18937222 market structure price decision

Presentation on:Market structure &Price decision

MARKET STRUCTURE &PRICE DECISIONSMARKET : In an economic sense ,a

market is a system By which buyers & sellers bargains for

the price of theProduct ,settle the price and transact

their business .

How the price for the commodity is determined in the market? Determination of price of a commodity

depends on the number of sellers and buyers .

Number of sellers of a product in a market determines the nature and degree of competition in the market .

The nature and degree of competition makes the structure of the market .

“Rule”:

“The higher the degree of competition, the lower firm degree of freedom. In pricing decision and control over the price of its own product.”

How the degree of competition affects price decision in different types of market structure?

Types of market structureMarket structure

No. of firms & degree of production differentiations

Nature of industries where prevalent

Control over prices

Methods of marketing

1.Perfect competition

Large number of firms with identical product

Financial market & some farm products

None Market exchange or auction

2.Imperfect competition

a. Monopolistic competition

Many firms with real of perceived products

Manufacturing; tea, toothpaste,t.v. sets etc.

some Competitive advertising quality rivalary

b. Oligopoly Little or no product differentiation

Aluminum, steel, car etc.

some Competitive advertising quality rivalry

c. Monopoly A single producer w/o close substitute

Public utilities, electricity etc.

Considerable but usually regulated.

Promotional advertisement if supply is large.

Types of market structure PERFECT COMPETITION IMPERFECT COMPETITION MONOPOLISTIC OLIGOPOLY

PERFECT COMPETITION

Objectives

After studying this chapter, you will able to Define perfect competition Explain how price and output are determined

in perfect competition Explain why firms sometimes shut down

temporarily and lay off workers Explain why firms enter and leave the industry Predict the effects of a change in demand and

of a technological advance Explain why perfect competition is efficient

Competition

Perfect competition is an industry in which:

Many firms sell identical products to many buyers.

There are no restrictions to entry into the industry.

Established firms have no advantages over new ones.

Sellers and buyers are well informed about prices.

Competition

How Perfect Competition Arises ?Perfect competition arises: When firm’s minimum efficient scale is

small relative to market demand so there is room for many firms in the industry.

And when each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm they buy from.

Competition

Price TakersIn perfect competition, each firm is a price taker.A price taker is a firm that cannot influence the price of a good or service.No single firm can influence the price—it must “take” the equilibrium market price.Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic.

Competition

Economic Profit and RevenueThe goal of each firm is to maximize economic profit, which equals total revenue minus total cost.Total cost is the opportunity cost of production, which includes normal profit.A firm’s total revenue equals price, P, multiplied by quantity sold, Q, or P Q.

Competition

A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.Figure 11.1 illustrates a firm’s revenue curves.

Competition

Figure shows that market demand and supply determine the price that the firm must take.

Competition

Figure 11.1(b) shows the demand curve for the firm’s product, which is also its marginal revenue curve.

Competition

Because in perfect competition the price remains the same as the quantity sold changes, marginal revenue equals price.

Competition

Figure 11.1(c) shows the firm’s total revenue curve.

The Firm’s Decisions in Perfect CompetitionA perfectly competitive firm faces two

constraints: A market constraint summarized by the

market price and the firm’s revenue curves A technology constraint summarized by

firm’s product curves and cost curves.

The Firm’s Decisions in Perfect Competition

The perfectly competitive firm makes two decisions in the short run:

Whether to produce or to shut down. If the decision is to produce, what quantity

to produce.A firm’s long-run decisions are:

Whether to increase or decrease its plant size.

Whether to stay in the industry or leave it.

The Firm’s Decisions in Perfect CompetitionProfit-Maximizing Output

A perfectly competitive firm chooses the output that maximizes its economic profit.One way to find the profit maximizing output is to look at the firm’s the total revenue and total cost curves.Figure on the next slide looks at these curves along with the firm’s total profit curve.


Part (a) shows the total revenue, TR, curve.

Part (a) also shows the total cost curve, TC.

Total revenue minus total cost is profit (or loss), shown in part (b).


Profit is maximized when the firm produces 9 sweaters a day.

At low output levels, the firm incurs an economic loss—it can’t cover its fixed costs.


At intermediate output levels, the firm earns an economic profit.

