Unit-4

Market structure and pricing practices

Market structure
• Market structure refers to the characteristics of the market that affect managerial decisions.
• The market structure is depend upon the number of firms, size of firms, industry
concentration etc.
• The factors which determine market structure are as
1. Number of firms in the industry
The number of firms in the industry determine the structure of the market
If the number of firms is only one – monopoly
Only two firms- duopoly
A few firms – oligopoly
Large no. of firms – monopolistic competition
Large no. of firms – perfect competition.
2. Size of the firms
The size of firms in each industry may be differents depending upon the types of market
structure.
The size of the firms viewed in terms of capital invested, value of product, number of labour,
amount of power material consumed volume of output.
3. Industry concentration
It refers to the size distribution of firms within an industry ,i.e extent of the
market share held by top firms.
Concentration ratio measures how much of total output in an industry is
produced by the largest firms in that industry.
4. Technology used to produce goods and services.
Industries also differ due to technologies used to produce goods and
services.
If technology , plant equipment to be able it produce large goods or
services.
5. Demand and market condition
If low demand low firms required . If demand high more firms required.
6. Potential for entry
In some industry it is easy to enter in market, in others, it is more difficulties.
Due to barrier to entry. (e.g patent )
 Perfect competition
• Perfect competition is the market structure in which there are many buyers
and many sellers of a homogeneous product selling at a uniform price.
• Perfect competition is the market structure characterized by a complete
absence of rivalry among the individual firms.
Features of perfect competition
• Many Buyers and Sellers: In a perfectly competitive market, there are a
large number of buyers and sellers, and each has a negligible impact on the
market price.
• Homogeneous Products: All products offered by firms in the market are
identical or perfect substitutes. Consumers perceive no differences
between the products of different sellers.
• Free Entry and Exit: Firms can freely enter or exit the market without
facing significant barriers. There are no obstacles to new firms entering the
industry, and existing firms can exit without facing significant costs.
• Perfect Information: Buyers and sellers have access to complete and perfect information
about prices, products, and production techniques.
• No Market Power: No individual buyer or seller has the ability to influence the market
price. Each firm is a price taker, meaning it accepts the market-determined price as given.
• Profit maximization: Firms in perfect competition maximize their profit by producing at a
level.
Monopoly
A monopoly is a market structure in which a single seller or producer dominates the entire
industry and is the exclusive provider of a particular good or service.
In a monopoly, there is only one firm, and it faces no competition.
This gives the monopolistic firm significant market power, allowing it to control the price,
quantity, and other aspects of the market.
Features of monopoly
• Single Seller: There is only one firm in the industry, and it is the sole provider of the
product or service.
• No Close Substitutes: The product or service offered by the monopolist has no close
substitutes, meaning consumers have limited or no alternative choices.
• Significant Barriers to Entry: Barriers to entry prevent new firms from entering the
market and competing with the monopolist. These barriers can include high startup
costs, exclusive access to resources, government regulations, .
• Price Maker: The monopolistic firm is a price maker, meaning it has the power to
set the price for its product. Unlike in perfect competition, where firms are price
takers, a monopoly can adjust the price to maximize its profit.
• Profit Maximization: A monopoly seeks to maximize its profit by producing at a
level where marginal cost equals marginal revenue. The monopolist does not
produce at the point where price equals marginal cost, as is the case in perfect
competition.
Monopolistic competition
Monopolistic competition is a market structure that combines elements of both
monopoly and perfect competition.
In a monopolistically competitive market, there are many sellers offering similar but
not identical products, and each firm has some degree of control over its pricing.
Banking, education clothing etc. are industries which have monopolistic
competition.
• Many Sellers: There are numerous firms in the market, and each one produces a
slightly differentiated product.
• Product Differentiation: Products from different firms have some perceived
differences, such as branding, quality, design, or other features. This
differentiation allows firms to have some control over their prices.
• Free Entry and Exit: Firms can enter or exit the market relatively easily, leading to
potential competition and adjustments to the number of firms over time.
• Some Market Power: While firms in monopolistic competition have some ability
to influence the price of their product, they are not price makers like monopolies.
Consumers can choose alternatives with similar characteristics from other firms.
• Non-Price Competition: Firms often engage in non-price competition, such as
advertising, branding, and product differentiation, to attract customers.
Oligopoly
Oligopoly is a market structure characterized by a small number of large firms
dominating the industry. In an oligopolistic market, the actions of one firm have a
significant impact on the others, and strategic interactions among the firms play a
crucial role.
(Ncell and NTC)
• Few Large Firms: There are only a small number of firms in the industry, and each
firm is relatively large compared to the overall market.
• Interdependence: The decisions made by one firm directly affect the others.
Firms are aware that their actions, such as pricing or product development, can
have consequences for the market and their competitors
• Product Homogeneity or Differentiation: Oligopolistic products can be either
homogeneous (similar) or differentiated. In some cases, firms may produce nearly
identical products, while in other cases, there may be product differentiation
through branding, features, or quality.
• Non-Price Competition: Firms in oligopolies often engage in non-price
competition, such as advertising, innovation, and marketing strategies, to
differentiate their products and gain a competitive edge.
Causes responsible for raising oligopoly
• Barriers to Entry: High barriers such as high startup costs, economies of scale, or
control over essential resources can limit new companies from entering the
market.
• Mergers and Acquisitions: Oligopolies can form through mergers and
acquisitions, where large companies combine forces to dominate the market.
• Product Differentiation: In some industries, companies may differentiate their
products through branding or unique features, creating a competitive advantage
that leads to oligopolistic market structures.
• Government Regulations: In certain cases, government regulations may
contribute to the formation of oligopolies by creating barriers to entry or favoring
existing large players.
Profit maximization goal of firm
• The main objectives of the firm s to maximize profit.
• A firms is said to be equilibrium when it is maximizing profit or
minimizing loss.
• A firms will be equilibrium when it has no advantage to increase or
decrease the output.
• When a firm is earning maximum profit or minimizing the loss, it is
said to be in equilibrium.
Approaches of firms equilibrium
1. Total revenue and total cost approach (TR-TC Approach)
2. Marginal revenue and marginal cost approach ( MR-MC Approach).
1. Total revenue and total cost approach (TR-TC Approach)
• According to TR-TC approach, a firm gains equilibrium position at that output at which the
difference between total revenue and the total cost is maximum. Every rational firm aims to
maximize profit.

