mrkt strctr price output reln,govt. interv

7/29/2019 Mrkt Strctr Price Output Reln,Govt. Interv.

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MARKET STRUCTURE

ANDOUTPUT-PRICING DECISIONS


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Firms output and pricing decisions depend on

the current market structure in which the firm

is operating i.e.

How much control over price we have.

whether the firm is competing in perfect

competition, monopoly, monopolistic

competition or oligopoly situation


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Competition vs. Monopoly

One useful way in which issues of competitionand monopoly can be investigated is calledthe Structure, Conduct and PerformanceModel


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Competition vs. Monopoly

Market

Structure Conduct Performance

e.g. number of

buyers and sellers

(the size of firms)

e.g. firm's goals,

pricing and output,

their investments

e.g. efficiency,

profitability and

growth


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MONOPOLY

PRICING& OUTPUT DECISIONS

SHORT RUN & LONG RUN


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Monopoly

Monopoly power refers to cases where

firms influence the market in some waythrough their behaviour determined bythe degree of concentration in the industry

Influencing prices Influencing output

Erecting barriers to entry

Pricing strategies to prevent or stifle competition May not pursue profit maximisation encouragesunwanted entrants to the market

Sometimes seen as a case of market failure


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Underperfect competition, pricing & outputdecision undermonopoly are based on

revenue & cost conditions i.e. AC and MCcurves, in a competitive & monopoly marketare generally identical, revenue conditionsdiffer.

Revenue conditions, I.e. AR and MR curves,

are different under monopoly because, unlike acompetitive firm, a monopoly firm faces a

downward sloping demand curve.


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Monopoly

Costs / Revenue

Output / Sales

AC

MC

ARMR

AR (D) curve for a monopolist

likely to be relatively price

inelastic. Output assumed to be

at profit maximising output (note

caution here not all

monopolists may aim

for profit maximisation!)

Q1

7.00

3.00

MonopolyProfit

Given the barriers to entry,

the monopolist will be able

to exploit abnormal profits

in the long run as entry to

the market is restricted.

This is both the short run and

long run equilibrium position

for a monopoly


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MONOPOLISTIC COMPETITION

PRICE & OUTPUT DECISIONS:

SHORT RUN & LONG RUN


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Pricing and output decisions under this kind of market

are similar to those under monopoly.

Firm under the monopolistic competition faces adownward sloping demand curve like monopolist

faces.

Decision rules regarding optimal output & pricing in

the long run are the same as in the short run.

In the long run, a monopolist get opportunity to expand

the size of its firm with a view to enhance its long-run

profits.


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Implications for the diagram:

Cost/Revenue

Output / Sales

MC

AC

Marginal Cost andAverage Cost will be the

same shape. However,

because the products are

differentiated in some

way, the firm will only be

able to sell extra output

by lowering price.

D (AR)

The demand curve facing

the firm will be downward

sloping and represents the

AR earned from sales.

MR

Since the additional

revenue received from

each unit sold falls, the

MR curve lies under the

AR curve.

We assume that the firm produces

where MR = MC (profit maximising

output). At this output level, AR>AC

and the firm makes abnormal profit

(the grey shaded area).

Q1

1.00

0.60

Abnormal Profit

If the firm produces Q1 and sells

each unit for 1.00 on average with

the cost (on average) for each unit

being 60p, the firm will make 40p x

Q1 in abnormal profit.

This is a short run

equilibrium position for

a firm in a monopolistic

market structure.


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Monopolistic or Imperfect

Competition

Implications for the diagram:

Cost/Revenue

Output / Sales

MC

AC

AR1MR1

This is the long run

equilibrium position

of a firm in

monopolisticcompetition.

Q2

AR = AC

C


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Monopolistic Competition

Firms have some degree of market power

but demand curve typically flatter than in monopolysince there is more competition

Output-pricing decision is defined by MR = MCas always

the absence of entry barriers means that supernormal profits are competed away...

firms end up producing where p = AC, but AC not atits minimum as in perfect competition, also p > MC

Output

DMR

ACMC

FP = AC1

Q1


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Price and Output Decision

in Oligopoly


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Oligopoly Features of an oligopolistic market structure:

Price may be relatively stable across the industrykinked demand curve?

Potential for collusion

Behaviour of firms affected by what they believe their rivals

might do interdependence of firms Goods could be homogenous or highly differentiated

Branding and brand loyalty may be a potent source ofcompetitive advantage

Non-price competition may be prevalent Game theory can be used to explain some behaviour

AC curve may be saucer shaped minimum efficient scalecould occur over large range of output

High barriers to entry


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Significance of Kinked demand curve in

oligopolistic market

Meaning of price rigidity

Why price rigidity arises

Kinked demand curve and price rigidity


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Price rigidity

Peculiar feature related to oligopoly

The tendency of the price to remain fixed orconstant irrespective of changes in price and

cost conditions in the industry.

The price once established remains unchanged

for a long period of time


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Why price rigidity arises

Under non-collusive oligopoly, there is a greater

amount of uncertainty regarding the behavior of

rival firms

The oligopolist does not know how his

competitor will react. Therefore every oligopoly

is confronted with indeterminate demand. One

such price is established, the firm sticks to thatprice, whatever may be the consequences.


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Kinked demand curve

First introduced by Prof. Paul Sameulson

Provides a convincing explanation of price rigidity

It does not explain how prices and output are

determined under oligopoly

Occurs when there is a sudden change in the slope ofdemand curve

Such change leads to a sharp corner in demand curve

Ki k d d d


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Kinked demand curve

D

MC1

MC2

k

D

A

B

MR

QOMR1

P

The principle of the kinked

demand curve rests on

the principle that:

a. If a firm raises its price,its rivals will not follow

suit

b. If a firm lowers its price,

its rivals will all do the

same


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GOVERNMENT INTERVENTION

INPRICE FIXING


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Governments interfere with the normal

process of price determination by fixing priceseither above the equilibrium or below it.

These govt. attempts require intervention withthe forces of supply or demand or both by

elaborate administrative regulations.

Att t t fi i b ilib i l l


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Attempts to fix prices above an equilibrium level

are illustrated by min. wage legislation & price

support policies.

When the govt. steps into fix a minimum price

(say,Rs.375 per quintal for Sugar) much above

the equilibrium price (say, Rs.300 per quintal),

consumers curtail their consumption of sugar

(postpone their purchases at all levels)

On the other hand, farmers are encouraged to

increase their production under the incentive of

higher prices.


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As a result, there is disequilibrium between

the demand and supply.

There are only 2 ways to maintain prices at a

high level

Govt. can buy large quantities to absorb thedifference between the quantity supplied & thequantity demanded

The govt. can ask the farmers to curtail theiroutput.


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Need For Government Intervention


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The need for govt. intervention with thefunctioning of the free market mechanism

has arisen out of the failure of the freemarket economy expected to ensure

That all those who are willing to work at prevailing

wage rate get employment;

That all those who are employed get their living in

accordance with their contribution to the totaloutput;


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That factors of production are optimally

allocated between the various industries

Production & distribution pattern of national

product is such that all get sufficient

income to meet their basic needs- food,

clothing, shelter, education, medical care

etc.


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All the Best for Your Final Exam

REFERENCES:

1.ME by K L Maheshwari

2 ME by D N Dwivedi

mrkt strctr price output reln,govt. interv

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