unit 4 managerial economicsmarkets -monopoly,oligopoly,etc

7/29/2019 unit 4 managerial economicsmarkets -monopoly,oligopoly,etc

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MARKET

A Market is a system by which buyers and sellers bargain for

the price of a product, settle the price and transact their

business-buy and sell a product.Or

Market is the whole area where the buyers and sellers of a

product or service are spread.

OrMarket is the set (combination) of all the actual and potential

customers of a product or service.

The market for a commodity may be

1.Local market

2.Regional market

3.National market

4.International market


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MARKET STRUCTURE

The nature and degree of competition make the structure of the

market.

So we can say that

Market structure refers to the nature and degree of the

competition in the market for goods and services.

DETERMINANTS OF MARKET STRUCTURE

1.No. of Buyers

2.No. of Sellers

3.Nature of the product

4.Conditions for entry and exit of the firms

5.Other determinants like economies of scale, govt. restrictions etc.


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TYPES OF MARKET STRUCTURE

PERFECT COMPETITION IMPERFECT COMPETITION

MONOPOLISTIC COMPETITION

OLIGOPOLY

MONOPOLY


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PERFECT COMPETITION

Under this competition a large no. of firms compete against each

other for selling their products. Products are almost homogenous.

A perfect market has the following characteristics1. A large no of sellers and buyers

2. Homogenous Products

3. Perfect mobility of factors of production

4. Free entry and exit of firms5. Perfect knowledge

6. Absence of artificial restrictionslike unions or consumer forums

7. No government intervention

PERFECT COMPETITION AND PURE COMPETITION

Perfect competition less perfect mobility of factors and perfect

knowledge is regarded as pure competition.


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PRICE DETERMINATION UNDER PERFECT COMPETITION

1.Short run

In Short run the firm may face three conditions

a. Abnormal profitIn this condition A.R. > A.C.

AR = MR = P

ATCMC

PROFIT

QTY.

PRICE

b. Losses

In this condition A.R. < A.C.


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P = AR =MR

MC

ATC

LOSSES

OUTPUT

P

RI

C

EE

C. Normal profits or breakeven

In this condition

AR = ACDiagram on next slide


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output

P

r

i

c

e

P = MR = AR

ATC

MC

E


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output

P

r

i

c

e

P = MR = AR

LAC

LMC

N

Long run

In long run most of the firms earn normal profits. in thiscondition

AR = AC or AR = MC.


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MONOPOLY

The term pure monopoly means an absolute power of a firm to produce and

sell a product that has no close substitute.

Monopoly is a form of market structure/organization in which there is asingle firm selling a commodity for which there is no close substitutes.

MAIN FEATURES OF MONOPOLY

1.Only single seller2.Many or few buyers3. No close substitute4.Have market power to decide and control the prices/ output.

5.Super normal profits6.Entry restricted for the new firms.


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CAUSES OF MONOPOLY

1.Product differentiation2. Strategic barriers like limit pricing3.Government Regulation licensing gas company, electricity

undertaking4. Capital requirements5.Possession of certain scarce raw materials, patent rights etc.6.Ignorance laziness and prejudice of buyers may create monopoly infavor of a particular producer.

ADVANTAGES OF MONOPOLY1.Innovation Oriented2.It may encourage Research and Development.3.Gain of economies of scale

DISADVANTAGES OF MONOPOLY

1.Restricted consumer choice2.Power of market in few hands3.High prices as no control on monopolist4.Not good for society / Risk to economy5.Misallocation of resources


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PRICE DETERMINATION UNDER MONOPOLY

A monopoly firm faces a downward sloping demand curve. The reason is amonopolist has the option and power to reduce the price and sell more or to

raise the price and still remain some customers. Therefore the given pricedemand relationship, demand curve under monopoly is a typical downwardsloping demand curve.When a demand curve is sloping downward ,marginal revenue curve liesbelow the AR curve and technically, the slope of the MR curve is twice that ofAR curve.

1.Super normal profit

PRICECOSTREVENUE

D= AR is the demand curve whose corresponding marginal revenue curve is

MR.Area bcap shows the profit, which are considered as supernormal profits.

