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Markets & Pricing Markets & Pricing
A3 - 2
Revenue Concepts• Total Revenue (TR) is defined as the total amount of
money received by a firm from goods sold or services rendered during a certain time period.
• Equation: Output price X Quantity
• Average revenue (AR) is the revenue earned per unit of output sold.
• Equation: Total revenue / Quantity
• Marginal Revenue(MR) is revenue a firm gains in producing one additional unit of commodity.
• Equation: Change in total revenue/Change in output.
P X Q
TR/Q
TR/Q = P
A3 - 3
Equilibrium
• Market demand is equal to market supply
For a firm
• The price at which the quantity demanded of the product equals its quantity supplied is called its equilibrium price and the corresponding quantity is its equilibrium quantity and the firm is said to be in equilibrium.
A3 - 4
Rule for Equilibrium
• If the production and sale of an additional unit of product adds more to revenue than to costs, profit is increased and thus that unit should be produced and sold. MR>MC
• If the additional unit of output involves larger costs than revenue, it should not be produced. MR<MC
• The firm is in equilibrium when MR =MC
A3 - 5
Market
‘Market means the general field within which the forces determine the price of a particular commodity operate’ – Ely
A market is a body of persons in such commercial relations that each can easily acquaint himself with the rates at which certain kinds of exchanges of goods or services are from time to time made by the others - Sidgwick
A3 - 6
Characteristics
• Consumers
• Sellers
• A Commodity
• A Price
A3 - 7
Classification of Markets
• Area: local, regional, national & international
• Nature of transactions: spot & futures
• Volume of transactions: whole sale & Retail
• Time: very short , short & long period
• Status of sellers: primary, secondary & terminal
• Regulation: regulated & unregulated
• Competition : perfect & imperfect
A3 - 8
Types of Markets - CompetitionType of Market
Nature of Product
No. of Buyers
No. of Sellers
Entry Conditions
Price Nature of decision variables
Perfect Competition
Homogeneous for all firms
large large Free entry, free exit
Uniform every where
Only Output
Simple & Discriminating Monopoly
“ “ One Entry barriers
High Either output or price & Discrimination in prices
Monopolistic Competition
Product differentiation by each firm
“ Many Product differention as entry barrier
Lower than Monopoly
Extent of product differentiation and promotion
Duopoly Homogeneous or differentiated
Large Two Product differentiation
High Competitors strategies
A3 - 9
Types of Markets - CompetitionType of Market
Nature of Product
No. of Buyers
No. of Sellers
Entry Conditions
Price Nature of decision variables
Oligopoly Homogeneous or differentiated
large A few Product differentiation
High Competitors strategies
Bilateral Monopoly
Homogenous
One One Entry barriers
Power of Seller or Buyer
Output and Price
Monopsony
“ “ Large Free entry Lowest possible price
Adjusting output according to price
Oligopsony
Homogeneous or differentiated
A few “ No entry barriers
“ Competitors strategies
A3 - 10
Monopoly
By
Mrs. N. Jayaprada
Monopoly
By
Mrs. N. Jayaprada
A3 - 11
• Meaning: only one firm produces and sells a particular commodity in the market.
• Definition: Firm and Industry coincide; the single firm producing the product is itself both the firm and the industry
Introduction
A3 - 12
Main Features
• One and only firm(Seller).
• Single product
• No rivals or direct competitors of the firm.
• Indirect competition may exist.
• No other seller can enter the market.
• Monopolist is price maker.
• The monopolist is rational.
• Independent decision making
A3 - 13
Causes of Origin of Monopoly
• Legal monopoly: Copyrights, Patents, TMs
• Government policies: licensing
• Natural resources
• Exclusive knowledge of technology by the firm.
• Public benefit or interest.
• Price policy of the firm
A3 - 14
Types
• Legal
• Economic
• Natural
• Regional
A3 - 15
Equilibrium
• The monopolist can control both the price and supply of the product. But at any point of time he can fix only one of them
• Equilibrium Rule: MC = MR
• The AR curve is demand curve
• Cost curves are identical of perfect market
A3 - 16
Short-Run Equilibrium -Monopoly Competition
AR
SAC
P
Co
st &
Rev
enu
e
Units of output
MR
SMC
E
C
A3 - 17
Long-Run Equilibrium Under Monopoly Competition
Pri
ce, R
even
ue,
Co
st
Quantity
MR
LMC
LAC
AR & D
E
P M
A3 - 18
Price Discrimination
• The practice of discriminating among buyers on the basis of price charged for the same good or service.
• To maximise the profit the seller practices the discriminating price strategy based on the buyers income level, expectations.
A3 - 19
Prerequisites
• Market control
• Division of market
• Different price Elasticities of demand in different markets.
