pricing and output determination in different markets: introduction next static screen chapter...

Pricing and Output Determination in Different Markets: Introduction

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Chapter objective:Upon completion of this lesson, you will be able to:

• Describe the factors influencing pricing strategies.• List the pricing strategies.• Identify the market structure.• Classify the market based on nature of competition.• Describe the short term and long term equilibriums in the various markets.

Prerequisite:To be able to go through this lesson, you should have read Chapter 6, ‘Pricing and Output Determination in Different markets’ of the book ‘Managerial Economics’.

Click Next to continue.

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Demand and Supply are the powerful forces operating in any market. They act and react with each other to determine the price of a product.

We shall see the market forces that are constantly at work and affect the pricing decisions. Let us first see the factors influencing pricing strategies.

Pricing and Output Determination in Different Markets: Introduction

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The factors influencing pricing strategies can be summarised in four categories:

Pricing and Output Determination in Different Markets:Factors Influencing Pricing Strategies

Competitors

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Costs:In order to make a profit, a business should ensure that its products are priced above their total average cost.

In the short-term, it may be acceptable to price products below total cost if this price exceeds the marginal cost of production.

This ensures that the sale still produces a positive contribution to fixed costs.

Click each Category to know the factors.

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Business Objectives

Costs

Customers



Competitors

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Business Objectives

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Business Objectives:Every business has an objective. Achieving the objective depends upon its products and services, in particular the cost at which these products and services are provided.



Competitors

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Business Objectives

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Customers:A business should price its products as per customer expectations.

Failing to do this can lead to unrealistic demand forecast which will lead to ineffective business and production planning.

Ideally, a business should attempt to quantify its demand curve to estimate what volume of sales will be achieved at given prices.



Competitors

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Business Objectives

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Competitors:If the business is a monopolist, then it can set any price.

At the other extreme, if a firm operates under conditions of perfect competition, it has no choice and must accept the market price.

In reality business is usually somewhere in between. So the chosen price needs to be very carefully considered relative to those of close competitors.

Pricing and Output Determination in Different Markets: Link Between Price And Business Objectives

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Objectives:

1. To Maximise Profits

2. To Meet a Specific Target Return on Investment (or on net sales)

3. To Achieve a Target Sales Level

4. To Maintain or Enhance Market Share

5. To Meet or Prevent Competition

To Maximize Profits:Although the ‘maximisation of profits’ can have negative connotations for ‘the public’, in economic theory, one function of ‘profit’ is to attract new entrants to the market.

The additional suppliers keep prices at a reasonable level. By seeking to differentiate their product from those of other suppliers, new entrants also expand the choice to consumers, and may vary prices as niche markets develop.c

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Click each Objective to view its correlation with the Pricing Strategy.

Now the most obvious question you might ask, is what is the link between price and business objectives? How does one affect the other? Why does this happen? Every business has some very basic objectives. Let us understand these objectives and their correlation with the Pricing Strategy.

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Pricing and Output Determination in Different Markets: Pricing Strategies

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Let us now understand the best pricing policy/strategy in particular situations.

Pricing Strategies Matrix

Penetration Pricing Strategy

Premium Pricing Strategy

Skimming Pricing Strategy

EconomyPricing StrategyL

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Premium Pricing:Use a high price where there is a uniqueness about the product or service. This approach is used where a substantial competitive advantage exists.

Such high prices are charged for luxuries such as Taj Hotel rooms, and Concorde flights.

Penetration Pricing:The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is increased. This approach is being used by Reliance India Mobile in order to attract new customers

Economy Pricing:This is a no frills lowprice. The cost ofmarketing andmanufacture are kept at minimum.Supermarkets oftenhave economy brandsfor soups, soaps, andother fast moving onsumer goods.

Skimming Pricing Strategy: Charges a high price because of a substantial competitive advantage, but price inevitably falls due to increased supply. In the 1970s, watch manufactures employed other marketing strategies and pricing approaches in a skimming approach, once other manufacturers entered the market and produced watches at a lower cost.

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1. Psychological Pricing 2. Product Line Pricing 3. Optional Product Pricing 4. Captive Product Pricing 5. Product Bundle Pricing 6. Promotional Pricing 7. Geographical Pricing 8. Value Pricing 9. Price Discrimination 10. Pre-emptive Pricing 11. Going-rate Pricing 12. Full Cost Pricing 13. Extinction Pricing 14. Expansionistic Pricing 15. Prestige Pricing 16. Average Cost Pricing

Psychological Pricing:This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example, shops like ‘49 & 99’ or ‘9 & 9 Dollar Shop’ come under price point perspective.

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Click each Strategy to know more about it.

Besides premium pricing, penetration pricing, economy pricing and skimming pricing, there are many more pricing policies/strategies. Given below are a few of them.

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Now that you have seen the various pricing strategies, lets have a knowledge check.

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Select the strategy that you think is appropriate and click Submit.

Economy Pricing

Promotional Pricing

Prestige Pricing

Value Pricing

Price Skimming

Premium Pricing

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You present to a firm, a substantial competitive advantage and hence you charge a high price. However, the advantage is not sustainable. Identify the pricing strategy that you will be using here.

Pricing and Output Determination in Different Markets: Models of Market Structure

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Now that we have studied the various pricing strategies, let us study the various markets and market classification.

Economists classify a firm’s market structure based upon its producing and selling environment.

