Managerial Economics

UNIT 3
 Types of market structure
• Market structure is the interconnected characteristics of a market, such
as the number and relative strength of buyers and sellers, degree of
freedom in determining the price, level and forms of competition, extent
of product differentiation and ease of entry into and exit from the
market
What is The market Structure?
Those characteristics of the market that
significantly affect the behavior and
interaction of buyers and sellers.
Things To Be Considered

Number and size of

sellers and buyers
Type of the product
Conditions of entry and
exit
Transparency of
Types Of Market Structure

1.Pure (perfect) Competition

2. Imperfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly
Types of Market Structure
Types of Market Structure
 PERFECT COMPETITION
• Potatoes Potatoes are sold in
• markets where all
vendors sell homogenous
products at homogeneous
prices.
• Example- Potato is sold
at markets etc. where all
vendors sell
homogenous
products, i.e. potato.
 Perfect Competition - Price and Output Determination
under short run
The single firm takes its price from the industry, and is, consequently, referred to as a price
taker. The industry is composed of all firms in the industry and the market price is where
market demand is equal to market supply. Each single firm must charge this price and
cannot diverge from it.
From this picture we can understand
that the industry is getting market
equilibrium where the demand and
supply is getting intersected at the point
E in that OP level of price and OQ level
of output.
In short run at OP price level AR and MR
is equal where the marginal cost and
average total cost is continuously
increasing.
The cost is less than the profit the
company is under super normal profit
suppose if the cost is above the revenue
curve the company under loss. During
the short run due free entry there are so
many company will enter and due free
exist there so many company will get
exit from the market
 Perfect Competition - Price and Output
Determination under short run
• However, in the long run firms are attracted into the industry if the

incumbent firms are making supernormal profits. This is because

there are no barriers to entry and because there is perfect

knowledge. The effect of this entry into the industry is to shift the

industry supply curve to the right, which drives down price until the

point where all super-normal profits are exhausted. If firms are

making losses, they will leave the market as there are no exit barriers,

and this will shift the industry supply to the left, which raises price

and enables those left in the market to derive normal profits.

 Perfect Competition - Price and Output
Determination under long run
The super-normal profit derived by the firm in the short run acts as an incentive for new
firms to enter the market, which increases industry supply and market price falls for all
firms until only normal profit is made.
 Monopolistic Competition (Imperfect Competition)

• Imperfect competition is a competitive market

situation where there are many sellers, but they are
selling heterogeneous (dissimilar) goods as opposed
to the perfect competitive market scenario. As the
name suggests, competitive markets that
are imperfect in nature.
 MONOPOLISTIC COMPETITION
• Monopolistic competition is a type of imperfect
competition such that one or two producers sell
products that are differentiated from one another as
goods but not perfect substitutes (such as from
branding, quality, or location).
• In monopolistic competition, a firm takes the
prices charged by its rivals as given and ignores
the impact of its own prices on the prices of other
firms.
• Consumers may like some special thing in
the particular brand.
 Assumptions of the Market
1. There are many producers and many consumers - the concentration
ratio is low

2. Consumers perceive that there are non-price differences

among products i.e. there is product differentiation –
competition is strong, plenty of consumer switching takes
place

3. Producers have some control over price - they are “price makers”
not “price takers” but the price elasticity of demand is higher than it
would be under a situation of monopoly

4. The barriers to entry and exit into and out of the market are
Monopolistic Competition: Falling AR and
MR, Price and Profits
Price,
Cost MC

AC

AR

MR

Output
 Monopolistic Competition:
Price,
Cost MC

P1 AC

AR

MR

Q1 Output
 Monopolistic Competition:
Price,
Cost MC

P1 AC

C1

AR

MR

Q1 Output
 Monopolistic Competition:
Price,
Cost MC
Abnormal profits
P1 AC

C1

AR

MR

Q1 Output
Short run Price and output determination
under Monopolistic Competition

Short-run equilibrium of the firm under

monopolistic competition. The firm maximizes
its profits and produces a quantity where the
firm's marginal revenue (MR) is equal to its
marginal cost (MC). The firm is able to collect a
price based on the average revenue (AR) curve.
The difference between the firm's average
revenue and average cost, multiplied by the
quantity sold (Qs), gives the total profit.

