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

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. 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. 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. 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. 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. 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. 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. 

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. 
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. 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. Price Determination under
Perfect Competition
 There are three periods namely:
1. Market Period
2. Short Period
3. Long Period
Sandeep Kapoor
MIET, Meerut

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. 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. 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. 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. 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. 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. 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. Price Determination under Perfect Competition
During Long Period
MC
Price
AC
P
R
Q
O
Quantity
Sandeep Kapoor
MIET, Meerut
AR = MR

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. 




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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Price rigidity under
Non Collusive model of OLIGOPOLY
Price
D1
D2
Output
Sandeep Kapoor
MIET, Meerut

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. 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. 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. Price rigidity under
Non Collusive model of OLIGOPOLY
Price
d
P
d
MC3
MC2
MC1
MR
Output
Sandeep Kapoor
MIET, Meerut

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. 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. 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. 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. 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. 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. 


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. 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. 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. 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. 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.  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. 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