MARKET STRUCTURE AND OUTPUT-PRICING DECISIONS

Firms output and pricing decisions depend on the current market structure in which the firm is operating i.e. How much control over price we have.
whether the firm is competing in perfect competition, monopoly, monopolistic competition or oligopoly situation

Competition vs. Monopoly

One useful way in which issues of competition and monopoly can be investigated is called the Structure, Conduct and Performance Model

Competition vs. Monopoly

Market Structure
e.g. number of buyers and sellers (the size of firms)

Conduct
e.g. firm's goals, pricing and output, their investments

Performance
e.g. efficiency, profitability and growth

MONOPOLY
PRICING& OUTPUT DECISIONS SHORT RUN & LONG RUN

Monopoly
Monopoly power refers to cases where firms influence the market in some way through their behaviour determined by the degree of concentration in the industry
Influencing prices Influencing output Erecting barriers to entry Pricing strategies to prevent or stifle competition May not pursue profit maximisation encourages unwanted entrants to the market Sometimes seen as a case of market failure

 Under perfect competition, pricing & output decision under monopoly are based on revenue & cost conditions i.e. AC and MC curves, in a competitive & monopoly market are generally identical, revenue conditions differ. Revenue conditions, I.e. AR and MR curves, are different under monopoly because, unlike a competitive firm, a monopoly firm faces a downward sloping demand curve.

Monopoly
Costs / Revenue

This is both the short run and long run equilibrium position for a monopoly Given the barriers to entry, the monopolist will be able to exploit abnormal profits AC in the long run as entry to the market is restricted. AR (D) curve for a monopolist likely to be relatively price inelastic. Output assumed to be at profit maximising output (note caution here not all monopolists may aim for profit maximisation!)
Output / Sales

MC
7.00

Monopoly Profit
3.00

MR
Q1

AR

MONOPOLISTIC COMPETITION
PRICE & OUTPUT DECISIONS: SHORT RUN & LONG RUN

 Pricing and output decisions under this kind of market are similar to those under monopoly. Firm under the monopolistic competition faces a downward sloping demand curve like monopolist faces. Decision rules regarding optimal output & pricing in the long run are the same as in the short run. In the long run, a monopolist get opportunity to expand the size of its firm with a view to enhance its long-run profits.

This is a short run equilibrium position for a firm in a monopolistic market structure.

Since the additional revenue received from each unit sold falls, the MR curve lies under the AR curve. MC

The demand curve facing the firm will be downward sloping and represents the AR earned from sales.
We assume that the firm produces where MR = MC (profit maximising output). At this output level, AR>AC and the firm makes abnormal profit (the grey shaded area).

Implications for the diagram:

Cost/Revenue

AC
1.00

Abnormal Profit
0.60

If the firm produces Q1 and sells each unit for 1.00 on average with the cost (on average) for each unit being 60p, the firm will make 40p x Q1 in abnormal profit. Marginal Cost and Average Cost will be the same shape. However, D (AR) because the products are differentiated in some Output / Sales way, the firm will only be able to sell extra output by lowering price.

MR
Q1

Monopolistic or Imperfect Competition

Implications for the diagram:
Cost/Revenue

MC AC

This is the long run equilibrium position of a firm in monopolistic competition.

AR = AC

MR1
Q2

AR1
Output / Sales

MC AC

Monopolistic Competition

P = AC1 MR Q1 D Output

Firms have some degree of market power

but demand curve typically flatter than in monopoly since there is more competition

Output-pricing decision is defined by MR = MC as always

the absence of entry barriers means that super normal profits are competed away...
firms end up producing where p = AC, but AC not at its minimum as in perfect competition, also p > MC

Price and Output Decision in Oligopoly

Oligopoly
Features of an oligopolistic market structure:
Price may be relatively stable across the industry kinked demand curve? Potential for collusion Behaviour of firms affected by what they believe their rivals might do interdependence of firms Goods could be homogenous or highly differentiated Branding and brand loyalty may be a potent source of competitive advantage Non-price competition may be prevalent Game theory can be used to explain some behaviour AC curve may be saucer shaped minimum efficient scale could occur over large range of output High barriers to entry

Significance of Kinked demand curve in oligopolistic market

Meaning of price rigidity
Why price rigidity arises Kinked demand curve and price rigidity

Price rigidity
Peculiar feature related to oligopoly The tendency of the price to remain fixed or constant irrespective of changes in price and cost conditions in the industry.

The price once established remains unchanged for a long period of time

Why price rigidity arises

Under non-collusive oligopoly, there is a greater amount of uncertainty regarding the behavior of rival firms The oligopolist does not know how his competitor will react. Therefore every oligopoly is confronted with indeterminate demand. One such price is established, the firm sticks to that price, whatever may be the consequences.

Kinked demand curve

First introduced by Prof. Paul Sameulson

Provides a convincing explanation of price rigidity

It does not explain how prices and output are determined under oligopoly Occurs when there is a sudden change in the slope of demand curve Such change leads to a sharp corner in demand curve

Kinked demand curve

The principle of the kinked demand curve rests on the principle that:

MC2
P MR A k MC1

a. If a firm raises its price, its rivals will not follow suit b. If a firm lowers its price, its rivals will all do the same

Q MR1

GOVERNMENT INTERVENTION IN PRICE FIXING

 Governments interfere with the normal process of price determination by fixing prices either above the equilibrium or below it. These govt. attempts require intervention with the forces of supply or demand or both by elaborate administrative regulations.

 Attempts to fix prices above an equilibrium level are illustrated by min. wage legislation & price support policies.

When the govt. steps into fix a minimum price (say,Rs.375 per quintal for Sugar) much above the equilibrium price (say, Rs.300 per quintal), consumers curtail their consumption of sugar (postpone their purchases at all levels)
On the other hand, farmers are encouraged to increase their production under the incentive of higher prices.

 As a result, there is disequilibrium between the demand and supply. There are only 2 ways to maintain prices at a high level
Govt. can buy large quantities to absorb the difference between the quantity supplied & the quantity demanded
The govt. can ask the farmers to curtail their output.

Need For Government Intervention

 The need for govt. intervention with the functioning of the free market mechanism has arisen out of the failure of the free market economy expected to ensure
That all those who are willing to work at prevailing wage rate get employment; That all those who are employed get their living in accordance with their contribution to the total output;

 That factors of production are optimally allocated between the various industries Production & distribution pattern of national product is such that all get sufficient income to meet their basic needs- food, clothing, shelter, education, medical care etc.

All the Best for Your Final Exam

REFERENCES:
1.ME by K L Maheshwari 2.ME by D N Dwivedi