unit 3
TRANSCRIPT
UNIT 3 PRODUCT AND FACTOR MARKET
MARKET- MEANING
• An arrangement whereby buyers and sellers come in close contact with each other directly or indirectly to sell and buy goods.
• A market consists of all firms and individuals who are willing and able to buy or sell a particular product.
MARKET - GENERAL TYPES
PRODUCT MARKET
• Product Market / Commodity market:
– Arrangement in effecting buying and selling of commodities. Eg. Cotton market, rice market, wheat market, tea market, Gold market,fish market etc.
– Market for precious metals such as gold & silver are called the Bullion market or Bullion Exchanges.
– Markets for capital change like Govt. securities, bonds and shares are called as Stock market or stock exchange.
FACTOR MARKETS
• Factors of production such as land, labor and capital are transacted. These are called as labor market, land market, and capital market.
TYPES OF MARKET
• Markets can be classified on the basis of different criteria
• Based on Area: – a) Local b) Regional C) National and d) International
market.
• Based on Nature of Transaction: – a) Spot market b) Future market.
• Based on Volume of Business: – a) Wholesale b) Retail
• Based on User: – a) B to B market b) Consumer market.
…CONTD
• Based on Time: – a) Very short period market b) Short period c)
Long period d) Very long period market.
• Based on status of sellers: – a) Primary Market b) Secondary market c)
Tertiary market.
• Based on regulation: – a) Regulated market b) Unregulated market.
• Based on Market Structure.
MARKET STRUCTURE
• Market structure refers to the basic characteristics of the market environment like
– No. of buyers, sellers, and potential entrants.
– Degree of product differentiation.
– Amount and cost of information about product price and quality.
– Conditions of entry and exit.
…CONTD
• According to Market Structure the markets are divided as below:
– Perfect Competition
– Imperfect competition
– Monopoly and Monopsony,
– Oligopoly and Oligopsony,
– Monopolistic Competition.
FIRMS IN COMPETITIVE MARKETS
PURE & PERFECT COMPETITION
• Competition among the sellers and buyers prevails in its most perfect form.
– Large Number of Sellers:
• Formed by large no. of actual and potential firms and sellers. Size of each firm is relatively small and individual supply has a negligible effect on the total supply.
– Large Number of Buyers:
• Formed by large no. of actual and potential buyers.
– Product Homogeneity:
• There is no product differentiation. So products can be readily substituted for each other.
…CONTD
• Free Entry and Exit: – There is no legal, technological, economic, financial
or any other barrier to their entry. Existing firms are free to quit market.
• Perfect knowledge of Market Conditions: – All the buyers and sellers possess perfect knowledge
about the existing market conditions.
• Pricing: – Since individual buyer or seller has no effect in
market demand and supply, they cannot exert any influence on the ruling market price.
..CONTD
• Perfect Mobility of Factors of Production: Factor costs are the same for all firms.
• Government Non-intervention:
– No tariffs, subsidies, rationing of goods, control on supply of raw materials and licensing policy.
THE MEANING OF COMPETITION
• A perfectly competitive market has the following characteristics:
– There are many buyers and sellers in the market.
– The goods offered by the various sellers are largely the same.
– Firms can freely enter or exit the market.
THE MEANING OF COMPETITION
• As a result of its characteristics, the perfectly competitive market has the following outcomes:
– The actions of any single buyer or seller in the market have a negligible impact on the market price.
– Each buyer and seller takes the market price as given.
– Thus each buyer and seller is a price taker.
REVENUE OF A COMPETITIVE FIRM
• Total revenue for a firm is the selling price times the quantity sold.
TR = (P X Q)
MARGINAL REVENUE OF A COMPETITIVE FIRM
• Marginal revenue is the change in total revenue from an additional unit sold.
MR =TR/ Q
REVENUE OF A COMPETITIVE FIRM
• For competitive firms, marginal revenue equals the price of the good.
TOTAL, AVERAGE, AND MARGINAL REVENUE FOR A COMPETITIVE FIRM
QUANTITY (Q)
PRICE (P)
TOTAL REVENUE TR = P X Q
AVERAGE REVENUE AR = TR /Q
MARGINAL REVENUE MR =∆TR/∆Q
1 6 6 6 -
2 6 12 6 6
3 6 18 6 6
4 6 24 6 6
5 6 30 6 6
6 6 36 6 6
7 6 42 6 6
8 6 48 6 6
PROFIT MAXIMIZATION FOR THE COMPETITIVE FIRM
• The goal of a competitive firm is to maximize profit.
– This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.
PROFIT MAXIMIZATION: A NUMERICAL EXAMPLE
QUANTITY (Q)
PRICE (P)
TOTAL REVENUE TR = P X Q
TOTALCOST (TC)
PROFIT (TR – TC)
AVERAGE REVENUE AR = TR /Q
MARGINAL REVENUE MR =∆TR/∆Q
MARGINAL COST MC =∆TC/∆Q
0 0 3 -3
1 6 6 5 1 6 - 2
2 6 12 8 4 6 6 3
3 6 18 12 6 6 6 4
4 6 24 17 7 6 6 5
5 6 30 23 7 6 6 6
6 6 36 30 6 6 6 7
7 6 42 38 4 6 6 8
8 6 48 37 1 6 6 9
P = AR = MR P=MR1
MC
PROFIT MAXIMIZATION FOR THE COMPETITIVE FIRM...