π = TR-TC
where; π = profit,

• TR = Total Revenue and

TC = Total Cost
The TR-TC approach of determining equilibrium under the perfect competition and monopoly is
explained as follows:-

A. Equilibrium of a firm under perfect competition:-

• Perfect competition is the market structure in which there are a large number of buyers and
sellers selling homogeneous products. A firm is a small part of the whole industry. Price is fixed by
the industry. The firm can sell as much as it wants only at the price fixed by the industry. The total
revenue curve is an upward sloping line which increases at the same rate in this market.
• It is generally assumed that Total Cost Curve is inversely ‘S’ shaped. A firm attains equilibrium at
that point at which the difference between TR and TC is maximum. It can be presented with the
help of the following diagram:-
• In the above figure, TR and TC represent Total Revenue and Total Cost curves.
• The difference between TR and TC is measured by the vertical distance between
TR and TC. Up to OQ1 level of output, the firm bears loss because Total Cost is
higher than Total Revenue.
• Between OQ1 and OQ3 level of output, the firm is in profit because TR is higher
than TC.
• The firm earns maximum profit at OQ2 level of output which is shown by the
vertical gap MN. The firm is in equilibrium at OQ2 level of output at point E which
is shown in the π curve (profit curve).
B. Equilibrium of a firm under monopoly:-
• Under monopoly, a firm determines the price of its product itself. The monopoly firm
increases its price to increase the revenue or may decrease the price to increase its sales.
Therefore, TR curve is inverse ‘S’ shaped. The firm chooses that level of output at which
the profit is maximum. The profit is maximized when there is a greater vertical distance
between TR and TC curves. It can be explained by the help of the following diagram:-

• In the above figure, TR and TC represent Total Revenue and Total Cost Curve. π curve
represents the profit curve. Before OQ1 and after OQ3 level of output, the firm bears
loss because the total cost is higher than total revenue. From OQ1 to OQ3 level of
output, the firm enjoys profit because TR is higher than TC. The maximum profit is the
vertical gap MN which is also represented in the π curve as Q2E. The firm is equilibrium
at this level of output and does not want to deviate from this point
Marginal revenue and marginal cost approach (MR-MC)
• MR-MC approach is a very important and useful method for determining the equilibrium
of the firm. Under this approach, the following conditions must be fulfilled to attain
equilibrium by the firm.
i. Necessary condition:-

• Marginal revenue should be equal to Marginal Cost i.e. MR=MC.