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Identify three factors that affect the “pricing power” of an
individual firm in monopolistic competition

1. There still may be many competitors keeping

pricing ‘low’

2. Product ‘differentiation’ allows firm to charge a

different price to reflect any unique qualities of
the product/service

3. Barriers to entry and exit of the market are low

so this requires firms to price competitively
 Long Run Equilibrium for
Monopolistic Competition
Price,
Cost MC

P1 AC

Unlike monopoly, there are no

barriers to entry. This means
that short run supernormal
profit attracts new producers
into the market

AR

MR

Q1 Output
 Long Run Equilibrium for
Monopolistic Competition
As more firms enter the
Price, C market, the demand curve
ost facing any existing firm MC
moves to the left
AC

P2

AR2
MR2

Q2 Output
Long run Price and output determination under Monopolistic
Competition

Long-run equilibrium of the firm under

monopolistic competition. The firm still
produces where marginal cost and
marginal revenue are equal; however, the
demand curve (MR and AR) has shifted as
other firms entered the market and
increased competition. The firm no longer
sells its goods above average cost and can
no longer claim an economic profit.

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 How does Monopolistic Competition differ from Perfect
Competition?
Perfect Monopolistic
Competition Competition

Number of producers (sellers in the market) Many Many

Types of goods and services available for

consumers Homogeneous Differentiated
Does the firm have control over their own No – Yes – some
prices? price pricing
takers power

Is branding / marketing important? No Yes – key non-price

competition

Are entry barriers zero, low or high? Zero barriers Low barriers
Does this market structure lead to allocative
efficiency in the long run? Yes: Price = MC Not quite (P>MC)

Does this market structure lead to

productive efficiency in the long run? Yes – min LRAC No – higher LRAC
 Monopoly
• The Word Monopoly is a Latin Term. „Mono‟
means Single and „Poly‟ means Seller.
• Monopoly is a form of Market Organization in
which there is only One Seller of the
Commodity.
• There are No Close Substitutes for the
Commodity sold by the Seller.
• Example : Indian Railways
 Monopoly Examples
• India railways
• Electricity
• Oil marketing companies - IOCL, BPCL, HPCL all
of them government companies.
• Pidilite- fevicol
• Gillette
• ITC Cigarettes
 Monopoly - Definition
• DEFINITIONS According To Koutsoyiannis ,
“Monopoly Is a Market Situation in Which
There is A single Seller, There are no close
substitutes for commodity it produces ,there
are barriers to entry.”
• According To Baumol, “A pure Monopoly is
defined as the firm that is also an industry. It is
the only supplier of some particular commodity
for which there exist no close substitutes.”
Monopoly
 FEATURES OR ASSUMPTIONS OF
MONOPOLY
• One seller and large number of Buyers.
• Monopoly is also an Industry.
• Restrictions on the Entry of the New Firms.
• No close Substitutes.
• Price Maker.
• Price Discrimination.
• Downward Sloping Demand Curve
Types Of Monopoly Practices
1. Perfect Monopoly
2. Imperfect Monopoly
3. Private Monopoly
4. Public Monopoly
5. Simple Monopoly
6. Discriminating Monopoly
7. Legal Monopoly
8. Natural Monopoly
9. Technological Monopoly
10. Joint Monopoly
 Perfect Monopoly
It is also called as absolute monopoly.
In this case, there is only a single seller of

product having no close substitute; not even

remote one.
There is absolutely zero level of competition.
Such monopoly is practically very rare.
Bill Gates played Perfect Monopoly in US for

MS Word.
 Imperfect Monopoly
It is also called as relative monopoly.
It refers to a single seller market having no close

substitute.
It means in this market, a product may have a

remote substitute. So, there is fear of competition

to some extent.
 e.g. jio is having competition from fixed
landline phone service industryVI and BSNL
 Private Monopoly

When production is owned, controlled and

managed by the individual, or private body or

private organization, it is called private monopoly.
e.g. ITC, Reliance, ETC., in India.
 Such type of monopoly is profit oriented.
 Public Monopoly
A Government monopoly (or Public monopoly) is a

form of coercive monopoly in which a government

agency or government corporation is the sole
provider of a particular good or service and
competition is prohibited by law.
It is a Monopoly created by the Government.
Railways, Electricity, Oil companies
 Simple Monopoly
It is also called Single-Price Monopoly.
The simple monopolist abides by the “law of one

price.” Everyone pays the same market price for

all units purchased.
Simple monopoly firm charges a uniform price

or single price to all the customers.