SMC

SAC

MR

D =AR

P

OUTPUT


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PRICE DISCRIMINATION

The act of selling the same article, product under a single control atdifferent prices to different buyers is known as price discrimination.Ex.- electricity charges

REASONS FOR PRICE DISCRIMINATION

1.Differentiated productsCourier services charge different charges for different products forthe same place. Same in the railway sector.

2.Geographical or tariff barriersDifferent tax structures exist in different countries/states.

3.Artificial differences between goodsChange In packing or showing that for a special class.

4.Elasticity of demandLow prices in highly elastic markets and higher prices in less elasticmarkets.

5.Exist in imperfect market


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DIFFERENCE BETWEEN PRICE DIFFERENTIATION AND PRICEDISCRIMINATION

Price discrimination is done at the firm level and for the sameproduct of same company.

Price differentiation is done for the another competitive firms.

Product differentiation is done at the other firms level. it is done to

differentiated the product from the competitors product.

Note : Product discrimination, Price differentiation and Pricediscrimination may help a firm profit maximization.


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MONOPOLISTIC COMPETITION

It is a market situation where there are many firms selling adifferentiated product. There is a keen competition but its not

perfect.

FEATURES OF MONOPOLISTIC COMPETITION

1. Large no. of sellers

2. Large no. of buyers

3. Non-price based competition

4. Freedom of entry and exit

5. Independent firms

6. Market research and innovation plays an important role in themonopolistic competition

7. Control over prices


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PRICE DETERMINATION UNDER MONOPOLISTIC COMPETITION

The price under monopolistic competition can be calculated in short run andlong run

Short run price determination1.Super normal profit

PRICECOSTREVENUE

D= AR is the demand curve whose corresponding marginal revenue curve isMR.Area bcap shows the profit, which are considered as supernormal profits.

SMC

SAC

MR

D =AR

P

OUTPUT


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2.Normal profit

In this case SAC equals to SMC.so whatever the firm is producing that isgiving a normal profit to the firm.

SMC

SAC

MR

D =AR

P

OUTPUT

PRICECOSTREVENUE


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2.Minimum loss

In this case the firm is not able to recover its SAC over the average variablecost. In this condition firm incurs loss.

SMC SAC

MR

D =AR

P

OUTPUT

PRICECOSTREVENUE AVC


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Long run price determination

In monopolistic competition in long run the firm earns only normal profit thatis due to competition among the producers and they are producing the

similar products which are having other substitute also.

Another reason for this isAs in short run the monopolistic firms earn supernormal profits there will bean incentive for the new entrants.

Diagram same as in normal profit


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OLIGOPOLY ( OLIGOPOLISTIC COMPETITION)

Oligopoly is defined as a market structure in which there are a fewsellers selling homogenous or differentiated products.

It may be of two types-

1.Homogenous oligopoly or pure oligopolyWhen the oligopoly firms sell the homogenous product.like-bread,cement,steel

,petrol, cooking gas ,aluminium etc.

2.Heterogenous oligopolyWhen the oligopoly firms sell the differentiated products.like-

automobiles,television sets, refrigerators etc.

Sources of oligopoly1.Huge capital investment

2.Economies of scale

3.Patent rights in case of heterogeneous oligopoly

4.Control over certain raw material

5.Merger and takeover


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FEATURES OF OLIGOPOLY

1.Small no. of large firms

2.Each seller knows his competitors individually in each market.

3.Any increase or decrease in the output will affect the market price.

or

The firms are independent.

4.These firms apply theory of group behavior to avoid the competition.

5.produce identical or differentiated products.

6.Direct impact of advertising and selling costs.

PRICE DETERMINATION UNDER OLIGOPOLISTIC COMPETITION

In oligopolistic competition the price for a product are decided on thebasis of group consent and the output is also decided. If there is any fall

in the prices then it is firstly discussed with the group and same for the

rise in the price. Competition in this type of structure is nonaggressive

so the firms at a specified output level can earn good profit.


