CHAPTER 10: PRICES, OUTPUT,

AND STRATEGY: PURE AND

MONOPOLISTIC COMPETITION
 INTRODUCTION

There are several different market structures in which

organizations can operate. The type of structure will
influence:
• Level of Profit
• Price
• Output
• Strategy
Structures are classified in terms of the presence or absence of competition.

Pure competition Monopolistic Competition

 COMPETITIVE STRATEGY

• Analyzes how the firm can secure differential access to key

resources.
• Designs business processes that are difficult to imitate and capable
of creating unique value for target customers.
• Provides road map for sustaining firm’s profitability principally
through innovation.
GENERIC TYPE OF STRATEGIES

• Focused on industry analysis

• Competitor analysis
• Strategic positioning
Product Differentiation Strategy
Involves competing on capabilities, brand naming, or product
endorsement.
Cost Based Strategy
Business decision to based the price of product on the cost
of production rather than external factors such as
competition and economic environment.
Information Technology Strategy
Is the overall plan which consists of objectives, principles and
tactics relating to use of technologies within a particular
organization.
 RELEVANT MARKET CONCEPT

Refers to group of firms that interact with each

other in a buyer-seller relationship.
PORTER’S FIVE FORCES STRATEGIC FRAMEWORK
The Threat of Substitute
• Occurs when companies within one industry are forced to
compete with industries producing substitute products or
services.

The Threat of Entry

• It refers to the threat new competitors pose to existing
competitors in an industry.
THE POWER OF BUYER AND SUPPLIER
THE POWER OF BUYER

• The ability of a buyer or a customer to drive price down.

• It is affected by the number of buyers or customers that a
business has.
• The smaller the number of buyers, the more power they hold.
POWER OF SUPPLIER

• It refers to how easily a supplier can drive up the price of goods and
services.
• It is affected by the number of suppliers, aspect of goods or services
that the supplier offers and how unique those aspects are.
• The fewer the number of suppliers, the more a company depends
upon a supplier and the more power a supplier holds.
 INTENSITY OF RIVALROUS TACTICS

• It is the major determinant on how competitive and profitable an

industry is.
• Firms compete for a market share.
• The intensity of the rivalry depends on several factors:
Number of competitors
Presence of Exit Barriers
Industry Growth
Type of Product
 MYTH OF MARKET SHARE

• For a business to become highly profitable it should design

strategy that reduces the threat of substitutes, the power of
buyer and supplier and the threat of new entry and also it
should adopt tactics and elicit tactical response from their
rivals.
THE CONTINUUM OF MARKET
STRUCTURES
M arket structure- relationship between individual firms and the
relevant market as a whole.

Depends upon:
1. The number and relative size of firms in the industry.
2. The similarity of the products sold by the firms of the industry; that is,
the degree of product differentiation.
3. The extent to which decision making by individual firms is
independent, not inter-dependent or collusive.
4. The conditions of entry and exit.
 FOUR SPECIFIC MARKET
STRUCTURES

Pure Competition Monopolistic Oligopoly Monopoly

Competition
 PURE COMPETITION

Characteristics:
1.There is a large number of buyers and sellers in the market, each of which is “small”
relative to the market.
2.A homogeneous product produced by each firm.
3.Complete knowledge of all relevant market information by all firms,.
4.Free entry and exit from the market.
Price is determined by the intersection of the market supply and demand curves.
Market supply and demand curves depend on all buyers and sellers.

• Contestable Markets- one with zero entry and exit costs. This means there are no barriers
to entry and no barriers to exit.
Hit-and-run entry- occurs when a firm temporarily enters a market and then leaves
when supernormal profits are exhausted.
FIGURE 10.3
PURE COMPETITION
 MONOPOLY

Characteristics:
1. Only one firm producing some specific product line.
2. No close substitute products.
3. No interdependence with other competitors.
4. Substantial barriers to entry that prevent competition from entering the industry.

The demand curve of the individual monopoly firm is identical with the industry
demand curve, because the firm is the entire relevant market.
MONOPOLY
MONOPOLISTIC COMPETITION

-industries with characteristics both of competitive market.

