Pricing decisions under different market structures
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This document summarizes pricing strategies under different market structures: - Perfect competition firms are price takers and price is determined by market supply and demand. - Perishable goods must be sold at the market price on the day, while non-perishable goods can be stored and sold when prices are higher. - Monopolies are price makers that charge high prices to earn monopoly profits through trial and error or by setting price where marginal revenue equals marginal cost. - Under monopolistic competition, firms set differentiated prices and the demand curve is elastic. In long run, entry of new firms eliminates economic profits. - Oligopolies may engage in price rigidity, non-price
Pricing decisions under different market structures
- 2. Perfect Competition pricing decisions.. are determined by the forces of demand and supply. The point of intersection between demand and supply curves determines the equilibrium price. Each firm is a price The Average Revenue Curve is horizontal and that AR = MR.
- 3. Market Price of a Perishable Commodity Eg.fruits and vegetables the supply is limited and cannot be stored for the next market period therefore the commodity must be sold away on the same day whatever the price may be.
- 4. Market Price of Non-Perishable goods can be preserved and carried over to the next market period. if price is very high the seller will be sell the whole stock. if price is low the seller will not sell any amount in the present market period, but will hold back for some better time. price below which the seller will refuse to sell is called the Reserve Price.
- 5. Pricing under Monopoly monopolist is a price maker. Initially he fixes the price through trial and error process, by balancing losses and gains. equilibrium ->MR = MC and corresponding point on the Average Revenue Curve determines the price to earn maximum profit. he will charge a high price and subsequently enjoy monopoly profits.
- 6. Pricing under Monopoly In the long run , the monopolist firm strives and plans to earn only profits He may also practice price-discrimination -charging different prices to different buyers and in different regions for the same product Selling his product in foreign market at a price lower than his own market is itself referred to as Dumping.
- 7. Pricing under Monopolistic Competition a group of producers producing same but not identical product compete with each other in the market. They practice product-differentiation instead of having a price war with each the prices charged are quite competitive in nature. Eg- Lux, Liril, Dove, etc.
- 8. Pricing under Monopolistic Competition In monopolistic competition, every firm has a certain degree of monopoly power and can take initiative to set a price. there can never be a unique price but the prices will be in a group reflecting the consumers’ tastes and preferences for differentiated products. the price of the product of the firm is determined by its cost function, demand, its objective etc
- 9. Pricing under Monopolistic Competition Demand curve /average revenue curve of a firm under monopolistic competition is elastic sloping downwards to the right but not perfectly elastic Reason : reduction in the price will increase the sales of the firm but it will have little effect on other firms as each will lose only a few of its customers. an increase in price will reduce demand substantially but each of its rivals will attract only a few of its customers. This happens because the products are close substitutes but not indentical. When it exercises some control over price, it resembles monopoly and when its demand curve is affected by market conditions it resembles pure competition. Such a situation is, characterised as monopolistic competition.
- 10. Pricing under Monopolistic Competition Every firm acts independently and for a given demand curve, marginal revenue curve and cost curves, the firm maximizes profit or minimizes loss when MC=MR
- 11. Pricing under Monopolistic Competition If a firm in a is making substantial amount of economic profits and assuming that the other firms in the market are also making profits, attracted by the super-normal profits, new firms will enter the group. As a result, there will be an increase in the number of close substitutes available in the market and hence the demand curve would shift downwards since each existing firm would lose market share. The entry of new firms would continue as long as there are economic profits. Thus monopolistic competition is similar to perfect competition where economic profits are eliminated in the long run.
- 12. Pricing under Monopolistic Competition The demand curve will continue to shift downwards till it becomes tangent to LRAC at a given price P1 and output at Q1 as shown in the figure. At this point of equilibrium, an increase or decrease in price would lead to losses. In this case the entry of new firms would stop, as there will not be any economic profits.
- 13. Pricing under Monopolistic Competition Due to free entry, many firms can enter the market and there may be a condition where the demand falls below LRAC and ultimately suffers losses resulting in the exit of the firms. Therefore under the monopolistic competition free entry and exit must lead to a situation where demand becomes tangent to LRAC Due to product differentiation/ availability of variety firms in the long run do not produce at the minimum point of their average cost curve, and thus there is excess capacity available with each firm and consumers pay the higher price for the increased variety available in the market.
- 14. Pricing under Oligopoly Under Oligopoly there are few sellers competing in the market. They may be rivals or may form collusion Each producer before he fixes the prices of his product tries to understand the price behavior of other producers in the market. Under Oligopoly there prevails the phenomenon of price rigidity. Firms may prefer to resort to non-price competition leaving each other to follow their own policies.
- 15. Kinked Demand Curve Each oligopolistic believes that if he lowers the price, his rivals will also lower their prices. Thus, the upper portion of the demand curve is price elastic. If he increases the price, the rivals will not and therefore, he will lose customers. This explains the inelastic lower portion of the demand curve.
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