Pricing and output decisions in different market situations – Monopoly and Duopoly competition - _Perfect and Imperfect - Pricing policies.

1. PREPARED BY
Ms.Jissy.C
Assistant Professor

2.  UNIT - IV
Pricing and output decisions in different market situations
– Monopoly and Duopoly competition - _Perfect and
Imperfect - Pricing policies.

3.  MARKET STRUCTURES
 It is a public Place in which goods & services are brought
& sold.
 Market is derived from the Latin Word”Mercatus” from
the verb “mercari”which means” to trade”.
According to Prof samuelson “ A market is a mechanism by
which buyers and sellers interact to determine the price
and quantity of a good or service”

4.  Basic Components of a market
 There should be buyers &sellers
 There should be contact between buyer & sellers
 Buyers & sellers should deal with the same commodity
 There should be a price for the commodity.
Features of market
Commodity
Buyers &sellers
Communication
Place/Area
Price

5.  Product Market& factor Market
Product market: Buying & selling of a commodity
Factor Market: There is a market for factors of production
Classification of Market
On the basis of area
On the basis of time
On the basis of nature of transactions
On the basis of volume of business
On the basis of status of sellers
On the basis of regulation

6.  Classification of market
On the basis of area
Local Market
National
Market
International
Market
On the basis of Time
Short Period
Very short
period
Long Period
Very long
Period

7.  Classification of market
On the basis of nature
of transactions
Spot
Market
Future
Market
On the basis
of volume of
busines
Whole Sale
Market
Retail market

8.  Classification of market
On the basis of status of
sellers
Primary Market
Secondary
Market
Terminal Market
On the basis of
Regulation
Regulated
Market
Unregulated
Market

9.  Classification of market
On the basis of
competition
Perfect
Competition
Monopoly
Monopolistic
Competition
Duopoly
&Oligoplly

10.  PERFECT COMPETITION
In perfect competition, there are large number of buyers
& sellers and the actions of individual buyers & sellers
cannot influence the market price.
Features of Perfect Competition
 Large numbers of buyer
 Homogenous Product
 Free entry & exit conditions
 Absence of govt or artificial restriction
 Perfect knowledge on the part of buyers & sellers
 Perfect mobility of factors of production
 Absence of transportation cost.

11. Conditions of Perfect Competition
 A firm in a perfectly competitive market may generate a
profit in the short-run, but in the long-run it will have
economic profits of zero.
 Perfect Competition in the Short Run: In the short run,
it is possible for an individual firm to make an economic
profit. This scenario is shown in this diagram, as the price
or average revenue, denoted by P, is above the average
cost denoted by C.

12.  Long Run
 Perfect Competition in the Long Run: In the long-run,
economic profit cannot be sustained. The arrival of new
firms in the market causes the demand curve of each
individual firm to shift downward, bringing down the
price, the average revenue and marginal revenue curve.
In the long-run, the firm will make zero economic profit.
Its horizontal demand curve will touch its average total
cost curve at its lowest point.


13.  Demand Curve in Perfect Competition
 A perfectly competitive firm faces a demand curve is a
horizontal line equal to the equilibrium price of the entire
market.
In a perfectly competitive market the market demand curve is
a downward sloping line, reflecting the fact that as the price
of an ordinary good increases, the quantity demanded of that
good decreases. Price is determined by the intersection of
market demand and market supply; individual firms do not
have any influence on the market price in perfect
competition. Once the market price has been determined by
market supply and demand forces, individual firms become
price takers. Individual firms are forced to charge the
equilibrium price of the market or consumers will purchase the
product from the numerous other firms in the market charging
a lower price (keep in mind the key conditions of perfect
competition). The demand curve for an individual firm is thus
equal to the equilibrium price of the market.

14.  DEMAND CURVE UNDER PREFECT COMPETATION
 Demand Curve for a Firm in a Perfectly Competitive
Market: The demand curve for an individual firm is equal
to the equilibrium price of the market. The market
demand curve is downward-sloping.