 He operates in a single market.
 Eg- Apple
 Discriminating Monopoly

Such a monopoly firm charges different price to

different customers for the same product. It

prevails in more than one market.
 An example is an airline monopoly.
Airlines frequently sell various seats at various

prices based on demand.

 Legal Monopoly
 It is a monopoly that is protected by law from
competition.
A government-regulated firm that is legally

entitled to be the only company offering a

particular service in a particular area.
For example, AT&T(American Telephone and
Telegraph Company) operated as a legal monopoly
until 1982 because it was supposed to have cheap
and reliable service for everyone.
 Natural Monopoly
A type of monopoly that exists as a result of the

high fixed or start-up costs of operating a business

in a particular industry.
Government often regulate certain natural

monopolies to ensure that consumers get a fair

deal.
The utilities industry is a good example of a

natural monopoly—Gas , Water, Power.

 Technological Monopoly
It emerges as a result of economies of large scale

production, use of capital goods, new production

methods, etc.
E.g. engineering goods industry, automobile

industry, software industry, etc.

Internet Explorer was the only browser available to

browse the web between 1995-2000.

 Joint Monopoly
If two or more business firms acquire monopoly

position through amalgamation, cartels, syndicates,

etc, then it becomes joint monopoly.
e.g. Actually, pizza making firm and burger making

firm are competitors of each other in fast food

industry. But when they combine their business, that
leads to reduction in competition. So they can enjoy
monopoly power in market.
• While a competitive firm is a price taker,
• Monopoly firm is a price maker.

• The fundamental cause of monopoly is

barriers to entry.

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Monopoly’s Total, Average, and Marginal
Revenue
 Demand and Marginal-Revenue Curves for a Monopoly

Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal
1 (average
0 revenue
–1 Quantity of Water
revenue)
–2 1 2 3
–3 4 5 6
–4 7 8
Profit Maximization

• A monopoly maximizes profit by producing

the quantity at which marginal revenue equals
marginal cost.
• It then uses the demand curve to find the price
that will induce consumers to buy that quantity.
 Profit Maximization for a Monopoly

Costs and
2. . . . and then the demand 1. The intersection of the
Revenue curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q Q Quantity
QMAX
 The Monopolist’s Profit
The monopolist will receive
economic profits as long as price is
Costs and greater than average total cost.
Revenue

Marginal cost

Monopoly B

E price
Monopoly Average total cost
profit

Average
total D C

Demand
cost

Marginal revenue

0 Quantity
QMAX
 The Deadweight Loss

• Because a monopoly sets its price above

marginal cost, it places a wedge between
the consumer’s willingness to pay and the
producer’s cost.
• This wedge causes the quantity sold to fall short of
the social optimum.

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 Deadweight Loss
• In a monopoly, the firm will set a specific price for a good that is available to

all consumers. The quantity of the good will be less and the price will be

higher (this is what makes the good a commodity). The monopoly pricing

creates a deadweight loss because the firm forgoes transactions with the

consumers.

• The deadweight loss is the potential gains that did not go to the producer or

the consumer. As a result of the deadweight loss, the combined surplus

(wealth) of the monopoly and the consumers is less than that obtained by

consumers in a competitive market. A monopoly is less efficient in total gains

from trade than a competitive market.

 The Inefficiency of Monopoly

Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
Demand
revenue

0 Monopoly Efficient Quantity

quantity quantity
 DEADWEIGHT LOSS
• Deadweight loss is the lost welfare because of
a market failure or intervention. In this case, it
is caused because the monopolist will set a
price higher than the marginal cost. This
means there will be people willing to pay
more than the cost of production which will
not be able to purchase the good because the
monopolist is maximizing profit.
 Oligopoly
• An oligopoly is a market structure in which a
few firms dominate. When a market is shared
between a few firms, it is said to be highly
concentrated
• An oligopoly is defined as a type of market
structure where two or more firms have
market control. Combined, they are able to
dictate prices and supply.
PRODUCT DIFFERENTIATION
 Oligopoly
In the words of Peter C.Dooley “ An Oligopoly
is a market of only a few sellers, offering either
homogenous or differentiated products.
Characteristics of an Oligopoly
Best defined by the actual behaviour of firms

