Surveys a number of essential issues related to pricing and public policy in market economies. Begins with a brief review of the price-determination process in competitive markets, then examines a range of topics involving pricing and public policy in monopoly and oligopoly markets. Includes a number of graphs that illustrate the relationship between costs, demand, price, efficiency, and profitability under various market conditions.

1. NOTE ON PRICING
AND PUBLIC POLICY
A Harvard Business School Case Study

2. Introduction




Prices determine the functioning of market
economies.
Under perfect competition, firms are price takers.
Situation is different in many real world markets.
Different market structures :
Perfect competition
 Monopoly
 Monopolistic competition
 Oligopoly


Market structure models help us organize and
understand apparent chaos of real-world markets.

3. The Concept of Imperfect
Competition

Refers to market structures between perfect
competition and monopoly

Types of imperfectly competitive markets
 Monopolistic
 Oligopoly
competition

4. Monopolistic Competition

Hybrid of perfect competition and
monopoly, sharing some of features of each
A
monopolistically competitive market has three
fundamental characteristics
 Many
buyers and sellers
 Sellers offer a differentiated product
 Sellers can easily enter or exit the market

5. Pricing | Competitive Markets

Price charged equals MC
& AC at equilibrium output
level.

When production costs are
reduced, excess profits
are obtained as
rents(Price – AC)
PRICE
PRICE
MC
AC
pcomp
Deman
d
Economi
c Rent
MC
pcomp
AC
Deman
d
qcomp
qinnov
QUANTITY
QUANTITY

6. Pricing | Natural Monopoly

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An industry in which economies of scale are so
important that only one firm can survive.
Its average cost are downward slopping over the whole
output.
Society benefits from allowing the natural monopoly to
occur. As it can increase output and allow prices to be
lower due to economies of scale
It would not be efficient to encourage competition as it
would mean creating duplicate networks that could not
gain economies of scale

Examples:




Distribution of Electricity
Railways
Pipelines
Fixed- line telephone networks

7. Economies of Scale | Natural
Monopolies

Economies of Scale occur because of two
factors
 High
Fixed Cost
 Costs
 Low
involved in setting up business
Marginal Cost
 Cost
of adding new consumers to the network is low

8. Potential Competition And Natural
Monopolies

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
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In case of negligible barriers to entry and exit, natural
monopolies charge prices that lead to no more than
normal profits by lowering prices in face of entry.
Franchise is not the best solution in terms of
inefficiencies! Franchising in this context is the
competitive bidding (of some form) for a long term
contract to operate a monopoly.
Natural Monopoly may eventually become Artificial
Monopoly.
Competition would lead to innovation at a much quicker
pace.
The incumbent faces possibility of losing market while
entrant foresees prospect of sharing!

9. Pricing | Oligopoly Markets

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Pricing depends on cost, demand characteristics and ability
of firms to collude
Cartels are unstable because there is an incentive to cheat
Significant decline in industry demand may lead to price wars
Price wars may lead to firms requesting assistance from govt.
in the form of subsidies/ setting minimum and target prices
Govt. intervention might reduce allocative efficiency
Oligopoly firm faces market power in certain geographic
markets, consumer groups, product lines, but also faces
constraints similar to those faced by monopolists.

10. Oligopoly vs. Other Market
Structures
Oligopoly presents the greatest challenge
to economists.
 Essence of oligopoly is strategic
interdependence.
 Need new tools of modeling.
 One approach—game theory—has
yielded rich insights into oligopoly
behavior.


11. Conclusion

The combination of market
imperfections, strategic actions on the part of
the firms and interest groups, and intervention
by the policy makers will shape the
levels, structure and dynamics of prices in any
given market.