A Market Structure is a simplified model of market of a given product with three defining characteristics:

• the number of firms, • the ease of entry and exit from the market,• the degree to which the product is differentiated.


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Pricing and Output Determination in Different Markets: Four Models of Market Structure

Models of Market Structure

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Perfect CompetitionMonopoly 3

Now that we know the defining characteristics, lets have a in-depth look at the market structure.

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Monopolistic Competition Oligopoly

Number of firms: many Ease of entry/exit: easy Type of product: homogeneous (standardized)

Number of firms: one Ease of entry/exit: no entry possible Type of product: unique

Number of firms: many Ease of entry/exit: easy Type of product: differentiated

Number of firms: few Ease of entry/exit: difficult Type of product: standardized or differentiated


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Pricing and Output Determination in Different Markets: Short Term and Long Term Equilibrium

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1 Equilibrium exists when the quantities of a good or resource demanded and supplied are equal. The type of market the firm is in decides the effect of equilibrium on the firm. These effects are both short term and long term.

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1The four key characteristics of perfect competition are: (1) large number of small firms, (2) identical products sold by all firms, (3) freedom of entry into and exit out of the industry, and (4) perfect knowledge of prices and technology. These four characteristics mean that a given perfectly competitive firm is unable to exert any control whatsoever over the market.


Perfect Competition

If firms are perfectly competitive, industry is making short term surplus (profits), more firms will enter the industry. In the long run this will increase the market supply of the product and reduce the market price as well as the profits until all firms in the industry make a normal profit (break even )

Show graph as well as the notes under it, as shown in Fig 9.2 For Short Term Equilibrium.& 9.3 for Long Term Equilibrium, in the SME notes.

Click Short Term Equilibrium tab to read about it in more details and click Long Term Equilibrium tab to read about it in more details.

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Short Term Equilibrium Long Term Equilibriuma b


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Monopoly

In a monopoly market, a monopolist is a price setter and not a price taker. Since a monopolist is the sole seller of a product for which there are no close substitutes, he can sell more units of the product only by lowering its price.

As long as the demand it faces and its cost curves remain unchanged, the monopolist will continue to earn profits in the short as well as long run because the entry into the market is blocked. It is to be noted that when the monopolist is in long-run-equilibrium it is also and necessarily in short-run-equilibrium. Show graph as well as the notes under it,

as shown in Fig 9.6 & 9.7, in the SME notes.

The four key characteristics of monopoly are: (1) a single firm selling all output in a market, (2) a unique product, (3) restrictions on entry into and exit out of the industry, and more often than not (4) specialized information about production techniques unavailable to other potential producers.

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Short Term Equilibrium Long Term Equilibrium

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Monopolistic Competition

In a monopolistic competition, every producer is selling his product under a particular brand or trade name. Before fixing the price he has to take into account the prices of substitutes. The prices charged by rivals enable him to fix his price. In a short run, a firm working under monopolistic competition can earn supernormalprofit as well as incur a loss or may earn normal profits.

Show graph as well as the notes under it, as shown in Fig 9.9 & 9.10, in the SME notes.

The four key characteristics of monopolistic competition are: (1) large number of small firms, (2) similar but not identical products sold by the firms, (3) relative freedom of entry into and exit out of the industry, and (4) extensive knowledge of prices and technology.

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Short Term Equilibrium Long Term Equilibriumb


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1The characteristics of an oligopoly industries are: (1) Few (two, three, four) sellers who control all or most sales, (2) Barriers to entry (it is difficult to start a new company in an oligopoly industry), (3) Firms in this industry are interdependent (one firm’s actions very much affect a rival firm’s well being), (4) Advertising is prevalent (firms frequently advertise on a national scale).


Oligopoly

Show graph as well as the notes under it, Fig. 22.1 (Page 430 from Mithani) and Fig. 10.4 (Page 349 from Peterson) in the same order one-by-one from the SME notes.

Major theories about oligopoly pricing:•Oligopoly firms collude to charge the monopoly price.•Oligopoly firms compete on price so that price and profit will be the same as a competitive industry.•Oligopoly price and profits will be between the monopoly and competitive ends of the scale.•Oligopoly prices and profits are 'indeterminate‘ (oligopoly seen as difficult to model).

Pricing strategies for business within an oligopoly can be expected to change over time.No one theory has been found that explains all the different types of behaviors seen in an oligopoly market.

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Graph 22.1a

Click Kinked Demand Curve graph to view it in detail.

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Now that we have seen the market structure, lets have a knowledge check.

Description Type of Elasticity

It refers to market wherein the products are all standardized. i. Oligopoly Market

It refers to market in which the products are highly differentiated. ii. Perfect Competition

It refers to market in which the products are either all standardized or differentiated.

iii. Monopolistic Competition

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Submit Solution

Pricing and Output Determination in Different Markets: Link Between Price And Business Objectives

To match a type of market to its proper product description, drag the types of market to the placeholders in the product description column. Click Submit when you are done.

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Pricing and Output Determination in Different Markets: Summary

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In this chapter, we have seen pricing strategies, market structure and classification, along with the short and long term effect of the market on the firm and its planning and operation.

You should now be able to:

• Describe the factors influencing pricing strategies.• List the pricing strategies.• Identify the market structure.• Classify the market based on nature of competition.• Describe the short term and long term equilibriums in the various markets.

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