15. MONOPOLY
 The word monopoly has been derived from the combination of
two words i.e., ‘Mono’ and ‘Poly’. Mono refers to a single and
poly to control.
 In this way, monopoly refers to a market situation in which
there is only one seller of a commodity.
 There are no close substitutes for the commodity it produces
and there are barriers to entry. The single producer may be in
the form of individual owner or a single partnership or a joint
stock company. In other words, under monopoly there is no
difference between firm and industry.
Definition
“Monopoly is a market situation in which there is a single seller.
There are no close substitutes of the commodity it produces,
there are barriers to entry”. -Koutsoyiannis

16.  Features of Monopoly
One Seller and Large Number of Buyers
No Close Substitutes
Difficulty of Entry of New Firms
Monopoly is also an Industry
Price Maker
Industrial Monopolies or Public Monopolies

17.  Nature of Demand and Revenue under Monopoly:
 In a monopoly situation, there is no difference between firm and industry.
Therefore, under monopoly, firm’s demand curve constitutes the industry’s
demand curve. Since the demand curve of the consumer slopes downward
from left to right, the monopolist faces a downward sloping demand curve.
It means, if the monopolist reduces the price of the product, demand of
that product will increase and vice- versa.
 In Fig. 1 average revenue curve of the monopolist slopes downward from
left to right. Marginal revenue (MR) also falls and slopes downward from
left to right. MR curve is below AR curve showing that at OQ output,
average revenue (= Price) is PQ where as marginal revenue is MQ. That way
AR > MR or PQ > MQ.

18. MONOPOLY EQUILIBRIUM AND LAWS OF COSTS
 Increasing Costs:
If the monopolist produces the commodity under the law of Diminishing
Returns or Increasing costs, he will get the maximum profit at point E
where marginal revenue is equal to marginal cost. This is indicated in Fig.
7. Here he produces OM units of the commodity and gets PM as the price.
His monopoly profit is represented by the shaded area PQRS. No other
alternative will give him this much of profit and hence this is the best
position for him provided he produces goods under the Law of Increasing
Costs.

19.  Diminishing Costs:
 The same approach will be applicable under the Law of Increasing Returns
or Diminishing Cost as explained in Fig. 8. Here AC and MC are falling. The
MC and MR are equal at point E. accordingly; the monopolist will produce
OM units of commodity and sell the same at PM Price. His net monopoly
revenue will be PQRS indicated by shaded area.

20.  Constant Costs:
 The determination of monopoly price under constant costs can be shown
with the help of Fig. 9. In the diagram, the AC curve will be a horizontal
line running parallel to OX and for all the levels of output AC will be equal
to MC. AR and MR represent the average revenue curve and marginal
revenue curve respectively. The equilibrium between MC and MR is brought
at point E when the output is OM. Thus, the monopolist will produce OM
and will sell it at PM Price. The monopoly profit will, therefore, be equal to
PERS which is represented by the shaded area.

21.  MONOPOLISTIC COMPETATION
 Monopolistic competition is a market structure which
combines elements of monopoly and competitive
markets. Essentially a monopolistic competitive market is
one with freedom of entry and exit, but firms can
differentiate their products. Therefore, they have an
inelastic demand curve and so they can set prices.
However, because there is freedom of entry, supernormal
profits will encourage more firms to enter the market
leading to normal profits in the long term.
 Definition: a market structure with a large number of
firms producing similar but differentiated products.
Barriers to entry and exit the market are low. Firms are
price makers as each firm possesses some market power.

22.  Features of Monopolistic Competation
 Large Number of Buyers and Sellers
 Free Entry and Exit of Firms
 Product Differentiation
 Selling Cost
 Lack of Perfect Knowledge
 Less Mobility
 More Elastic Demand

23.  Price-output determination under Monopolistic
Competition: Equilibrium of a firm
In monopolistic competition, since the product is
differentiated between firms, each firm does not have a
perfectly elastic demand for its products. In such a
market, all firms determine the price of their own
products. Therefore, it faces a downward sloping demand
curve. Overall, we can say that the elasticity of
demand increases as the differentiation between
products decreases

24.  Short run Equilibrium
 Fig. 1 above depicts a firm facing a downward sloping,
but flat demand curve. It also has a U-shaped short-run
cost curve.