A3 - 20
Bases
• Personal
• Geographical
• Time
• Purpose of use
A3 - 21
Oligopoly
• Oligopoly = market dominated by a few sellers, at least several of which are large enough relative to the total market that they can influence the market price
• Oligopoly more intense competition than pure competition
A3 - 22
Oligopoly
• Why Oligopolistic Behavior is So Difficult to Analyze¤ Oligopolistic firms interact with each other
in complex ways, and almost anything can and sometimes does happen under oligopoly.
A3 - 23
Oligopoly
• Lines of Attack:¤ Ignore interdependence¤ Strategic interaction¤ Cartels¤ Price leadership and tacit collusion
• To understand everything except first point, you must understand Game Theory
A3 - 24
Oligopoly and Game Theory
• Game Theory analyzes problems where agents account for others’ actions when taking a decision
• Ex: duopoly – two firms serving one market¤ Each firm supplies half of total quantity¤ Choice of firm 1 affects choice of firm 2
and vice versa
A3 - 25
Monopolistic Competition, Oligopoly, & Public Welfare
• Behavior is so varied that it is hard to come to a simple conclusion about welfare implications.
• In many circumstances, the behavior of monopolistic competitors and oligopolists falls short of the social optimum.
A3 - 26
Monopolistic Competition, Oligopoly, & Public Welfare
• Oligopolistic market can be perfectly contestable:¤ If firms can enter and exit without losing
the money they have invested
• If so, then the performance of the firms is likely to be close to perfectly competitive
• And thus, socially efficient
A3 - 27
Comparing the Four Market Forms
• Perfect competition and pure monopoly are uncommon in reality.
• Many monopolistically competitive firms exist.
• Oligopoly firms account for the largest share of the economy’s output.
A3 - 28
Comparing the Four Market Forms
• Profits are zero in long-run equilibrium under perfect competition and monopolistic competition because of free entry and exit.
• Consequently, AC = AR = P in long-run equilibrium under these two market forms.
A3 - 29
Comparing the Four Market Forms
• In equilibrium, MC = MR for the profit-maximizing firm under any market form.
• In the equilibrium of the oligopoly firm, MC may be unequal to MR.
A3 - 30
Comparing the Four Market Forms
• Perfectly competitive firm and industry theoretically efficient allocation of resources.
• Monopoly and monopolistic competition are likely inefficient allocation of resources.
• Under oligopoly, almost anything can happen, impossible to generalize about its vices or virtues.
A3 - 31
TABLE 5: Attributes of the Four Market Forms
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
A3 - 3232
By
Mrs. N. Jayaprada
Perfect Competition Markets
A3 - 3333
Introduction
• The concept of competition is used in two ways in economics.¤ Competition as a process is a rivalry
among firms.¤ Competition as the perfectly competitive
market structure.¤ A perfectly competitive market is one in
which economic forces operate unimpeded
A3 - 34
A Perfectly Competitive Market
• A perfectly competitive market must meet the following requirements: The number of sellers and buyers is large.
There are no barriers to entry and exit. The firms’ products are identical or standardised.
Both buyers and sellers are price takers. Each buyer and seller operates under conditions of
certainty. There is complete information.
Firms are profit maximizers. Each firm takes its independent action. Perfect mobility of factors of production
No Governmental intervention.