Quantity 0
Costs and
Revenue
ATC
AVC
QMAX
The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue.
MC1
Q1
MC2
Q2
PROFIT MAXIMIZATION FOR THE COMPETITIVE FIRM
• Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
PROFIT MAXIMIZATION FOR THE COMPETITIVE FIRM
When MR > MC increase Q
When MR < MC decrease Q
When MR = MC Profit is maximized. The
firm produces up to the point where MR=MC
THE INTERACTION OF FIRMS AND MARKETS IN COMPETITION
Firm Market Price And Costs
Price
qF QM
a
b
c
d
A
B
q1 q2 q3 q4 Q1 Q2
MC
P=MR0
ATC
P=MR1 AVC
S1
S2
D0
10
ATC =7
10 units
The Marginal-Cost Curve and the Firm’s Supply Decision...
Quantity 0
Costs and
Revenue
MC
ATC
AVC
Q1
P1
P2
Q2
This section of the firm’s MC curve is also the firm’s supply curve (long-run).
THE FIRM’S SHORT-RUN DECISION TO SHUT DOWN
• A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.
• Exit refers to a long-run decision to leave the market.
THE FIRM’S SHORT-RUN DECISION TO SHUT DOWN
• The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
– Sunk costs are costs that have already been committed and cannot be recovered.
THE FIRM’S SHORT-RUN DECISION TO SHUT DOWN
• The firm shuts down if the revenue it gets from producing is less than the variable cost of production.
– Shut down if TR < VC
– Shut down if TR/Q < VC/Q
– Shut down if P < AVC
THE FIRM’S SHORT-RUN DECISION TO SHUT DOWN...
Quantity
ATC
AVC
0
Costs
MC
If P < AVC, shut down.
If P > AVC, keep producing in the short run.
If P > ATC, keep producing at a profit.
Firm’s short-run supply curve.
THE FIRM’S SHORT-RUN DECISION TO SHUT DOWN
• The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve.
THE FIRM’S LONG-RUN DECISION TO EXIT OR ENTER A MARKET
• In the long-run, the firm exits if the revenue it would get from producing is less than its total cost.
– Exit if TR < TC
– Exit if TR/Q < TC/Q
– Exit if P < ATC
THE FIRM’S LONG-RUN DECISION TO EXIT OR ENTER A MARKET
• A firm will enter the industry if such an action would be profitable.
– Enter if TR > TC
– Enter if TR/Q > TC/Q
– Enter if P > ATC
THE COMPETITIVE FIRM’S LONG-RUN SUPPLY CURVE...
Quantity
MC = Long-run S
ATC
AVC
0
Costs
Firm enters if P > ATC
Firm exits if P < ATC
EQUILIBRIUM OF PERFECTLY COMPETITIVE FIRM
• Short run case: – In a competitive situation, all firms get the same
price for their homogeneous product regardless of the quantity sold.
– MR = AR
• Firm may end up with making either profit or loss.
• Long run case: – In long run profit or loss will disappear due to free
entry and exit. – P=AR=MR=AC=MC
MONOPOLY
MONOPOLY
• While a competitive firm is a price taker, a monopoly firm is a price maker.
• A firm is considered a monopoly if . . .
– it is the sole seller of its product.
– its product does not have close substitutes.
MONOPOLY- CHARACTERISTICS
• Only one seller. • There are many buyers. • Many entry barriers such as
– natural , economic, technological or legal.
• Monopoly firm is a price maker. • There is no closely competitive substitutes. • Monopolist has a complete control over the market supply
and price. According the supply the price is fixed or vice versa.
• Product is Homogenous. • No difference between firm and industry. • Economies of scale
WHY MONOPOLIES ARISE
• The fundamental cause of monopoly is barriers to entry.
WHY MONOPOLIES ARISE
• Barriers to entry have three sources:
– Ownership of a key resource.
• This tends to be rare. Example………………?
– The government gives a single firm the exclusive right to produce some good.
• Patents, Copyrights and Government Licensing.
– Costs of production make a single producer more efficient than a large number of producers.
• Natural Monopolies .Example………..?
TYPES OF MONOPOLY.
• Pure Monopoly – No close substitutes available.
• Imperfect Monopoly – Close substitutes are available.
• Legal, Natural(size of the market is too small), Technological and joint monopolies.
• Private monopoly
• Public or social monopoly.
• Regional monopoly
ORIGIN OF MONOPOLY - REASON
• Patent right for products.
• Government Policies such as granting licenses.
• Ownership and control of raw materials.
• Exclusive knowledge of technology by the firm.
• May be size of market can accommodate only a single firm.
