Chapter 5: Pricing under various

Markets
Managerial Economics
Meaning of Market
A place / region where Sellers and buyers are
interacted with goods and service by selling and
purchasing at a given price. It is considered as a Process

Goods and service
Buyers and sellers
A place or region
Given price
Perfect Competition Market
Classification of Market
Markets Form
Perfect Competition Imperfect Competition
Monopolistic Competition
Oligopoly
Duopoly
Monopoly
Meaning of Perfect Competition Market
A Market situation in which a large number of
producers or sellers producing and selling
homogeneous product.
Meaning of Perfect Competition Market
A Market situation in which a large number of
producers or sellers producing and selling
homogeneous product.
Main features of Perfect Competition Market
Each sellers sell a small portion total
Single sellers has no influence on market
Sellers are price taker
Large no. of buyers
and sellers
Identical product
Same price and cost
Homogeneous
product
There is no government or other control
Free entry and
exit
Main features of Perfect Competition Market
Perfect knowledge about the prevailing price.
Perfect knowledge
about market
Large no. of firm, so no transport or selling
cost
Homogeneous product, so no advt. needed
Absents of selling
cost and Advt.
cost
Price is determined in the industry .
A single price of
product
Example: Agricultural products
Price determination Under PC
Equilibrium of the Industry:
When the total output of the industry is equal to
the total demand
Price prevailing is the equilibrium price
No buyer goes dissatisfied who wanted to buy at
that price and none of the sellers is dissatisfied
that he could not sell his goods at that price
If price changes or the quantity changes the firm
wont remain in equilibrium
Meaning of Perfect Competition Market
Price determination in the industry
Price
Output
Demand Curve
Supply Curve
Excess supply
Excess Demand
Equilibrium of the Firm:
When it maximizes its profit
The output which gives maximum profit is called
equilibrium output
In equilibrium state the firm has no incentive to
increase or decrease its output.
Firms are price takers because of presence of large no
of firms in the market with identical or homogeneous
products
They have to accept the price fixed by the industry as
a whole


Price determination Under PC
Meaning of Perfect Competition Market
Nature of demand and AR, MR Curve of a firm
Out put Price TR AR MR
1 10
2 10
3 10
4 10
5 10
6 10
7 10
8 10
Price
Output
Price=AR=MR
Demand and AR, MR Curve of a firm
Out put Price TR AR MR
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
6 10 60 10 10
7 10 70 10 10
8 10 80 10 10
Meaning of Perfect Competition Market
Price determination in the industry
Price
Output
Price=AR=MR
Firm ( is a Price Taker)
Price
Output
Industry
Demand Curve
Supply Curve
First Condition for maximization of profit > MR= MC

Second Condition for maximization of profit > MC curve cut MR curve
from below
Meaning of Perfect Competition Market
The firms equilibrium(Out put determination)
Price
Output
Price=AR=MR
Firm ( is a Price Taker)
Price
Output
Industry
Demand Curve
Supply Curve
MC
O M
MC=MR
E E0
First Condition for maximization of profit is MR= MC

Second Condition for maximization of profit is MC curve cut MR curve
from bellow
Meaning of Perfect Competition Market
Short run equilibrium of a firm with abnormal /super
normal profit
Profit
Price
Output
Price=AR=MR
Firm with Profit
MC
O M
MC=MR
E
AC
Meaning of Perfect Competition Market
Short run equilibrium of a firm with No profit No Losses
Price
Output
Price=AR=MR
Firm with Profit
MC
O M
MC=MR
E
AC
Meaning of Perfect Competition Market
Short run equilibrium of a firm with Losses
Losses
Price
Output
Price=AR=MR
Firm with Profit
MC
O M
MC=MR
E
AC
Meaning of Perfect Competition Market
Long run equilibrium of a firm with Normal Profit
Price
Output
Price=AR=MR
Firm with Profit
LMC
O M
MC=MR
E
LAC
Introduction
Monopoly is a market structure in which a
single firm makes up the entire market.
Monopolies exist because of barriers to entry
into a market that prevent competition.
18
The Monopolists Price and Output
Graphically
The marginal revenue curve is a graphical
measure of the change in revenue that occurs
in response to a change in output.
It tells us the additional revenue the firm will
get by expanding output.
19
MR = MC Determines the Profit-
Maximizing Output
If MR > MC, the monopolist gains profit by
increasing output.
If MR < MC, the monopolist gains profit by
decreasing output.
If MC = MR, the monopolist is maximizing
profit.
20
The Price a Monopolist Will Charge
The MR = MC condition determines the
quantity a monopolist produces.
The monopolist will charge the maximum
price consumers are willing to pay for that
quantity.
That price is found on the demand curve.
21
The Price a Monopolist Will Charge
To determine the profit-maximizing price
(where MC = MR), first find the profit
maximizing output.
22
Determining the Monopolists Price
and Output
MC
$36
30
24
18
12
6
0
6
12
Price
1 2 3 4 5 6 7 8 9 10
D
MR
Monopolist
price
23
Comparing Monopoly and Perfect
Competition
Equilibrium output for both the monopolist
and the competitor is determined by the MC
= MR condition.
24
Comparing Monopoly and Perfect
Competition
Because the monopolists marginal revenue is
below its price, price and quantity will not be
the same.
The monopolists equilibrium output is less
than, and its price is higher than, for a firm
in a competitive market.
25
Comparing Monopoly and Perfect
Competition
$36
30
24
18
12
6
0
6
12
Price
MC
1 2 3 4 5 6 7 8 9 10
D
MR
Monopolist
price
Competitive price
26
Profits and Monopoly
Draw the firm's marginal revenue curve.
Determine the output the monopolist will
produce by the intersection of the MC and MR
curves.
27
Profits and Monopoly
Determine the price the monopolist will
charge for that output.
Determine the average cost at that level
of output.
28
Profits and Monopoly
Determine the monopolist's profit (loss) by
subtracting average total cost from average
revenue (P) at that level of output and
multiply by the chosen output.
29
Profits and Monopoly
The monopolist will make a profit if price
exceeds average total cost.
The monopolist will make a normal return
if price equal average total cost.
The monopolist will incur a loss if price is
less than average total cost.
30
A Monopolist Making a Profit
A monopolist can make a profit.
31
A Monopolist Making a Profit
Price
ATC
MC
Quantity
P
M