25.  Conditions for the Equilibrium of an individual firm
 The conditions for price-output determination and
equilibrium of an individual firm are as follows:
 MC = MR
 The MC curve cuts the MR curve from below.
 In Fig. 1, we can see that the MC curve cuts the MR curve
at point E. At this point,
 Equilibrium price = OP and
 Equilibrium output = OQ
 Now, since the per unit cost is BQ, we have
 Per unit super-normal profit (price-cost) = AB or PC.
 Total super-normal profit = APCB

26.  The following figure depicts a firm earning losses in the
short-run
 From Fig. 2, we can see that the per unit cost is higher
than the price of the firm. Therefore,
 AQ > OP (or BQ)
 Loss per unit = AQ – BQ = AB
 Total losses = ACPB

27.  Long-run equilibrium
 If firms in a monopolistic competition earn super-normal
profits in the short-run, then new firms will have an
incentive to enter the industry. As these firms enter, the
profits per firm decrease as the total demand gets shared
between a larger number of firms. This continues until all
firms earn only normal profits. Therefore, in the long-run,
firms, in such a market, earn only normal profits.

28.  As we can see in Fig. 3 above, the average revenue (AR)
curve touches the average cost (ATC) curve at point X.
This corresponds to quantity Q1 and price P1. Now, at
equilibrium (MC = MR), all super-normal profits are zero
since the average revenue = average costs. Therefore, all
firms earn zero super-normal profits or earn only normal
profits
 It is important to note that in the long-run, a firm is in an
equilibrium position having excess capacity. In simple
words, it produces a lower quantity than its full capacity.
From Fig. 3 above, we can see that the firm can increase
its output from Q1 to Q2 and reduce average costs.
However, it does not do so because it reduces the average
revenue more than the average costs. Hence, we can
conclude that in monopolistic competition, firms do not
operate optimally. There always exists an excess capacity
of production with each firm.

29.  OLIGOPOLY
 Oligopoly is a situation in which few large firms compete
against each other and there is an element of
interdependence in the decision making of these firms. A
policy change on the part of one firm will have immediate
effects on competitors who react with their counter
policies.
 Features
 Small number of large sellers
 Interdependence
 Price rigidity
 Monopoly element
 Advertising
 Group Behavior
 Indeterminate demand curve

31.  Pricing Under Oligopoly
 Kinked demand curve was used by Prof.Paul.M.Sweezy.
 Kinked demand curve due to price rigidity
 If the firms raise the price :- Rivals will not follow it
Elastic Demand
Inelastic Demand
MR
P
K
L
N
MR 1
B
Output
P
r
i
c
e
C
o
s
t
DPB is the demand curve
DP Elastic Demand
PB Inelastic Demand
PN is the Rigid price

32.  At PN Price, the firm produces & sell ON output
 If price rises above P elastic demand curve, so demand for
the firms product falls
 If Price falls ,other firms follow it therefore No Increase in
sales. PB demand curve (inelastic) MR is Negative
 Gap KL depends on elasticity above & below the kink
 Gap is large it elasticity is greater above the kink &
Inelasticity is greater than above kink
 Price willn’t change in oligopoly unless there is a drastic
change in demand & lost conditions

33.  Duopoly
Duopoly means “two”& poly means “sellers
 A duopoly is a situation where two companies together own all, or
nearly all, of the market for a given product or service. A duopoly is
the most basic form of oligopoly, a market dominated by a small
number of companies.
 Characteristics of Duopoly
 Each seller is fully aware of his rival’s motive and actions.
 Both sellers may collude (they agree on all matters regarding the
sale of the commodity).
 They may enter into cut-throat competition.
 There is no product differentiation.
 They fix the price for their product with a view to maximising their
profit

34.  Cournet Model (Duopoly)
The Cournet model developed by Antoine Cournet in the
year 1838 .This model analyses the process of equilibrium
in a duopoly situation when each duopolistic assumes that
his rival will not react when he changes his output to
maximize profits.
Assumptions
 Two firms, each owing an artesian mineral water well;
 Both operate their wells at zero marginal cost2;
 Both face a demand curve with constant negative slope;
 Each seller acts on the assumption that his competitor
will not react to his decision to change his and price

35.  Diagram Representation:
 Cournot’s duopoly model is presented in Fig. 1. To begin
the analysis, suppose that there are only two firms. A and
B, and that, initially. A is the only seller of mineral water
in the market. In order to maximize his profits (or
revenue), he sells quantity OQ where his MC = O MR, at
price OP2 His total profit is OP2PQ.