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KINKED DEMAND CURVEA kinked demand curve is said to occur when there is a sudden change in

the slope of the demand curve ,this gives rise to a kink, that a is a sharp

corner in the demand curve. We would get such a curve when it is

assumed that the rivals will lower their prices when the oligopolist lowershis own price but that rivals will not increase their prices when the

oligopolist raises his prices.

A kink takes place due to the following reasons

- A reaction to price reduction

- Reaction to price increase

price

quantity

d

d1

D

D1


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COLLUSIVE OLIGOPOLYIn this type of market condition the competing firms make some

kind of agreement about pricing and the output.

When firms enter into this type of agreements it is known as

collusive agreements and this type of oligopoly is known as

collusive oligopoly. These collusions may be of two types-

1.Cartels or perfect collusion2.Price leadership or imperfect collusions

1.CartelsIn this firms co-operate each other to make their bargaining

positions stronger. It is an agreement among the independent firms

regarding prices,output,market-sharing etc.it is a strong incentive

for the oligopolist. It is opposite to the competition. Cartels may beof two types-

a. Centralized cartels-the decisions regarding price and output aretaken by the central cartel board.

b. Market share cartels- It is done on the bases of market sharing

by non price competition and market sharing by quota.


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2.PRICE LEADERSHIPIt is said to exist when firms fix their prices in a manner dependent

upon the price charged by one of the firms in the industry. The firms

which sets the price is known as price leader and the firms which

follow this price are known as price followers.

TYPES OF PRICE LEADER

a. Dominant - powerful enough to set a price and others are forcedto follow that.

b. Barometric leading firm is followed because the prices it sets

reflects the market forces and the needs of the other firms in the

industry.

c. Exploitive or aggressive one big firm come to establish itssupremacy in the market by following aggressive price policies.


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ADVANTAGES OF PRICE LEADERSHIP

1.Price leadership tends to influence price in the direction ofstability

2.It considerably reduces the no. of possible reactions top[rice change.

3.Smqall firms need not to waste their time on costing.

4.It avoids the expense of production / cost studies andmarket surveys as a basis of estimating demand.

5.It gives both the big and small firms enough chance to earnthe profit.


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CHARACTERISTIC FEATURES OF PRICE LEADERSHIP

1.A price leader usually aims at making few but larger and

dramatic price changes.

2.Normally the price leader usually leads in price rises.in cases of

price reduction ,the leader actually becomes follower.

3.The leader should change the price when he feels that thechange in cost and demand conditions is permanent. Frequent

changes undermine the leaders prestige.

4.There is a growing tendency for price leaders to take a long run

point view.

5.With the passage of time the price leader tends to loose relative

market position.


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WHETHER TO BE A PRICE LEADER OR A FOLLOWER

If the firm is small or medium one than there is no .the firm is

forced into a followership position.

A price follower need to have an alert information system and

has to determine which competitors to follow, when and how

far.

M k E ilib i


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Market Equilibrium

Equilibrium:

Equilibrium means a state of rest; or stability or a position from whichno change is required

firm

A firm is a unit engaged in the production of a particular commodity for

sale with profit.Acc. To Watson:

A firm is a unit engaged in the production for sale at profit and with

the objective of maximizing the profit.

Industry

A group of firms producing homogeneous good is called an industry.

M i f E ilib i


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Meaning of Equilibrium

A firm is said to be in equilibrium when it is does not intend to

Change the volume of output which it is producing.

The firm will be in this position when it reveal max. profit or the

max. loss.

Acc. To Hansen,:

A firm will be in equilibrium when it is of no

advantage to increase or decrease its out put.

Industry Equilibrium :


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Industry Equilibrium :

Industry equilibrium is a situation where ,

1- All the individual firms are in equilibrium and hence do notchange the level of their output.

2- Where there is no incentive for the outside firm to come in and join

the industry.Market equilibrium principle

A firm will always try to choose that level of output which provides

maximum profit at a given point of time. Two following approaches

can be discussed regarding this1.Total revenue and total cost approach

According to this approach difference between total revenue


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and total cost tells about the firms profit and loss. A point or

level of output where TR-TC is maximum is considered as the

optimal output point.