A3 - 3535
The Competitive Industry and Firm
Units of output
Price per unit
D
35
S
Market
Demand Curve
Facing the Firm
35
Firm
1.The intersection of the market supply and the market demand
curve…
3.The typical firm can sell all it wants at the
market price…
Units of output
Price per unit
2.determine the equilibrium market
price
4.so it faces a horizontal demand
curve
A3 - 3636
Goals and Constraints of the Competitive Firm
• Perfectly competitive firm faces a cost constraint like any other firm
• Cost of producing any given level of output depends on ¤ Firm’s production technology ¤ Prices it must pay for its inputs
A3 - 37
Costs Relevant to a FirmP=MR= AR Output Total cost Marginal
CostAverage
Total CostTotal
RevenueProfit TR-TC
0 40.00 - - 0 -40.00
35.00 1 68.00 28.00 68.00 35.00 -33.00
35.00 2 88.00 20.00 44.00 70.00 -18.00
35.00 3 104.00 16.00 34.67 105.00 1.00
35.00 4 118.00 14.00 29.50 140.00 22.00
35.00 5 130.00 12.00 26.00 175.00 45.00
35.00 6 147.00 17.00 24.50 210.00 63.00
35.00 7 169.00 22.00 24.14 245.00 76.00
35.00 8 199.00 30.00 24.88 280.00 81.00
35.00 9 239.00 40.00 26.56 315.00 76.00
35.00 10 293.00 54.00 29.30 350.00 57.00
A3 - 38
TC TR
0
To
tal c
os
t, r
eve
nu
e
385350315280245210175140105
7035
Quantity1 2 3 4 5 6 7 8 9
Profit Determination Using Total Cost and Revenue
Curves
Maximum profit =81
130
Loss
Loss
Profit
Profit =45
A3 - 39
C
A
P = AR = MR
Costs
1 2 3 4 5 6 7 8 9 10 Quantity
60
50
40
30
20
10
0
AB
MC
Marginal Cost, Marginal Revenue, and Price
0123456789
10
28.0020.0016.0014.0012.0017.0022.0030.0040.0054.0068.00
Price = MR Quantity Produced
Marginal Cost
35.0035.0035.0035.0035.0035.0035.0035.0035.0035.0035.00
A3 - 40
Short run Equilibrium
• Depending upon the positions of the short run cost curves, in short run, individual firm can make
• Super normal profits
• Normal profits
• Losses
40
A3 - 41
(a) Super Profit case (b) Normal profit case (c) Loss case
Determining Profits Graphically
Quantity Quantity Quantity
Price65 60 55 50 45 40 35 30 25 20 15 10 5 0
65 60 55 50 45 40 35 30 25 20 15 10 5 01 2 3 4 5 6 7 8 910 12 1 2 3 4 5 6 7 8 910 12
D
MC
A P = MR=AR
B ATC
E
Profit
C
MC
ATC
MC
ATC
Loss
65 60 55 50 45 40 35 30 25 20 15 10 5 0 1 2 3 4 56 7 8 910 12
P = MR=ARP=MR=AR
Price Price
A3 - 42
Determining Profit and Loss From a Graph
• Find output where MC = MR.¤ The intersection of MC = MR (P) determines the
quantity the firm will produce if it wishes to maximize profits.
Find profit per unit where MC = MR. Drop a line down from where MC equals MR,
and then to the ATC curve. This is the profit per unit. Extend a line back to the vertical axis to identify
total profit.
A3 - 43
Determining Profit and Loss From a Graph
• The firm makes a super profit when the ATC curve is below the MR curve.
• The firm makes a normal profit when the ATC curve is equal to the MR curve.
• The firm incurs a loss when the ATC curve is above the MR curve.
A3 - 44
Special case: Exit / Shutdown Point• The shutdown point is the point at which the
firm will be better off it shuts down than it will if it stays in business.
• If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss.
• It is taking less of a loss than it would by shutting down.
Condition I – Price < AVC – Shut downCondition II – Price >= AVC – Continue
A3 - 45
MC
P = MR=AR
2 4 6 8 Quantity
Price
60
50
40
30
20
10
0
ATC
AVC
Loss
A
The Shutdown Decision
A3 - 46
Long-Run Competitive Equilibrium
• Profits and losses are inconsistent with long-run equilibrium.¤ Profits create incentives for new firms to
enter, output will increase, and the price will fall until zero profits are made.
¤ The existence of losses will cause firms to leave the industry.
¤ In the long-run equilibrium of a competitive industry, all firms make normal profits.
A3 - 47
Long-Run Competitive Equilibrium
MC
P = MR=AR
0
60
50
40
30
20
10
Price
2 4 6 8 Quantity
SRATC LRATC
P=MR=AR=SAC=SMC=LAC
A3 - 48
Price Determination in a Perfectly Competitive Industry
• In the short run, the price does more of the adjusting.
• In the long run, more of the adjustment is done by quantity.
A3 - 49
Price Determination in a Perfectly Competitive Industry
Price Determination in Market Period (very short run)
• Supply of the commodity is fixed as inputs are fixed in supply.
• Demand changes Price and Equilibrium points also change accordingly.
D’D
D”
D
D”
D’
P
P”
P’ E
E”
E’
Quantity of Good X
Pri
ce
of
Go
od
X
s
A3 - 50
Price Determination in a Perfectly Competitive Industry
Price Determination in short run
• Supply of the commodity changes as variable factors can be changed but scale of plant is not possible.
• Demand changes Price and Equilibrium points also change accordingly.
D’
DD”
D
D”
D’
PP”
P’
E
E’
Quantity of Good X
Pri
ce
of
Go
od
X
E”
s
s
A3 - 51
Price Determination in a Perfectly Competitive Industry
Price Determination in Long Run
• Supply of the commodity fully adjusted to meet the changes in the industry as scale of plant is possible.
• Supply changes Price and Equilibrium points also change accordingly.
D’D
D’
D
P
P’
E
E’
Quantity of Good X
Pri
ce
of
Go
od
X
E”
LPS
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