0
MR
D
Q
M
Profit
C
M
A
B
32
A Monopolist Breaking Even
A monopolist can break even.
33
A Monopolist Breaking Even
Price
MC
Quantity
P
M

0
MR
D
Q
M
ATC
34
A Monopolist Making a Loss
A monopolist can make a loss.
35
A Monopolist Making a Loss
Price ATC
MC
Quantity 0
MR
D
Q
M
Loss
P
M
C
M

B
A
36
Cartels
Cartels can be defined as the formal organization of
group of firms that tries to act as if it is one firm in
the industry. Cartels appoint a central agency to deal
with the day to day affairs and to regulate the price.
Example: Organization of Petroleum Exporting
Countries (OPEC) is perhaps the best known cartel
worldwide. OPEC restricts the production of oil to
create the scarcity of oil in the international market.
It was between 1972 and 1974, when the price of oil
rose from $3 to $12. It was due to the restrictions on
the oil production by the member countries.

Cartels are of two types,
Joint profit maximization cartels
cartels aimed at market sharing.
Cartels Aimed at Joined Profit
Maximization
The aim of such a cartel is to maximize
the industry profit.
Firms enter into a direct agreement with
the aim of reducing the uncertainty as a
result of the mutual interdependence.

Market Sharing Cartels
As the name suggests in this form of cartel,
firms share the market, keeping a considerable
degree of freedom concerning the style of their
output, their selling activities and other
decisions.
There are two methods for sharing the market:
non-price competition agreements and
determination of quotas.

Non-price competition agreements
In this type of cartel, firms agree on a price, at
which each of them can sell any quantity
demanded.
Prices are set by hard bargaining. Cost structure
of the firm plays an important role. The firm with
low cost structure would like to go for lower
price, whereas the firms with high cost structure
pressing for high prices.
Firms maintain freedom of advertising and selling
policies

Sharing of the market by agreement
on quotas
Here firms agree on a specific quantity of
quota to be sold in the market at an agreed
price.
In this type of cartels too, cost structure of the
firm plays an important role. Based on the cost
structure firms decide on the output that each
firm can produce.
If the cost structure is same for all the firms,
they produce the same quantity.
Measurement of Monopoly Power
Consumers has less choice of product & price
If the product of monopolists are input to
other firm, the situation poses a great risk from
security point of view as well as from the
macro economic point of view
Any trouble within the monopoly firm, if the
production stops, the entire economy is thrown
out of gear
Governments have often sought to control
monopolies
Monopolies & Restrictive Trade Practices Act
(MRTP) in India is an example.
So the consideration of measuring monopoly
power come into existence
Main Measure are:
1) Number of firms criterion: counting the
number of firms in an Industry Many a times
Oligopoly is deemed to be monopolist
Limitation : Size of the firm
2) Concentration Ratio: measures the percentage
share of one firm or a group of the largest firm in
the total Industry output
Limitation: No consideration of Unused/idle capacity
Local/National Difference Not Considered
3) Excess Profit Criterion: J.S. Bain Promoted this
method
If a firms profit rate continuously remains higher than
all opportunity costs necessary for keeping the firm in
the industry, it should be construed that the firm is
making excess profits.
Lerners Measure:
MP = P - MC
P
Where, MP is Monopoly Power, P is Price and MC is marginal
cost
Limitation: Any firm can earn super-normal profit in a short run
Statistical Data regarding marginal cost can hardly be available
4) Cross Elasticity Criterion:
Prof. R. Triffin has suggested this method.
The lower the cross elasticity of the product, the
greater would be the degree of the producers
monopoly and vice-versa
Limitation: only relative measure and not single
usable index of monopoly power.