A market dominated by a few large firms

High market concentration ratio

Each firm supplies branded products

Barriers to entry and exit

Interdependent strategic decisions by firms

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SRM Institute of Science and Technol
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SRM Institute of Science and Technol
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SRM Institute of Science and Technol
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SRM Institute of Science and Technol
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 Oligopoly differentiated market -Kinked
Demand Curve
 The kinked demand curve was first used by Paul M Sweezy to
explain price rigidity.
 Here each Oligopolist will act and react to any decision taken by
the firm regarding the price.
 Such a situation can be seen where products of all the firms are
quite similar and their prices are also the same.
 If one firm is selling the products at a price less than that of its
competitors, the competitors will be compelled to reduce their
prices to match with the firm’s price.
 On the other hand, if one firm decides to sell the products at a
higher price, its competitors will not react by increasing their
prices.
 Cont.
 So in the 1st situation [price reduction] the firm does not get
more customers, while in the next situation [price rise] the firm
loses its customers to the rivals.
 Thus, the firm under oligopoly realize that it is better to stick to
one price than to start a price war.
 Consequently firms in oligopoly do not raise their prices due to
the possibility of loosing customers. And they do not even cut
the prices because of the fear of price war.
 So prices in oligopoly tend to be sticky.
 Kinked Demand Curve Diagam

PRICE

OUTPUT
SRM Institute of Science and Technol
ogy,VDP
 Cont.
 It can be seen from the diagram that the kinked demand
curve AKB is made up of 2 segments.
 The demand segment corresponding to lower price is less
elastic than the demand segment corresponding to higher
price.
 This is because , price reduction by a firm is followed by
its rivals where as price increase is not followed by the
rival firms.
 Thus, here in the diagram original prevailing price is OD
where sales are equal to ON.
 Now the firm raise the price from OD to OE, the rivals do
not follow this price rise so the sales are reduced from ON
to OM.
 Cont.
 Thus AK part of demand curve appears more realistic.
 Likewise, when the firm lowers its price from OD to Of
but as other rival firms also follow this price reduction,
there is only a marginal increase in sale from ON to OP
and hence the KB part of the demand curve appears less
elastic
 Thus, price rigidity is explained by kinked demand curve
theory, the prevailing price is OD at which kink is found
(K) in the demand curve AB, the price OD will tend to
remain stable or rigid at each of the firms in oligopoly will
not see any gain in lowering it or raising it.
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SRM Institute of Science and Technol
ogy,VDP
 Oligopoly
• To fix up a price under oligopoly the economy
suggest two solution by assuming two
collusion
1. Cartel
• Firm jointly fix the price and output
2. Price Leadership
• The assumes the leadership position and fix price and
output

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ogy,VDP
Price and output determination under oligopoly

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ogy,VDP
Price and output determination under price
leadership

SRM Institute of Science and Technol

ogy,VDP
PRICE DISCRIMINATION
 PRICING
• Price is the money value of the goods and
services. In other words, it is the exchange value
of a product or service in terms of money. To the
seller, price is a source of revenue. To the buyer,
price is the sacrifice of purchasing power.
 PRICING
• Formulating price policies and setting the price are
the most important aspects of managerial decision
making. Price in fact, is the source of revenue which
the firm seeks to maximize. Again, it is the most
important device a firm can use to expand the
market. If the price is set too high, a seller may price
himself out of the market. If it is too low, his income
may not cover costs, or at best, fall short of what it
could be. In other words, if the Company prices too
much, it will make fewer sales. If it charges too little,
it will sacrifice profits. So the price must be fixed
judiciously.
Meaning of Pricing
• Pricing is one of the most important elements of
the marketing mix
• Price is the marketing variable that can be
changed most quickly
• The price of a product may be seen as a financial
expression of the value of that product
• The concept of value can therefore be expressed
as:
(Perceived) VALUE = (perceived) BENEFITS -(perceived) COSTS
 Factors governing prices

Internal Factors
1.Cost: The price must cover the cost of production including
materials, labour, overhead, administrative and selling expenses and a
reasonable profit.
2.Objectives: While fixing the price, the firm‟s objectives are to be
taken into consideration. Objectives may be maximum sales, targeted
rate of return, stability in prices, increase market share, meeting or
preventing competition, projecting image etc.
3.Organizational factors: Internal arrangement of the organization.
Organizational mechanism is to be taken into consideration while
deciding the price.
4.Marketing Mix: Other element of marketing mix, product, place,
promotion, pace and politics are influencing factors for pricing. Since
these are interconnected, change in one element will influence the
other.
 Factors governing prices