At high output levels, the firm again incurs an economic loss—now it faces steeply rising costs because of diminishing returns.

The Firm’s Decisions in Perfect CompetitionMarginal Analysis

The firm can use marginal analysis to determine the profit-maximizing output. Because marginal revenue is constant and marginal cost eventually increases as output increases, profit is maximized by producing the output at which marginal revenue, MR, equals marginal cost, MC.Figure on the next slide shows the marginal analysis that determines the profit-maximizing output.


If MR > MC, economic profit increases if output increases.

If MR < MC, economic profit decreases if output increases.

If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized.

The Firm’s Decisions in Perfect CompetitionProfits and Losses in the Short Run

Maximum profit is not always a positive economic profit.To determine whether a firm is earning an economic profit or incurring an economic loss, we compare the firm’s average total cost, ATC, at the profit maximizing output with the market price. Figure 11.4 on the next slide shows the three possible profit outcomes.


In part (a) price equals ATC and the firm earns zero economic profit (normal profit).


In part (b), price exceeds ATC and the firm earns a positive economic profit.


In part (c) price is less than ATC and the firm incurs an economic loss—economic profit is negative and the firm does not even earn normal profit.

The Firm’s Decisions in Perfect CompetitionThe Firm’s Short-Run Supply Curve

A perfectly competitive firm’s short run supply curve shows how the firm’s profit-maximizing output varies as the market price varies, other things remaining the same.Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve.But there is a price below which the firm produces nothing and shuts down temporarily.

The Firm’s Decisions in Perfect CompetitionTemporary Plant Shutdown

If price is less than the minimum average variable cost, the firm shuts down temporarily and incurs a loss equal to total fixed cost.This loss is the largest that the firm must bear.If the firm were to produce just 1 unit of output at price below average variable cost, it would incur an additional (and avoidable) loss.


The shutdown point is the output and price at which the firm just covers its total variable cost.This point is where average variable cost is at its minimum.It is also the point at which the marginal cost curve crosses the average variable cost curve.At the shutdown point, the firm is indifferent between producing and shutting down temporarily.It incurs a loss equal to total fixed cost from either action.


If the price exceeds minimum average variable cost, the firm produces the quantity at which marginal cost equals price.Price exceeds average variable cost, and the firm covers all its variable cost and at least part of its fixed cost.


Figure shows how the firm’s short-run supply curve is constructed.If price equals minimum average variable cost, $17 in this example, the firm is indifferent between producing nothing and producing at the shutdown point, T.


If the price is $25, the firm produces 9 sweaters a day, the quantity at which P = MC.

The blue curve in part (b) traces the firm’s short-run supply curve.

If the price is $31, the firm produces 10 sweaters a day, the quantity at which P = MC.

The Firm’s Decisions in Perfect CompetitionShort-Run Industry Supply Curve

The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant.


The quantity supplied by the industry at any given price is the sum of the quantities supplied by all the firms in the industry at that price.


At a price equal to minimum average variable cost—the shutdown price—the industry supply curve is perfectly elastic because some firms will produce the shutdown quantity and others will produces zero.

Output, Price, and Profit in Perfect CompetitionShort-Run Equilibrium

Short-run industry supply and industry demand determine the market price and output. Figure shows a short-run equilibrium at the intersection of the demand and supply curves.

Output, Price, and Profit in Perfect Competition

A Change in Demand An increase in demand bring a rightward shift of the industry demand curve: the price rises and the quantity increases.

A decrease in demand bring a leftward shift of the industry demand curve: the price falls and the quantity decreases.

Output, Price, and Profit in Perfect CompetitionLong-Run Adjustments

In short-run equilibrium, a firm may earn an economic profit, earn normal profit, or incur an economic loss and which of these states exists determines the further decisions the firm makes in the long run.In the long run, the firm may: Enter or exit an industry Change its plant size

Output, Price, and Profit in Perfect CompetitionEntry and Exit

New firms enter an industry in which existing firms earn an economic profit. Firms exit an industry in which they incur an economic loss.Figure on the next slide shows the effects of entry and exit.


As new firms enter an industry, industry supply increases.The industry supply curve shifts rightward.

The price falls, the quantity increases, and the economic profit of each firm decreases.


As firms exit an industry, industry supply decreases.