2.Marginal revenue and marginal cost approach

The relation between marginal revenue and marginal cost

determines the optimal output that should be produced by afirm. A firm should increase its output till the point MR =MC is

reached. So in this condition the equilibrium point is

MR = MC

A firm should increase its output if MR > MC&

A firm should reduce its output if MR < MC


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Pricing&

Pricing Strategies

Pricing


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PricingPrice is the Quantity of money received by the seller for any

goods or service offered to the customer

Objectives of Pricing-

1- Maximize current profits and return on the investment

2- Exploit competitive position

3- Balancing price over the product line.

Factors affecting the Pricing-

1- Internal factor 2- External factor


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Internal Factor-

Organizational Factors

Marketing Mix Product Differentiation

Cost of the product

Objective of the firm

External Factor-

Demand

Competition

Suppliers

Economic Conditions

Buyers

Government

Pricing Strategies


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Pricing Strategies

Penetration Pricing


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Penetration Pricing

Price set to penetrate the market

Low price to secure high volumes

May be useful if launching into a new market

Market SkimmingHigh price, Low volumes

Suitable for products that have short life cycles or which will

face competition at some point in the future.

Examples include: Play station, jewellery, digital technology,new DVDs, etc.


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Value Pricing (Pricing based on the Consumer Perception)

Price set in accordance with customer perceptions about the value of the product/service.

Examples include status products/exclusive products

Companies may be able to set prices according to perceivedvalue.

Loss Leader (Sold below cost to attract customer elsewhere)

Goods/services deliberately sold below cost to encourage saleselsewhere

Purchases of other items more than covers loss on item sold


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Psychological Pricing

Used to play on consumer perceptions

Classic example Rs. 499 instead of 500.

Links with value pricing high value goods priced according towhat consumers THINK should be the price

Going Rate (Price Leadership)

In case of price leader, rivals have difficulty in competing on price too high and they lose market share, too low and the priceleader would match price and force smaller rival out of market

May follow pricing leads of rivals especially where those rivals

have a clear dominance of market share

Where competition is limited, going rate pricing may beapplicable banks, petrol, supermarkets, electrical goods findvery similar prices in all outlets

T d P i i ( d f k)


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Tender Pricing (Bids for work)

Many contracts awarded on a tender basisFirm (or firms) submit their price for carrying out the work

Purchaser then chooses which represents best value

Mostly done in secret

Price Discrimination (Different price for same goods orServices)

Charging a different price for the same good/service in differentmarkets

Requires each market to be impenetrable

Requires different price elasticity of demand in each market


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Destroyer Pricing/Predatory Pricing (Aims to forceout competitor)

Deliberate price cutting or offer of free gifts/productsto force rivals (normally smaller and weaker) out ofbusiness or prevent new entrants

Anti-competitive and illegal if it can be proved

Absorption/Full Cost Pricing

(To set price for covering of FC, VC)

Full Cost Pricing attempting to set price to cover both

fixed and variable costs

Absorption Cost PricingPrice set to absorb some of thefixed costs of production


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Marginal Cost Pricing(Set Price in relation to MC)

Marginal cost the cost of producing ONE extra unit

Allows variable pricing structure

Contribution Pricing

Contribution = Selling Price Variable (direct costs)

Prices set to ensure coverage of variable costs and acontribution to the fixed costs

Similar in principle to marginal cost pricing

Break-even analysis might be useful in such circumstances


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Target Pricing

Setting price to target a specified profit level

Estimates of the cost and potential revenue at differentprices, and thus the break-even have to be made, to

determine the mark-up

Mark-up = Profit/Cost x 100

Cost-Plus Pricing

Calculation of the average cost (AC) plus a mark up.

AC = Total Cost / Output


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Influence of Elasticity

Any pricing decision must be mindful of the impact of

price elasticity

The degree of price elasticity impacts on the level of

sales and hence revenue

Elasticity focuses on proportionate (percentage) changes

PED = % Change in Quantity demanded / % Change in

Price

unit 4 managerial economicsmarkets -monopoly,oligopoly,etc

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