ECONOMIES OF SCALE AS A CAUSE OF MONOPOLY
Average total cost
Quantity of Output
Cost
0
MONOPOLY VERSUS COMPETITION
• Monopoly
– Is the sole producer
– Has a downward-sloping demand curve
– Is a price maker
– Reduces price to increase sales
Competitive Firm
Is one of many
producers
Has a horizontal
demand curve
Is a price taker
Sells as much or as
little at same price
Quantity of Output
Demand
(a) A Competitive Firm’s Demand Curve
(b) A Monopolist’s Demand Curve
0
Price
0 Quantity of Output
Price
Demand
DEMAND CURVES FOR COMPETITIVE AND MONOPOLY FIRMS
A MONOPOLY’S REVENUE
• Total Revenue
– P x Q = TR
• Average Revenue
– TR/Q = AR = P
• Marginal Revenue
– d TR/ d Q = MR
A MONOPOLY’S MARGINAL REVENUE
• A monopolist’s marginal revenue is always less than the price of its good.
– The demand curve is downward sloping.
– When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
A MONOPOLY’S TOTAL, AVERAGE, AND MARGINAL REVENUE
QUANTITY (Q)
PRICE (P)
TOTAL REVENUE TR = P X Q
AVERAGE REVENUE AR = TR /Q
MARGINAL REVENUE MR =∆TR/∆Q
11 0
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4
A MONOPOLY’S MARGINAL REVENUE
• When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q).
– The output effect
• more output is sold, so Q is higher.
– The price effect
• price falls, so P is lower.
DEMAND AND MARGINAL REVENUE CURVES FOR A MONOPOLY...
Quantity
Price
11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
1 2 3 4 5 6 7 8
Marginal revenue
Demand (average revenue)
PROFIT-MAXIMIZATION FOR A MONOPOLY...
Monopoly price
Quantity QMAX 0
Costs and Revenue
Demand
Average total cost
Marginal revenue
Marginal cost
A
1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity...
B
2. ...and then the demand curve shows the price consistent with this quantity.
COMPARING MONOPOLY AND COMPETITION (PERFECT)
• For a competitive firm, price equals marginal cost.
– P = MR = MC
• For a monopoly firm, price exceeds marginal cost.
– P > MR = MC
A MONOPOLY’S PROFIT
• Profit equals total revenue minus total costs.
– Profit = TR - TC
– Profit = (TR/Q - TC/Q) x Q
– Profit = (P - ATC) x Q
THE MONOPOLIST’S SUPER NORMAL PROFIT...
Quantity 0
Costs and Revenue
Demand
Marginal cost
Marginal revenue
QMAX
B Monopoly price
E
Average total cost D
Average total cost
C
THE MONOPOLIST’S NORMAL PROFIT...
Quantity 0
Costs and Revenue
Demand
Marginal cost
Marginal revenue
QMAX
B Monopoly price
E
Average total cost
Average total cost
Monopoly LOSS
THE MONOPOLIST’S LOSS...
Quantity 0
Costs and Revenue
Demand
Marginal cost
Marginal revenue
QMAX
B Monopoly price
E
Average total cost
Average total cost
THE MONOPOLIST’S PROFIT
• The monopolist will receive economic profits as long as price is greater than average total cost.
PUBLIC POLICY TOWARD MONOPOLIES
• Government responds to the problem of monopoly in one of four ways.
– Making monopolized industries more competitive.
– Regulating the behavior of monopolies.
– Turning some private monopolies into public enterprises.
– Doing nothing at all.
MARGINAL-COST PRICING FOR A NATURAL MONOPOLY...
Regulated price
Quantity 0
Loss
Price
Demand
Marginal cost
Average total cost Average
total cost
MONOPOLY SUPPLY CURVE
• There is no definite supply curve for monopolist.
• Monopoly is a price maker the firm itself sets the price of the product it sells instead of taking the price as given.
• MC= MR for profit maximization
PRICE DISCRIMINATION
• Price discrimination is the practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. In order to do this, the firm must have market power.
PRICE DISCRIMINATION
• Two important effects of price discrimination:
– It can increase the monopolist’s profits.
– It can reduce deadweight loss.
• But in order to price discriminate, the firm must
– Be able to separate the customers on the basis of willingness to pay.
– Prevent the customers from reselling the product.
PRICE DISCRIMINATION BASES
• Personal – example -Concessions in tickets
• Geographic – example - Oils, food items different prices in different
area
• Time – example - News paper ads, off season discounts,
phone calls
• Purpose of use – Example – electricity rates .
PRICE DISCRIMINATION IN MONOPOLY
• Reasons:
– Difference in price elasticity :
• Different elasticity with different customers. Eg. Income, available of substitutes.
– Market segmentation.
– Effective separation of sub markets.
– Legal sanction for price discrimination. Eg. Electricity.
– Difference in quality.
– Ignorance of product knowledge or lack of mobility.
DEGREE OF PRICE DISCRIMINATION
• Price discrimination of the first degree : – This is said t occur when the monopolist is able to
sell each separate unit of the output at a different price to the same buyer
– Example – reservation .
• Price discrimination of the second degree: – Seller divides buyer according to their income,
location types of uses of the product.
• Price discrimination of the third degree: – The goods are divided into different blocks of units
and for each block a different price is charged.