The industry supply curve shifts leftward.

The price rises, the quantity decreases, and the economic profit of each firm increases.

Output, Price, and Profit in Perfect CompetitionChanges in Plant Size

Firms change their plant size whenever doing so is profitable.If average total cost exceeds the minimum long-run average cost, firms change their plant size to lower costs and increase profits.Figure on the next slide shows the effects of changes in plant size.


If the price is $25, firms earn zero economic profit with the current plant.


But if the LRAC curve is sloping downward at the current output, the firm can increase profit by expanding the plant.


As the plant size increases, short-run supply increases, the price falls, and economic profit decreases.


Long-run equilibrium occurs when the firm is producing at the minimum long-run average cost and earning zero economic profit.

Output, Price, and Profit in Perfect CompetitionLong-Run Equilibrium

Long-run equilibrium occurs in a competitive industry when:

Economic profit is zero, so firms neither enter nor exit the industry.

Long-run average cost is at its minimum, so firms don’t change their plant size.

Competition and EfficiencyEfficient Use of Resources

Resources are used efficiently when no one can be made better off without making someone else worse off. This situation arises when marginal benefit equals marginal cost.

Competition and EfficiencyChoices, Equilibrium, and Efficiency

We can describe an efficient use of resources in terms of the choices of consumers and firms coordinated in market equilibrium.We derive a consumer’s demand curve by finding how the best (most valued by the consumer) budget allocation changes as the price of a good changes.So consumers get the most value out of their resources at all points along their demand curves, which are also their marginal benefit curves.

Competition and Efficiency

We derive a competitive firm’s supply curve by finding how the profit-maximizing quantity changes as the price of a good changes.So firms get the most value out of their resources at all points along their supply curves, which are also their marginal cost curves.In competitive equilibrium, the quantity demanded equals the quantity supplied, so marginal benefit equals marginal cost.All gains from trade have been realized.


Competitive equilibrium is efficient only if there are no external benefits or costs. External benefits are benefits that accrue to people other than the buyer of a good.External costs are costs that are borne not by the producer of a good or service but by someone else.


Figure illustrates an efficient allocation of resources in a perfectly competitive industry.In part (a), each firm is producing at the lowest possible long run average total cost at the price P* and the quantity q*.


Figure shows the market.Along the demand curve D = MB the consumer is efficient.Along the supply curve S = MC the producer is efficient.


The quantity Q* and price P* are the competitive equilibrium values.So competitive equilibrium is efficient.

The consumer gains the consumer surplus,

and the producer gains the producer surplus.

& Imperfect Competition

Imperfect Competition

Imperfectly Competitive Firms Have some control over price Price may be greater than the marginal

cost of production Long-run economic profits are possible


Imperfectly Competitive Markets Reduce economic surplus to varying

degrees Are very common

Forms of Imperfect Competition

Pure Monopoly (most inefficient) The only supplier of a unique product

with no close substitutes This is the one we’ll pay most attention

to

Forms of imperfect Competition

Oligopoly (theoretically more efficient than a monopoly) A firm that produces a product for which

only a few rival firms produce close substitutes

Collusion is a big problem Oil Electricity Vitamins

Forms of imperfect Competition

Monopolistic Competition (closest to perfect competition) A large number of firms that produce

slightly differentiated products that are reasonably close substitutes for one another


The Essential Difference Between Perfectly and Imperfectly Competitive Firms The perfectly competitive firm faces a

perfectly elastic demand for its product. The imperfectly competitive firm faces a

downward-sloping demand curve.


In perfect competition Supply and demand determine

equilibrium price. The firm has no market power.

At the equilibrium price, the firm sells all it wishes.

If the firm raises its price, sales will be zero.

The firm’s demand curve is the horizontal line at the market price.


With imperfect competition The firm has some control over price or

some market power. The firm faces a downward sloping

demand curve.

The Demand Curves Facing Perfectly and Imperfectly Competitive Firms

Quantity

$/un

it of

out

put

Quantity

DMarket price P

rice

D

Perfectly competitive firm Imperfectly competitive firm

Monopolist Charecteristics They do not have to compete with other

individual participants in the market. They are the only sellers in the market. For a firm to continue as a monopolist in

the long run, there must be factors that must prevent the entries of other firms.

