Markets & Pricing Markets & Pricing

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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

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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.

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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

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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

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Characteristics

• Consumers

• Sellers

• A Commodity

• A Price

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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

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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

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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

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Monopoly

By

Mrs. N. Jayaprada

Monopoly

By

Mrs. N. Jayaprada

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• 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

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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

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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

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Types

• Legal

• Economic

• Natural

• Regional

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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

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Short-Run Equilibrium -Monopoly Competition

AR

SAC

P

Co

st &

Rev

enu

e

Units of output

MR

SMC

E

C

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Long-Run Equilibrium Under Monopoly Competition

Pri

ce, R

even

ue,

Co

st

Quantity

MR

LMC

LAC

AR & D

E

P M

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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.

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Prerequisites

• Market control

• Division of market

• Different price Elasticities of demand in different markets.

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Bases

• Personal

• Geographical

• Time

• Purpose of use

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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

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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.

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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

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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

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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.

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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

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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.

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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.

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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.

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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.

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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

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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

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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

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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

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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

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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

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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

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(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

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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.

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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.

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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

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MC

P = MR=AR

2 4 6 8 Quantity

Price

60

50

40

30

20

10

0

ATC

AVC

Loss

A

The Shutdown Decision

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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.

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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

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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.

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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