– Example – cinema tickets
MONOPOLY POWER • It refers to the restraints imposed over his
competitors by the price-maker. • Methods of measuring monopoly power:
– Lerner’s measure: The difference between price and marginal cost measures the degree of monopoly power.
– Triffin’s measure: In terms of price cross-elasticity of demand. If the cross elasticity of demand is zero, implying the firm has an absolute monopoly power.
– Bain’s measure: Measured in terms of supernormal profits. i.e. the gap between price and average cost at equilibrium.
– Rothschild’s measure: Slope of the firm’s demand curve / slope of the industry’s demand curve.
MONOPOLISTIC COMPETITION
THE FOUR TYPES OF MARKET STRUCTURE
Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition
• electricity
• operating system
• solar power
• Crude oil
• Novels
• Movies
• Wheat
• Milk
Number of Firms?
Type of Products?
Many firms
One firm
Differentiated products
Identical products
TYPES OF IMPERFECTLY COMPETITIVE MARKETS
• Monopolistic Competition
– Many firms selling products that are similar but not identical.
• Oligopoly
– Only a few sellers, each offering a similar or identical product to the others.
MONOPOLISTIC COMPETITION
Markets that have some features of competition and some features of
monopoly.
MONOPOLISTIC COMPETITION- ATTRIBUTES
• Large number of buyers
• Large number of sellers.
• Product differentiation by each firm.
• Free entry. Only product differentiation act as entry barrier.
• Price will be higher than perfectly competitive firm but lower than a monopolist.
• May be price Competition or Non price competition.
• Higher elasticity of demand.
• Selling cost makes the difference.
MONOPOLISTIC COMPETITORS IN THE SHORT RUN
(a) Firm Makes a Profit
Quantity 0
Price
Demand
MR
ATC
Profit
MC
Profit- maximizing quantity
Price
Average total cost
A MONOPOLISTIC COMPETITOR IN THE LONG RUN...
Quantity
Price
0
Demand MR
ATC
MC
Profit-maximizing quantity
P=ATC
MONOPOLISTIC VERSUS PERFECT COMPETITION
• There are two noteworthy differences between monopolistic and perfect competition
– excess capacity and markup.
EXCESS CAPACITY
• There is no excess capacity in perfect competition in the long run.
• Free entry results in competitive firms producing at the point where average total cost is minimized, which is the efficient scale of the firm.
• There is excess capacity in monopolistic competition in the long run.
• In monopolistic competition, output is less than the efficient scale of perfect competition.
EXCESS CAPACITY...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR (demand
curve)
MC ATC
Price
Demand
MC ATC
Excess capacity
Quantity produced
Efficient scale
P = MC
Quantity produced
= Efficient scale
P
MARKUP OVER MARGINAL COST
• For a competitive firm
– price equals marginal cost.
• For a monopolistically competitive firm
– price exceeds marginal cost.
MARKUP OVER MARGINAL COST
• Because price exceeds marginal cost
– an extra unit sold at the posted price means more profit for the monopolistically competitive firm.
MARKUP OVER MARGINAL COST
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MC P = MR (demand
curve)
MC ATC
Quantity produced
Price
Demand
Marginal cost
MC ATC
MR
Markup
Quantity produced
MONOPOLISTIC VERSUS PERFECT COMPETITION...
Quantity
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Quantity
Price
P = MR (demand
curve)
MC
ATC
Quantity produced
Efficient scale
Price
Demand
MC ATC
P = MC
Excess capacity
Marginal cost
Markup
MR
Quantity produced = Efficient scale
ADVERTISING
• When firms sell differentiated products and charge prices above marginal cost.
• Each firm has an incentive to advertise in order to attract more buyers to its particular product.
ADVERTISING
• Firms that sell highly differentiated consumer goods typically spend between 10 and 20 percent of revenue on advertising.
• Overall, about 2 percent of total revenue, or over 100 billion a year, is spent on advertising.
ADVERTISING
• Critics of advertising argue that firms advertise in order to manipulate people’s tastes.
• They also argue that it impedes competition by implying that products are more different than they truly are.
ADVERTISING
• Defenders argue that advertising provides information to consumers
• They also argue that advertising increases competition by offering a greater variety of products and prices.
• The willingness of a firm to spend advertising rupees can be a signal to consumers about the quality of the product being offered.
BRAND NAMES
• Critics argue that brand names cause consumers to perceive differences that do not really exist.
• Economists have argued that brand names may be a useful way for consumers to ensure that the goods they are buying are of high quality. – providing information about quality.
– giving firms incentive to maintain high quality.
OLIGOPOLY
IMPERFECT COMPETITION
Imperfect competition includes industries in which firms have
competitors but do not face so much competition that they are price takers.
TYPES OF IMPERFECTLY COMPETITIVE MARKETS
• Oligopoly
– Only a few sellers, each offering a similar or identical product to the others.
• Monopolistic Competition
– Many firms selling products that are similar but not identical. ………* ALREADY SEEN
CHARACTERISTICS OF AN OLIGOPOLY MARKET
• Few sellers offering similar or identical products
• Interdependent firms
• Best off cooperating and acting like a monopolist by producing a small quantity of output and charging a price above marginal cost
• There is a tension between cooperation and self-interest.