Characteristics:
1. A few dominant firms and a large number of competitive fringe firms.
2. Dominant firms selling products that are differentiated in some manner.
3. Independent decision making by individual firms.
4. Ease of entry and exit from the market as a whole but very substantial
barriers to effective entry among the leading brands.
Because each firm produces a differentiated product, it is difficult to define an
industry demand curve in monopolistic competition.
MONOPOLISTIC COMPETITION
 OLIGOPOLY

Characteristics:
1. Market having a few closely related firms.
2. Distinguished by a noticeable degree of interdependence among firms in the
industry.
The relationship between price and output for a single firm is
determined not only by consumer preferences, product substitutability,
and level of advertising, but also by the responses that other
competitors may make to a price change by the firm.
OLIGOPOLY
PRICE-OUTPUT DETERMINATION
UNDER PURE COMPETITION
PURE/PERFECT COMPETITION

• Many firms are selling identical products, with no firms large

enough, relative to the entire market, to be able to influence
market price.
• Because there are many sellers and buyers in the type of
competition, every seller/firm is a price taker, and so are the
buyers.
Short-run
• Firms either make transitory profits, or operate at temporary loss in
the short-run.
Long-run
• In the long-run, with the entry of new firms in the industry, the price of
the product will go down as a result of the increase in supply of output,
and cost will go up as a result of more intensive competition for factors
of production.
 PRICE-OUTPUT DETERMINATION
UNDER MONOPOLISTIC COMPETITION
MONOPOLISTIC COMPETITION

A market structure with a relatively large number of

firms, each selling a product that is differentiated in some
manner from the products of its fringe competitors, and
with substantial barriers to entry into the group of leading
firms.
Short run
• Just as in the case of pure competition, a monopolistically
competitive firm may or may not generate a profit in the short
run.

Long run
• Monopolistically competitive market are almost the same as in
perfect competition, with the exception of monopolistic
competition having heterogenous product, and that monopolistic
competition involves a great deal of non price competition.
 SELLING AND PROMOTIONAL EXPENSES

-referred as advertising. The cost incurs to make the product or

services better known to consumers.
2 Distinct types of Benefits :
• Greater demand for the general product (shifted upward) – as
monopolists undertake advertising campaign.
• Shift the demand function at the expense of other firms offering
similar products – strategy pursued by oligopolies
DETERMINING THE OPTIMAL LEVEL OF SELLING AND
P RO M OT I O N A L O U T L AYS

• The most important tools of non-price competition.

• A straightforward application of marginal decision-making rules
followed by profit maximizing firms.
• Helps the firm to decide whether to make an advertising outlay or
reduce the level of advertising in generating a greater margin
Optimal Advertising Intensity
• Optimal expenditure on demand-increasing (promotions, couponing,
direct mails and media such as T.V, radio, newspapers and magazines).
2 Determinants of Optimal Advertising
• Gross Margin
• Advertising elasticity of demand
• *Sometimes the price of a product to be sell change after a successful ad
campaign.
THE NET VALUE OF ADVERTISING

• Although advertising can rise entry barriers and maintain market

power of dominant firms, advertising reduces the prices paid
• Advertises who misrepresent their product cannot succeed in
achieving the firm’s objective.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION

• Presence of “lemon markets”

• Prevalence of asymmetric information
• Lower quality products are often selected rather than the high
quality products.
 INCOMPLETE VS ASYMMETRIC
INFORMATION

Incomplete Information
• Uncertain and pervasive

Asymmetric Information
• Limited access to information of one party
 SEARCH GOODS VS EXPERIENCE GOODS

Search goods Experience goods

• Includes merchandise and tangible • Includes service type of business
products • Asymmetric information is prevalent
• Recourse can be done
• Information about the product can
be complete or incomplete.
SOLUTIONS TO THE ADVERSE
SELECTION PROBLEM
ADV E R SE SE L E CT ION

• Asymmetric information can lead to adverse selection,

incomplete markets and is a type of market failure.
• Refers generally to a situation which sellers have information the
buyers do not have, or vice versa, about some aspect of product
quality.
• For example, in a secondhand car market, a seller may know
about a vehicle’s defect and charge the buyer more without
disclosing the issue.
S O L U T I O N : T WO A P P R OAC H E S

• 1. Regulatory agencies
- For the government to regulate in ways that encourage firms to reveal honest
information about them, so that investors and customers may distinguish good from bad firms.
- Federal Trade Commission, Food and Drug Administration, Consumer Product Safety
Commission, etc.

• 2. Mutual Reliance: Hostage Mechanisms

- a self-enforcing private solution mechanism
- example: exchange of hostages, such as reputational assets of each company
 BRAND-NAME REPUTATIONS AS HOSTAGES

• Brand names are capital assets that provide future net cash flows from repeat-purchase
customers as long as the brand reputation holds up.

• Brand names deliver a hostage, providing assurances to buyers that the seller will not misrepresent
the quality of an experienced good.
• Successful brands can be extended to sell other products.
Non-Redeployable Assets
• Assets whose liquidation value in second-best use is low. Usually this occurs
when the assets depend on a firm-specific input.

Asset Specificity
• The difference in value between first-best and second-best use.
• In summary, asymmetric information causes competitive markets for experience
goods to differ rather than markedly from the competitive markets for search
goods.