Finally, the product of the firm must be highly differentiated from other goods

Five Major Sources of Market Power

Market power = barriers to entry Exclusive control over inputs Patents and copyrights Government licenses or franchises Economies of scale (natural

monopolies) Networked economies

Profit Maximization forthe Monopolist

A price taker (perfect competition) and a price setter (imperfect competition) share two economic goals. They want To maximize profits To select the output level that maximizes

the difference between TR and TC, where MB= MC.


For a producer MB = Marginal Revenue (MR) or a

change in a firm’s total revenue that results from a one-unit change in output


Marginal Revenue for the Monopolist Perfect competition and monopolies

Both increase output when MR > MC. Calculate MC the same way. Do not have the same MR at a given price.

In perfect competition: MR = P In monopoly: MR < P

The Monopolist’s Benefit from Selling an Additional Unit

Pric

e ($

/uni

t)

Quantity (units/week)

D

8

8

2

6

3

5

• If P = $6, then TR = $6 x 2 = $12• If P = $5, then TR = $5 x 3 = $15• The MR of selling the 3rd unit = $3 (15-12)• For the 3rd unit, MR = $3 < P = $5

Marginal Revenue inGraphical Form

Observations MR < P MR declines as quantity

increases MR is the change

between two quantities MR < P because price

must be lowered to sell an additional unit

6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

Marginal Revenue inGraphical Form

Pric

e &

mar

gina

l rev

enue

($/

unit)

Quantity (units/week)

6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

8

8

D

432-1

3

5

1

MR

Short-Run Profit Maximization for a Monopolist


Profit Maximizing Decision Rule When MR > MC, output should be

increased. When MR < MC, output should be reduced. Profits are maximized at the level of

output for which MR = MC. What’s the marginal revenue for a

competitive firm?

Public Policy TowardNatural Monopoly

Methods of Controlling Natural Monopolies State ownership and management

Weighing the benefit of marginal cost pricing versus the cost of less incentive for innovation

Is it true that there is less incentive for innovation? Anecdotal example of trains in WWI

In a democracy, politicians have to provide public services and keep taxes low to get re-elected

Methods of Controlling Natural Monopolies

State regulation of private monopolies Cost-plus regulation

High administrative cost Less incentive for innovation P does not equate to MC

Methods of Controlling Natural Monopolies

Exclusive contracting for natural monopoly Competition for the contract

theoretically sets P = MC Example of water in Buenos Aires Difficulty when fixed costs are high such

as electric utilitiesVigorous enforcement of anti-trust laws.

The act of selling the same article ,pruduct under a single control,at different prices to different buyers is known as price discrimination.

PRINCIPLE FORMS OF PRICE DISCRIMINATION Personal price discrimination Group price discrimination Product price discrimination

PERSONAL PRICE DISCRIMINATION INCOME OR SERVICE=doctor’s fees

GROUP OF PRICE DISCRIMINATION AGE=children’s/senior citizen fare SEX=concessional rates to ladies in

tour.e,g;in railway fare MILITARY STATUS=lower admission

charge for men in uniform LOCATION=zone prices.lower export

prices STATUS OF BUYER=concessions to

students USE OF PRODUCT=elec. charges .

PRODUCT OF PRICE DISCRIMINATION QUALITY=better quality,higher prices LABLES=higher prices for branded

products . Size - large size –higher price Time - off-season rates ,excursion

rates in transport .

MARKET SEGMENTATION Segmentation of markets on the basis of

the nature of the goods and service . Segementation owing to the snobbish

out look of the consumer Segmentation by graphical location Segmentation on the basis of the use of

product or service . Segmentation on the basis of the time

of purchase . Segmentation by the size of purchase

order .

DEGREES OF PRICE DISCRIMINATION 1ST degree –it is also known as perfect

price discrimination .price discrimination of the first degree is said to occur when the monopolist is able to sell each separate units of the output at different price ..

2nd degree –In price discrimination of the second degree bias are divided in to different groups and from each group a different prize is charged which is the lowest demand price of that group ,means maximum is charged for some given minimum block of output .

3rd degree – In price discrimination of the third degree ,profit maximizing monopolist set different prizes in different markets having demand curves with different elasticties .

18937222 market structure price decision

Documents