….contd
• Few sellers. • Large buyers. • Product can be homogenous. • Entry barriers due to product differentiation due
to few firms dominating the market. • Prices are fixed high but always have the fear of
rivals. • All factors of production, advertisement and
selling expenses primarily depend upon competitors strategy.
REASONS FOR OLIGOPOLY
• Strategic material supplies and patented production techniques.
• Product differentiation
• Customer loyalty to established brands.
• Economies of scale.
• Restriction on the entry of new firms exercised by the existing firms.
• Restriction on the entry of new firms exercised by Government.
CLASSIFICATION OF OLIGOPOLY • Perfect oligopoly / Homogenous oligopoly
– homogenous product.
• Imperfect oligopoly / Heterogeneous oligopoly – Product differentiation.
• Open oligopoly – Free entry of new firms
• Closed oligopoly – Entry barriers.
• Partial oligopoly – Price leader
• Full oligopoly – No price leader.
• Agreement between firms / Cartels / Collision.
OLIGOPOLY PRICES, OUTPUT AND PROFITS
• Normally in oligopoly the firm’s pricing policy will be based on their rival firms.
• Rivals are likely to follow suit.
• Oligopoly firms hesitate to reduce price except to meet a price cut by one of the group.
• So, initiation of price cuts is infrequent except under serious market pressure on profits at existing prices.
• If one firm increases price, there is a good chance that others will follow suit.
KINKED DEMAND CURVE.
• When there is a sudden change in the slope of the demand curve then it is called as kinked demand curve. ( Sharp Corner in the demand curve).
• Price Reduction : – Actually the demand of the firm should increase. But it will
increase for a very short period and then there will not be any significant increase in sales. Because the rival firms will follow suit.
• Increase in price: – If the rival firms doesn’t follow suit, then the price increase
will cause a substantial decline in his sales.
• So neither a price increase nor a price reduction will be an attractive proposition for the oligopolist. Existence of price rigidity.
PERFECT COLLUSION / CARTELS.
• A cartel is an explicit agreement among independent firms on subjects like prices, output, market sharing etc.
– Centralised cartels.
– Market Sharing cartels.
IMPERFECT COLLUSION / PRICE LEADERSHIP.
• A traditional firm or the firm which has largest market share or the firm which always initiate a price change are called as leaders.
• If these company changes the price and all other companies tend to follow the suit is called as price leadership.
• Market share of a firm = Sales of firm / Total Market sales.
NON PRICE COMPETITION
• Usually a cut in a price by a firm will follow suit by its rival firms.
• This will lead to Price war.
• Price competition is always dangerous.
• Because it will squeeze profits.
• So it will be a better strategy to compete with the rival firms in various parameters other than price.
• These various parameters will take gestation period to imitate by the competitors.
VARIOUS PARAMETERS IN NON PRICE COMPETITION
• Know-how barriers • Advertisement. • Personal selling. • Product improvements or better products. • Product research and development. • Better quality packing and appearance. • Easier credit terms. • Home delivery. • After sales services. • Longer period of guarantee. • New promotional strategies. • Companies image.
A DUOPOLY EXAMPLE
A duopoly is an oligopoly with only two members. It is the simplest type
of oligopoly.
COMPETITION, MONOPOLIES, AND CARTELS
• The duopolists may agree on a monopoly outcome.
– Collusion
• The two firms may agree on the quantity to produce and the price to charge.
– Cartel
• The two firms may join together and act in unison.
SUMMARY OF EQUILIBRIUM FOR AN OLIGOPOLY
• Possible outcome if oligopoly firms pursue their own self-interests:
– Joint output is greater than the monopoly quantity but less than the competitive industry quantity.
– Market prices are lower than monopoly price but greater than competitive price.
– Total profits are less than the monopoly profit.
HOW THE SIZE OF AN OLIGOPOLY AFFECTS THE MARKET OUTCOME
• How increasing the number of sellers affects the price and quantity:
– The output effect: Because price is above marginal cost, selling more at the going price raises profits.
– The price effect: Raising production lowers the price and the profit per unit on all units sold.
HOW THE SIZE OF AN OLIGOPOLY AFFECTS THE MARKET OUTCOME
• As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market.
• The price approaches marginal cost, and the quantity produced approaches the socially efficient level.
GAME THEORY AND THE ECONOMICS OF COOPERATION
• Game theory is the study of how people behave in strategic situations.
• Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action.
GAME THEORY AND THE ECONOMICS OF COOPERATION
• Because the number of firms in an oligopolistic market is small, each firm must act strategically.
• Each firm knows that its profit depends not only on how much it produced but also on how much the other firms produce.
THE EQUILIBRIUM FOR AN OLIGOPOLY
• A Nash equilibrium is a situation in which economic factors interacting with one another each choose their best strategy given the strategies that all the others have chosen (I.e. Dominant Strategy)
PRICING
FACTORS GOVERNING PRICE • External Factors:
– Elasticity of supply and demand. – Extent of competition in the market. – Trend of the market. – Purchasing power of buyers. – Government policies towards prices.
