.e. Net Profit margin. Thus we can calculate the actual price of the product as P = AVC + GPM (Gross Profit Margin) P = AVC + (NPMSandeep Kapoor +AFC) MIET, Meerut
  62. 62. Full Cost Pricing      The net profit margin is known to the firm from its past experience. This margin is expected to cover regular investments in long run. Thus the sum of AVC, AFC & NPM gives an estimated desired price Which covers up the cost & yields normal profits. The desired price becomes the basis for determination of actual profit. Sandeep Kapoor MIET, Meerut
  63. 63. Skimming Pricing    One of the most commonly discussed strategies is skimming strategy. This strategy refers to the firm’s desire to skim the market by selling at a premium price. This strategy delivers results in the following situations:  When the target market associates quality of the product with its price.  And high price is perceived to mean high quality of the product. Sandeep Kapoor MIET, Meerut
  64. 64. Skimming Pricing  When the customer is aware & is willing to buy the product at a higher price just to be an opinion leader.  When the product is perceived as enhancing the customer’s status in society  When the product represents significant technological break-through & is perceived as a high technology product.  In adopting the skimming strategy the firm’s objective is  To achieve an early B.E.P. & to maximize profits in a shorter time span. Sandeep Kapoor MIET, Meerut
  65. 65. Penetration Pricing  As opposed to the skimming strategy.  The objective of the penetration pricing is foot hold in a highly competitive market.  The objective of this strategy is market market penetration.  Here the firm prices its products lower others in competition.  It delivers results in following situation:     to gain a share or than the When the size of the market is large & it is a growing market. When customers loyalty is not high. When firm uses it as an entry strategy. Where price quality association is weak. Sandeep Kapoor MIET, Meerut
  66. 66.  These Product Line Pricing are a set of price strategies which a multi product firm can usefully adopt.  An important fact to be noted is that their product have to be related.  In other words belonging to the same product family.  Price Bundling:   It means bundling the price of the products by combining the product line. On the other hand single product is sold at higher price.  Premium  Pricing: It means to charge extra price for some added features in same product as maruti does for Lx, Lxi, Vxi and Zxi Sandeep Kapoor
  67. 67. Product Line Pricing  Optional  It means pricing for accessories which are always optional.  Captive    part pricing: It refers to semi variable pricing such as post paid mobile, electricity etc.  By  product Pricing: It means the pricing of spare parts or ancillary product It is relatively higher than the basic product.  Two  Pricing: product pricing: It refers to the pricing of a same product family but each individual product is inferior to the earlier one. As with the case of petrol, diesel and kerosene. Sandeep Kapoor