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MARKET STRUCTURE AND OUTPUT-PRICING DECISIONS

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MARKET STRUCTURE AND OUTPUT-PRICING DECISIONS Powered By Docstoc
					   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             Conduct            Performance

e.g. number of        e.g. firm's goals,    e.g. efficiency,
buyers and sellers    pricing and output,   profitability and
(the size of firms)   their investments      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        This is both the short run and
                                         long run equilibrium position
                                         for a monopoly
Costs / Revenue
                                           Given the barriers to entry,
                                  MC       the monopolist will be able
£7.00                                      to exploit abnormal profits
                                        AC in the long run as entry to
        Monopoly                           the market is restricted.

          Profit
                                       AR (D) curve for a monopolist
£3.00                                  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!)
                        MR   AR
                                                    Output / Sales
                   Q1
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          Since the additional                  The demand curve facing
equilibrium position for     revenue received from                 the firm will be downward
a firm in a monopolistic     each unit sold falls, the             sloping and represents the
market structure.            MR curve lies under the               AR earned from sales.
                             AR curve.
                                                             We assume that the firm produces
         Implications for the diagram:                       where MR = MC (profit maximising
                                                   MC        output). At this output level, AR>AC
  Cost/Revenue
                                                             and the firm makes abnormal profit
                                                             (the grey shaded area).
                                                              AC
 £1.00
                                                             If the firm produces Q1 and sells
                                                             each unit for £1.00 on average with
          Abnormal Profit                                    the cost (on average) for each unit
 £0.60                                                       being 60p, the firm will make 40p x
                                                             Q1 in abnormal profit.
                                                                        Marginal Cost and
                                                                        Average Cost will be the
                                                                        same shape. However,
                                         MR                 D (AR) because the products are
                                                                        differentiated in some
                                Q1
                                                         Output / Sales way, the firm will only be
                                                                        able to sell extra output
                                                                        by lowering price.
                    Monopolistic or Imperfect
                         Competition

          Implications for the diagram:
                                            MC
  Cost/Revenue                                                   This is the long run
                                                                 equilibrium position
                                                      AC         of a firm in
                                                                 monopolistic
                                                                 competition.
AR = AC




                                          AR1
                         MR1
                    Q2                          Output / Sales
                                                           MC AC
                                                 F
                                       P = AC1
Monopolistic Competition                              MR     D
                                                 Q1
                                                                 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:

        D                                    a. If a firm raises its price,
                                                its rivals will not follow
                                                suit
                                   MC2
                                             b. If a firm lowers its price,
P                        k                      its rivals will all do the
                                                same
                                       MC1
            MR

                 A


                                        D

                             B


    O                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

				
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