• Internal Factors: – The costs. – The management policy towards gross margin & sales
turnover. – The basic characteristics of the product – The stage of the product on the product life cycle. Extent
of distinctiveness of the product. – Extent of product differentiation practiced.
• Consideration while pricing:
– General Objectives of Business.
• Survival
• Continued existence.
• Rate of growth
• Market share
• Maintenance of control or leadership
• Profit.
– Competitive situation.
– Product & Promotional strategies.
– Nature of price sensitivity.
– Conflicting interests of manufacturers and middlemen.
– Active entry of non-business groups into the determination of prices.
OBJECTIVES OF PRICING POLICY • Maximization of profits for entire product line.
• Discouraging the entry of competitors.
• Adaptation of prices to fit the diverse competitive situations faced by different products.
• Flexibility to vary prices to meet changes in economic conditions affecting the various consumer industries.
• Stabilization of prices and margin
• Market penetration.
• Early cash recovery.
• For achieving satisfactory rate of return.
ROLE OF COSTS IN PRICING
• Cost in Selling & Marketing.
• Cost is related with volume of production. – Price decisions cannot be based merely on cost.
• In the long run prices should cover costs.
• Relevant cost: all direct costs are relevant. Problem arises in a multi product firm.
• Demand factor in pricing – Cost reduction
– Elasticity of demand.
REASONS FOR INCREASING PRICES.
• Costs of Raw material increase
• Increase in demand than supply.
• Advertising.
• Change in the position of the product.
• Increase in the Per capita income.
PRICE DISCRIMINATION
• Charging different Prices on some systematic basis .
• Time Price Differentials: – Clock time differentials. Eg. Telephone service
charges – Calendar-time differentials. Eg. Off season rates in
Hospitality industry.
• User Price Differentials. Eg. Electricity. • Quality Price Differentials. • Quantity Price Differentials. Eg. Slab system,
Functional discounts.
…contd
• Geographic price Differentials: – Free on Board pricing (F.O.B)
– Delivered pricing.
– Zone pricing.
– Basing point pricing.
• Personal price Differentials.
• National Areas Price Differentials / Export price Differentials.
• Cash Discounts.
PRICING STRATEGIES.
• Stay-out Pricing. • Price lining. • Psychological pricing. • Limit Pricing. • Skimming price • Penetration price • Sliding down the demand curve. • Premium pricing. • Fraction below competition. • Price Discrimination. • Bench mark Pricing.
PROCESS OF PRICING FOR GOODS & SERVICES.
• Individuals affected by pricing decision: – Sales promotional personnel. – Rival firms & potential rival firms. – Consumers and potential consumers. – Middlemen / Suppliers. – The Government.
• Multi-stage process: – Determining target group. – Decision about the firm’s image. – Selection of sales strategy. – Choice of pricing policy & pricing strategy. – Setting specific prices.
CONSIDERATIONS IN PRICING
• Impact of price and output on revenue & cost.
• Elasticity of demand.
• Incremental contribution of output to overheads and profit.
• Output level that can contribute maximum towards overheads and profit.
• Possibilities of price adjustments to changes in cost and demand conditions.
…contd
• Consideration of goodwill.
• Impact of price change in a product on the product line.
• Finding out long run / short run implications of any price change.
• Consideration of rivals price strategies & reactions.
• Coordination of pricing policy with overall corporate goals.
PRICING OVER THE LIFE CYCLE OF A PRODUCT
• Introduction
• Growth stage.
• Maturity.
• Stage of decline.
FACTOR MARKETS
FACTOR OF PRODUCTION
• Used to produce some output.
– It also called an input or a productive resource.
• Examples: labor, machinery, raw materials, land
FACTOR MARKET
• A market for a factor of production.
– Example: The market for construction workers brings together the buyers and sellers of construction workers’ services.
• The demand for an input is derived from the demand for the output that the input helps produce.
DERIVED DEMAND
IMPORTANT NOTE
• A firm might be a perfect competitor in the product market and might not be a perfect competitor in the factor market, or vice versa.
FOUR POSSIBILITIES FOR A FIRM
• Perfect competitor in the product market, and perfect competitor in the factor market.
• Perfect competitor in the product market, but not a perfect competitor in the factor market.
• Not a perfect competitor in the product market, but a perfect competitor in the factor market.
• Not a perfect competitor in the product market, and not a perfect competitor in the factor market.
Example: The local water company is the only water company in the area. It is one of many employers who hire accountants.
This firm is not a perfect competitor
in the product market (water market).
It may be a perfect competitor in the factor market (market for accountants).
PRICE-TAKING IN THE FACTOR MARKET
• Just as a firm in a perfectly competitive product market takes the price of the product as given
• A firm in a perfectly competitive factor market takes the price of the factor as given.
• The firm can hire as much of the input as it wants at the going input price. – So, the supply curve of the input to the firm is a
horizontal line at the input price.
price of labor
labor
PL
S
PRICE OF LABOR
FACTOR MARKET TERMS
MARGINAL RESOURCE COST (MRC)
• The change in total cost that results from the employment of an additional unit of an input.