36.  Now let B enters the market. The market open to him is
QM which is half of the total market. He can sell his
product in the remaining half of the market. He assumes
that A will not change his price and output as he is making
the maximum profit i.e., A will continue to sell OQ at
price OP2 Thus, the market available to B is QM and the
demand curve is PM.
 When to get maximize revenue, B sells ON at price OP1,
His total revenue is maximum at QRP’N. Note that B
supplies only QN = 1/4 = (l/2)/2 of the market.) With the
entry of B, price falls to OP1 Therefore, A’s expected
profit falls to OP1 PQ Faced with this situation, A attempts
to adjust his price and output to the changed conditions.
He assumes that B will not change his output QN and price
OP1 as he is making maximum profit.

37.  Accordingly, A assumes that B will continue to supply 1/4 of
market and he has 3/4 (= 1 – 14) of the market available to
him. To maximise his profit. Supplies 1/2 of (3/4), i.e., 3/8 of
the market. Note that A’s market share has fallen from 1/2 to
3/8.
 Now it is B’s turn to react. Considering Cournot’s assumption,
B assumes that A will continue to supply only 3/8 of the
market and market open to him equals 1 – 3/8 = 5/8.
 In order to maximise his profit under the new conditions B
supplies 1/2 x 5/8 = 5/16 of the market. It is now for A to
reappraise the situation and adjust his price and output
accordingly.
 This process of action and reaction continues in successive
periods. In the process, A continues to lose his market share
and B continues to gain. Finally situation is reached when their
market shares equal at 1/3 each.
 Any further attempt to adjust output produces the same
result. The firms, therefore, reach their equilibrium position
where each one supplies one-third of the market.

38.  DUOPSONY
A duopsony is an economic condition in which there are only
two large buyers for a specific product or service. Combined,
these two buyers determine market demand, giving them
considerably strong bargaining power, assuming they are
outnumbered by firms vying to sell to them.
MONOPSONY
Monopsony is a market structure in which a single buyer
substantially controls the market as the major purchaser of
goods and services offered by many would-be sellers.
The microeconomic theory of monopsony assumes a single
entity to have market power over all sellers as the only
purchaser of a good or service.

39.  Pricing Policy
 In business, a systematic approach is required in pricing
the commodities produced. Decision-making in this
respect is very important, as it leads to a permanent
source of revenue to the business and also survival in the
venture. It is the most important device for the firm to
expand its market.
 If the price is too high, a seller may have to go out of the
market. If the price is too low, the firm may not cover its
cost and face loss. Hence, setting prices is a complex
problem. There is no cut and dried formula for fixing the
prices. It depends upon various situations in the business.

40.  Objectives of Pricing Policy
Price Stabilization
Maintenance of market share
Target return on capital
Prevention of competition
Ethical pricing policy
Good return for product line
Liquidity

41.  Factors Involved in Pricing Policy
Objective of the business
Cost of Production
Demand for the product
Consumer psychology & Pricing
 Pricing Methods
 Cost Based Pricing
 Demand based Pricing
 Competition Based Pricing
 Other Based Pricing

42. Cost Based Pricing
 Cost-based pricing refers to a pricing method in which
some percentage of desired profit margins is added to the
cost of the product to obtain the final price
 It can be divided in two types cost-plus pricing and
markup pricing.
Demand-based Pricing:
 Demand-based pricing refers to a pricing method in which
the price of a product is finalized according to its
demand. If the demand of a product is more, an
organization prefers to set high prices for products to gain
profit; whereas, if the demand of a product is less, the
low prices are charged to attract the customers.

43. Competition-based Pricing
 Competition-based pricing refers to a method in which an
organization considers the prices of competitors’ products
to set the prices of its own products. The organization
may charge higher, lower, or equal prices as compared to
the prices of its competitors.
Other Pricing:
 Value Pricing
 Target Return Pricing
 Going Rate Pricing
 Transfer Pricing