• ii. Sufficient condition:-

Marginal Cost curve must intersect the Marginal Revenue curve from below.
The MR-MC approach of determining equilibrium under the perfect competition and
monopoly is explained as follows:-
A. Equilibrium of a firm under perfect competition:-
• Perfect competition is characterized by a large number of buyers and sellers. Firms
produce homogeneous goods and they are taken as the price takers. In this market, the
firm has no control over the price. It must sell the products at that price which is
determined by the industry. So, the price remains uniform. Therefore, the AR curve and
MR curve are the same and parallel to X-axis. MC curve is U-shaped. The determination
of equilibrium of a firm under perfect competition using this approach can be shown
graphically as follows:-
• In the above figure, MR and MC represent Marginal Revenue and
Marginal Cost curve. MC equals MR at point A and points E which
fulfills the necessary condition. Point E fulfills both necessary and
sufficient condition. So, Point 'E' is the equilibrium point and OQ2 is
the equilibrium level of output.
B. Equilibrium of a firm under monopoly or imperfect competition:-
• In the monopoly market, the firm is the price maker. It can sell less output at a
high price and more output at a low price. So, AR and MR curves slope
downward. The MC curve is U-shaped. The equilibrium of the firm under
monopoly using MR-MC approach can be explained by the help of the following
diagram:-

• In the above figure, MR represents the Marginal Revenue curve which is

downward sloping and MC represent Marginal Cost curve which is U- Shaped.
The point 'E' is the equilibrium point because, at this point, MC equals MR and
MC cuts MR from below. So, the firm is in equilibrium at OQ level of output and
can maximize its profit.
Pricing practices
There are various real practices of pricing. Among them, important
practices are discussed in this section,
Price discrimination
Price discrimination refers to selling same product at different price to
different customer or in different market.
Price discrimination is possible only in the monopoly because even
though different buyers would know that they are differently charged,
they have no alternative sources of buying the product.
The main objective of price discrimination are profit maximization,
capture foreign market etc.
(e.g. Cinema hall, NEA charge different rate of electricity for household
consumption and industrial use. )
Condition for price discrimination
The following condition must be fulfill for price discrimination
1. Monopoly power
Price discrimination is possible only if monopoly exists and there is no
competition in the market.
2. Market segmentation
The market can be segmented into different groups based on factors
such as willingness to pay, price sensitivity, demographics, location, or
purchasing power. The seller must be able to identify and separate
these segments.
3. Different elasticities of demand
The demand for the product must have different elasticities in different
market segments. This means that consumers in one segment are more
willing to pay higher prices than consumers in another segment.
Degree of types of price discrimination
First-Degree Price Discrimination (Perfect Price Discrimination):
• In this type, the seller charges each consumer the maximum price they are willing to pay.
• The seller captures the entire consumer surplus.
• Difficult to implement in practice because it requires detailed information about each
individual's willingness to pay.
Second-Degree Price Discrimination:
• In this type, prices vary based on the quantity consumed or the characteristics of the
product.
• Commonly seen in markets where sellers offer discounts for bulk purchases.
• The seller does not know the buyer's exact willingness to pay but uses observable
characteristics to set prices.
Third-Degree Price Discrimination:
• In this type, prices are based on observable characteristics of different customer
segments, such as age, location, income, or education.
• The seller divides the market into distinct groups and charges different prices to each
group.
• This is more practical and widely used compared to perfect price discrimination
Cost plus pricing
• Cost-plus pricing is a pricing strategy where a company determines the cost
of producing a product and then adds a markup to set the selling price. The
cost-plus pricing formula is:
• Selling Price=Cost+Markup
• Here, the "cost" refers to the total cost incurred in producing a product,
including both variable costs and fixed.
• The "markup" is the additional amount added to the cost to establish the
profit margin.
• This approach is straightforward and ensures that the company covers its
costs while generating a desired level of profit.
• Cost-plus pricing is commonly used in industries where the costs of
production are relatively stable., such as manufacturing.
.
• The steps of cost plus pricing are
1. Determining Actual cost of producing a commodity
In this first step the firm determine average cost of production . It is the total cost
divided by total output.
AC= TC/Q
2. Adding Mark-up on estimated average cost
In the second step, mark-up on cost is calculated. Mark up on cost is defined as the
profit margin of an individual product expressed as a percentage of per unit cost
M=
Or M*AC=P-AC
P=M*AC+AC
P=AC(1+M)
3. Mark-up price
mark up on price is also used to determine price of the product. Mark up on cost
and mark up on price are the alternative methods of pricing. Mark up on price is
the profit margin for an individual product expressed as percentage.
Markup on price =
Two –part tariff
• A two-part tariff is a pricing method where a consumer pays different
prices for different quantities of a product without any upfront
payment.
• two-part tariff is an economic principle where the price of a product
or service is split into two parts, but the consumer only pays the part
they choose depending on their usage.
Condition requires for two part tariff
1. The firm should have capacity to control price.
2. The demand of consumer must be homogeneous.
3. The firm must have control over entrance right.
Bundle pricing
A "bundling tariff" typically refers to a pricing strategy or business model
where multiple products or services are bundled together and offered as a
single package at a combined price. This approach is commonly used in
various industries, such as cable TV, internet services, and software.
in the context of telecommunications, for example, a bundling tariff might
include a combination of services such as internet, cable TV, and phone
services for a single monthly fee. Similarly, in the software industry, a bundle
might include multiple software applications or features sold together.
Advantage of bundling
1. Bundling helps to increase sales volume.
2. Bundling makes easier for business to target potential consumer.
3. Bundling helps in price optimization. (Gain profit)
Wages differentials
• Wages differential is defined as a the difference in wages between workers with
different skill in the same industry,
• It is the differences in the wage rates for different group of workers.
• We know that there are very great differences in wages rate in different
occupation.
Nature and causes of wages differentials
1. Compensating wage differentials – different wages for people with similar skills.
For eg, high and low wages paid night rtaxi driver and day taxi driver.
i. Cost of training – some jobs like medical, managerial profession, require heavy
monetary investment . The jobs need high investment in term of money and term
of money and time are generally paid high wages.
ii. Cost of living - area to area different salary paid to workers ( city to another city)
iii. Risk of performing job – wages paid according to risk like pilot , mining have
higher risk
.
2. Non- compensation wage differentials- non- compensation wage differentials
are those for which there is non compensation such as wages different because
different in individual qualities, differ in price etc.
i. Individual qualities of labour- different efficiency , skilled mental ability, talent.
ii. Differences in price of the product- paid wages according to the price of profuct ,
if price high high wages paid
iii. Market imperfection – if shortage of labour occur company paid high wages
iv. Other factors –other factor like gender, colour, caste etc also causes non
compensation wages