MRC = ∆TC / ∆ L
MARGINAL PHYSICAL PRODUCT (MPP) OR MARGINAL PRODUCT (MP)
• The change in the quantity of output that results from the employment of an additional unit of an input.
MPP = ∆Q / ∆ L
MARGINAL REVENUE PRODUCT (MRP)
• The change in total revenue that results from the employment of an additional unit of an input.
MRP = ∆TR / ∆ L
WHAT IS THE DIFFERENCE BETWEEN THE MPP AND MRP?
• Suppose your company produces chairs.
– The MPP tells how many more chairs you can make if you hire another worker.
– The MRP tells how much more revenue you can make from the additional chairs produced by the additional worker
ALTERNATIVE FORMULA FOR MRP
MRP = TR = TR Q L L Q
= TR Q Q L
= MR . MPP
So, MRP = MR . MPP
Example: A firm sells its shirts in a perfectly competitive product market for Rs 10 each.
L Q
0 0
10 70
20 130
30 180
40 220
50 250
60 270
70 280
Example: A firm sells its shirts in a perfectly competitive product market for Rs 10 each.
L Q MPP=Q/L
0 0 ---
10 70 7
20 130 6
30 180 5
40 220 4
50 250 3
60 270 2
70 280 1
Example: A firm sells its shirts in a perfectly competitive product market for Rs 10 each.
L Q MPP=Q/L TR=PQ
0 0 --- 0
10 70 7 700
20 130 6 1300
30 180 5 1800
40 220 4 2200
50 250 3 2500
60 270 2 2700
70 280 1 2800
Example: A firm sells its shirts in a perfectly competitive product market for Rs 10 each.
L Q MPP=Q/L TR=PQ MR =TR/Q
0 0 --- 0 ---
10 70 7 700 10
20 130 6 1300 10
30 180 5 1800 10
40 220 4 2200 10
50 250 3 2500 10
60 270 2 2700 10
70 280 1 2800 10
Example: A firm sells its shirts in a perfectly competitive product market for Rs 10 each.
MRP =TR/L L Q MPP=Q/L TR=PQ MR =TR/Q MRP= MR•MPP
0 0 --- 0 --- ---
10 70 7 700 10 70
20 130 6 1300 10 60
30 180 5 1800 10 50
40 220 4 2200 10 40
50 250 3 2500 10 30
60 270 2 2700 10 20
70 280 1 2800 10 10
Focusing on the first and last columns of the previous table, we have the MRP schedule.
L MRP
0 ---
10 70
20 60
30 50
40 40
50 30
60 20
70 10
PLOTTING POINTS WE HAVE A GRAPH OF THE MRP CURVE.
MRP
labor
0 10 20 30 40 50 60 70
70 60 50 40 30 20 10
MRP
MRP > MRC employ more input
MRP < MRC cut back employment
MRP = MRC profit-maximizing employment level
WHEN SHOULD YOU EMPLOY MORE OF AN INPUT?
PROFIT-MAXIMIZING CONDITION FOR INPUT USAGE:
MRP = MRC
MRC in a Perfectly Competitive Labor Market
• Each time a firm hires another unit of labor, its cost increases by the price of the labor (PL).
– So for a firm in a perfectly competitive labor market, MRC = PL .
( firm is not in a perfectly competitive labor market, is possible…………….)
• Suppose the firm in the example we considered earlier is also perfectly competitive in the labor market.
– So the MRC is the same as the price of labor or the market wage.
• Let’s see what the demand curve for labor is for this firm.
– What we need to know is how many workers will be hired at various wage levels.
Remember: You hire workers as long as they add at least as much to revenues as to cost.
Suppose the market wage is Rs 70. How many workers will you hire?
10 Suppose the market wage is Rs 60. How
many workers will you hire? 20 Suppose the market wage is Rs 50. How
many workers will you hire? 30 Suppose the market wage is Rs 40. How
many workers will you hire? 40
L MRP 0 ---
10 70
20 60
30 50
40 40
50 30
60 20
70 10
A FIRM’S DEMAND CURVE FOR LABOR
Rs
labor
0 10 20 30 40 50 60 70
70 60 50 40 30 20 10
demand curve for labor
THE SUPPLY OF LABOUR
• The LABOUR FORCE:
– all individuals in work or seeking employment
• Labor supply
– for an individual, the decision on how many hours to offer
to work depends on the real wage
– an individual’s attitude towards leisure and income
determines if more or less hours of work are supplied at a
higher real wage rate.
THE INDIVIDUAL’S SUPPLY CURVE OF LABOUR
Hours of work supplied
SS1 For the labor supply curve SS1, an increase in the real wage induces higher labor supply.
SS2
Whereas for SS2, there comes a point where a higher wage induces less hours of work to be supplied: labor supply is backward-bending.
THE LABOR DEMAND CURVE SHIFTS BECAUSE
1)An increase or decrease in the price of output.
An increase in the price of widgets, increases the MP of each worker, and increases the demand for labor in widget factories.
Improvements in widget technology increases the MP of labor, which increases the demand for labor in widget factories.
A fall in the supply of iron to make widgets will decrease the MP of widget workers and decrease the demand for widget workers.
