theory of pricing- perfect competition

8/14/2019 Theory of Pricing- Perfect Competition

http://slidepdf.com/reader/full/theory-of-pricing-perfect-competition 1/20

THEORY OF PRICING- PERFECT

COMPETITION

(No market power)



CRITERIA FOR MARKET CLASSIFICATION

• Number of sellers

• Number of buyers

•Type of Product

• Conditions of entry & exit



MARKET STRUCTURE

Perfect Competition

Monopolistic Competition

OligopolyMonopoly

M o r

e C o m p e

t i t i v e

L e s

s C om p e

t i t i v e



FOUR BASIC MARKET TYPES



PERFECT COMPETITION

• Many buyers and sellers

• Buyers and sellers are price takers

• Product is homogeneous

• Easy market entry and exit



PRICE DETERMINATION



PRICE DETERMINATION

625 5QD P = − 175 5QS P = +

QD QS =

625 5 175 5 P P − = +

450 10 P =

$45 P =

625 5 625 5(45) 400QD P = − = − =

175 5 175 5(45) 400QS P = + = + =



EQUILIBRIUM

Total Profits = TR -TC

dΠ = d(TR) - d(TC) = 0

dQ dQ dQ

MR - MC = 0

MR = MC



CONDITIONS FOR FIRM’S EQUILIBRIUM

Necessary condition

MC = MR

Sufficient condition

MC curve must be rising at the point of equilibrium

& must intersect MR curve from below (i.e. theslope of MC> slope of MR)



SHORT-RUN EQUILIBRIUM: A CASE OF PROFIT



SHORT-RUN EQUILIBRIUM: A CASE OF LOSS

MC

AC

AR = MR

OUTPUT

PRICE

&COST

O X

Y



Exercise

• TR = 300 Q – Q 2 / 2

• TC = 5000 + 60 Q + Q 2

• What is the profit maximising price & output

rate? What is the amount of economic profit?

• At what output rate is AC minimum? What is the

amount of economic profit at this output rate?



LOSSES AND SHUTDOWN DECISION

• Firm keeps on operating even when it incurslosses because it is able to cover a part of itsfixed cost

• As long as firm covers its variable cost & somepart of fixed cost, it is advisable to continue

production• Shut down point: point at which firms cover

only variable costs of production (minimumAVC)

• Shut down O/P: O/P corresponding to SDP



AVC

ATC

MC

MR1

MR2

P1

P2

Q Q1Q2

A

B

D

E




Quantity TFC TVC TC MC AVC ATC0 5 0 5

1 5 5 10 5 5.00 10.00

2 5 9 14 4 4.50 7.00

3 5 12 17 3 4.00 5.674 5 14 19 2 3.50 4.75

5 5 17 22 3 3.40 4.40

6 5 21 26 4 3.50 4.33

7 5 26 31 5 3.71 4.43

8 5 32 37 6 4.00 4.63

9 5 39 44 7 4.33 4.89




Decision regarding shut down

As long as P > AVC, firm is better off if it

continues to produce because revenue will

be sufficient to cover variable costs and

make a contribution towards fixed costs



EXAMPLE

A bicycle manufacturer faces a horizontal demand

curve. Firm’s total variable cost is given by the

equation:

TVC = 150Q – 20Q 2 + Q 3

where Q is the quantity

Below what price should the firm shut down its

operations?



Solution

• AVC = 150 – 20Q + Q 2

• MC = 150 – 40Q + 3Q2

• SDP: P = Min AVC

• At min AVC, Q = 10• When Q = 10, MC = 50

• So P = 50 (P = MC is the eqm condition)

• If P falls below 50, firm should Shut down



LONG-RUN EQUILIBRIUM

theory of pricing- perfect competition

Documents