Interest rate differentials

Interest rate differential refers to the difference in interest rate between two
similar interest bearing assets or securities.
• Under carry trade, investors borrow at a low interest rate and invest in an asset
yielding a higher rate of return.
For examples, if the bond yields 10 percent yield rate and next bond generate 6
percent yield rate, then 4 percent would be the interest rate differentials.
Numerical
1. calculate equilibrium level of output of the firm when marginal
revenue is MR=300-0.5Q and marginal cost MC=50+2Q.
Solution,
MR= 300-0.5Q
MC= 50+2Q
For equilibrium level of output,
MR=MC
Or, 300-0.5Q=50+2Q
Or, Q=250/2.5 = 100 units
1.Let the demand function P= 20-Q and cost function C=𝑸𝟐 +8Q+2. find profit maximizing output,
price and maximum profit.
Solution,
Demand function P=20-Q For profit maximizing output or equilibrium
Cost function, C= 𝑸 +8Q+2.
𝟐 MR=MC
We know that, 20-2Q=2Q+8
-2Q-2Q= 8-20
TR= P*Q -4Q= -12
= (20-Q)Q Q= 12/4
= 20Q- 𝑄 3 Units
( ) Price (P)= 20-Q
MR=
= 20-3
(20Q− ) =Rs17
=
Maximum profit = TR-TC
= 20- 2Q = P*Q –(𝑸𝟐+8Q+2)
( )
MC= =17*3-𝟑𝟐 + 𝟖 ∗ 𝟑 + 𝟐)
( ) = 51-35
= =Rs. 16
( +8Q+2)
==
=2Q+8
3.Consider the following table
Output 0 1 2 3 4 5 6 7 8

TR 0 110 200 270 320 350 360 350 320

TC 200 220 236 248 264 300 360 448 560
Profit (𝜋) - - - - - - - - -

a. Complete the above table.

b. Graph TR,TC and profit curves and explain equilibrium according TR and TC approach.
c. Which market does it indicate and why?
a. Solution,

Output 0 1 2 3 4 5 6 7 8

TR 0 110 200 270 320 350 360 350 320

TC 200 220 236 248 264 300 360 448 560
profit(𝜋) -200 -110 -36 22 56 50 0 -98 -240
b. TR,TC and profit curves are graphical as follows

In the above figure, X-axis represents quantity of output and Y- axis represented total cost and total
revenue, curve respectively.
Before point A and beyond point B, TC greater than TR therefore, there is loss. Between point A nad
B there is profit because TR greater than TC at 4th unit of output. There fore the firm equilibrium at
4th unit of output.
At thus output, the firm is maximum profit equal to Rs 56.
C. This show or indicates imperfect competition ( monopoly) because total revenue is increase in
increasing at the decreasing rate point B and their after it is falling.
4. consider the following scheduling
Output 0 1 2 3 4 5 6 7 8 9 10135 11
0
Price (p) 200 200 180 160 140 120 100 80 60 40 20 0
Total revenue 0 200 360 480 560 600 600 560 480 360 200 0
(MR)
Marginal - 200 160 120 80 40 0 -40 -80 -120 -160 -200
revenue (MR)
Total cost 150 270 360 420 460 520 600 700 850 1050 1350 1750
(TC)

a. Graph total revenue, marginal revenue and demand curve, and

show the relationship between total revenue and marginal revenue
with price elasticity of demand .
b. Using scheduling and graph, the TR-TC approach of firm firm
equilibrium.