3) A change in the supply of linked factors of production.
2) Change in technology.
THE LABOR SUPPLY CURVE SHIFTS BECAUSE:
1) A change in attitudes regarding work.
2) Change in opportunity
3) Immigration policies.
Changing opportunities may cause a worker in one field to seek work in a higher paying position elsewhere.
An increase in the immigration will increase the supply of labor.
Prior to World War II, few women worked outside the home. A changing attitude regarding working has increase the supply of labor for females.
Q of labor for total labor market
Q of labor for an individual firm
Wage rate (Rs)
P
Q Q
S1
D=MRP
S = MRC W1
Q
The Supply of and Demand for Labor in a Competitive Labor Market.
D=mrp
w2
When the supply of labor increases from S1 to S2, the wage rate falls from W1 to W2 and firms begin to hire
more labor increasing quantity from L1 to L2.
S2
L1 L2
S
D
When there is demand for the good or services in the product market (causing P and Q to go up). . . .
P
Q
S
D
. . . . and because Q went up, there is a derived demand for resources (labor) in the factor
market (causing W and Q to go up).
W
Q of Labor Product Market Resource Market
P1
P
W1
Q1 QL1
Q QL
W
S
D
IMPORTANT: do NOT label the supply curve for the labor market as “S”. . . .
P
Q
MFC
D
. . . . .label it MFC (marginal factor cost)
W
Q
Product Market Resource Market
P1
P
W1
Q1 Q1
Q Q
W
S
D
IMPORTANT: do NOT label the demand curve for the labor market as “D”. . .
P
Q
MFC
MRP
. . . . .label it MRP (marginal revenue
product)
W
Q
Product Market Resource Market
MRP1 D1
P1
P
W1
Q1 Q1
Q Q
W
LABOUR SUPPLY IN AGGREGATE
• If we consider the economy as a whole, or an industry
• A higher real wage rate also encourages a higher participation rate
• so labour supply is likely to be upward-sloping
LABOUR MARKET EQUILIBRIUM FOR AN INDUSTRY
• The industry supply curve SLSL slopes up – higher wages are needed to
attract workers into the industry
• For a given output demand curve, industry demand for labour slopes down
• Equilibrium is W0, L0.
Quantity of labour
DL
DL SL
SL
W0
L0
A SHIFT IN PRODUCT DEMAND
Quantity of labour
DL
DL SL
SL
W0
L0
Beginning in equilibrium,
The new equilibrium is at W1, L1.
L1
W1
a fall in demand for the product also shifts the derived demand for labour to D'L
D'L
D'L
A CHANGE IN WAGES IN ANOTHER INDUSTRY
Quantity of labour
DL
DL SL
SL
W0
L0
Again starting in equilibrium,
An increase in wages in another industry attracts labour,
The new equilibrium is at W2, L2.
L2
W2
so industry supply shifts to the left –
S'L
S'L
TRANSFER EARNINGS AND ECONOMIC RENT
• Transfer earnings
– the minimum payments required to induce a factor of production to work in a particular job.
• Economic rent
– the extra payment a factor receives over and above the transfer earnings needed to induce the factor to supply its services in that use.
TRANSFER EARNINGS AND ECONOMIC RENT (2)
D
D
SS
Wa
ge
Quantity
A
W0
L0
E
In labour market equilibrium at W0, L0,
If workers were paid only the transfer earnings, the industry would need only pay AEL0 in wages.
But if all workers must be paid the highest wage needed to attract the marginal worker into the industry (W0), then workers as a whole derive economic rent of 0AEW0.
0 A
INFRAMARGINAL RENT vs
PURE ECONOMIC RENT
in the Labor Market
There are two types of rent:
1) Inframarginal rent
2) Economic rent
INFRAMARGINAL RENT
S
D
Firms demand labor from households…..
…..households supply labor to the firms.
Wage
Quantity
The number of workers hired is Q…..
Q
……and the wage rate is W.
W
INFRAMARGINAL RENT
S
D
If you notice, many workers are willing to work below the equilibrium wage.
Wage
Quantity Q
W
Even though they are willing to work for less, they are
paid the equilibrium wage rate. This means workers are receiving added profit above
what they are paid for…
This added profit is called INFRAMARGINAL RENT.
PURE ECONOMIC RENT
MFC
MRP
First we label the derived demand and supply curves correctly.
Wage
Quantity Q
W
In any industry, the firm will hire only so many workers. So at some Q, the supply curve becomes perfectly
inelastic.
PURE ECONOMIC RENT
MFC
MRP
Wage
Quantity Q
W
In the short run, if derived demand for labor increases
without a change in the supply of labor, MRP
increases.
MRP1
PURE ECONOMIC RENT
MFC
MRP
Wage
Quantity Q
W
Individuals who were willing to work for W are now
earning W1 and are now earning PURE ECONOMIC
RENT.
MRP1
W1
COST MINIMIZATION
• An ISOQUANT
– shows the different minimum quantities of inputs required to produce a given level of output
• An ISOCOST curve
– shows the different input combinations with the same total cost, given relative factor prices.
Capital
Lab
ou
r
I I'
I''
KA
L0
A