5.Product differentiation: One of the objectives of

product differentiation is to charge higher prices.
6.Product life cycle: At various stages in the
Product Life Cycle, various strategic pricing
decisions are to be adopted, eg. In the introduction
stage. Usually firm charges lower price and in
growth stage charges maximum price.
7.Characteristics of product: Nature of product,
durability, availability of substitute etc. will also
influence the pricing.
 Factors governing prices

External Factors.
• Demand: If the demand for a product is Inelastic it is
better to fix a higher price and if demand is elastic,
lower price may be fixed.
• Competition: Number of substitutes available in the
market and the extent of competition and the price of
competition etc. are to be considered while fixing a
firm price.
• Distribution channels: Conflicting interest of
manufacturers and middleman is one of the of the
important factor that affect the pricing decision.
Manufacturer would desire that middleman should sell
the product at a minimum mark up.
 Factors governing prices
• General economic conditions: During inflation a
firm forced to fix a higher price and in deflation
forced to reduce the price.
• Government Policy: While taking pricing
decision, a firm has to take into consideration the
taxation policy, trade policies etc. of the
Government.
• Reaction of consumers: If a firm fixes the price of
its product unreasonably high, the consumer
may boycott the product.
 To maximize profits

 To increase sales

 To increase the market share

 To satisfy customers, and

 To meet the competition

 Pricing Policies

• Price policies are those management guidelines that

control the day to day pricing decision as a means of
meeting the objectives of the firm such as
maximization of profit, maximization of sales,
targeted rate of return, survival, stability of prices,
meeting or preventing competition etc.
• A pricing policy is a standing answer to recurring
question. A systematic approach to pricing requires
the decision that an individual pricing situation be
generalised and codified into a policy cover­age of all
the principal pricing problems. Policies can and
should be tailored to various competitive situations.
 6 Steps in Setting the Price
Selecting Determinin Estimatin
pricing
the objective g g
demand costs
Price
objective Deman Cost
d s

Selecting Analyze competitors’

Selecting
pricing costs, prices, and
the final
method offers
price
Pricin
Fina g Competito
l metho rs
pric d
e
 (Steps)How should a
company set prices for
products or services?
STEPS:
1) Select the PRICE OBJECTIVE
2) Determine DEMAND

3) Estimate COSTS
4) Analyze competitor PRICE MIX
5) Select PRICING
METHOD

6) Select FINAL PRICE

The following are the different
methods of pricing Demand-
Cost-based
1.
oriented Pricing
Pricing (a)Price
Methods discrimination
Strategy-based
2.

(a)Cost plus (b)Perceived value

Pricing
pricing pricing
3.
(a)Market skimming
(b)Marginal cost
Competition- (b)Market Penetration
pricing
oriented
4.
(c)Two-part pricing
Pricing (d)Block Pricing
(a)sealed bid (e)Commodity
pricing bundling
(b)going rate (f)Peak load pricing
 Cost plus pricing:
Product unit’s total cost + percentage of profit.
Commonly followed in departmental stores.
Does not consider the competition factor.

 Marginal cost pricing:

Also called break-even pricing.
Selling price is fixed in such a way that it covers
fully the variable or marginal cost
 Sealed bid Pricing: This method is more
popular in tenders & contracts. Each
contracting firm quotes its price in a sealed
cover called ‘tender’. All the tenders are
opened on a scheduled date and the person
who quotes the lowest price is awarded the
contract.

 Going rate Pricing: Price is charged in tune

with the price in the industry as a whole. When
one wants to buy or sell gold, the prevailing
market rate at a given point of time is taken as
the basis to determine the price
 Price discrimination: Practice of charging
different prices to customers for the same good.
It is also called differential pricing. Prices are
discriminated on the basis of customer
requirements, nature of product itself,
geographical areas, income group etc..

 Perceived value pricing: price fixed on the

basis of the perception of the buyer of the
value of the product. For example: Mobile
phones without touch screens these days
 Market Skimming: When the product is
introduced for the first time in the market, the
company follows this method. Under this
method, the company fixes a very high price for
the product. The idea is to charge the customer
maximum possible. Mostly found in technical
products.
 Market Penetration: Opposite to the market
skimming method.Here the product is fixed so
low that the company can increase its market
share.

 Two-part pricing: A firm charges a fixed fee

for the right to purchase its goods, plus a per
unit charge for each unit purchased.
Organizations such as country clubs, golf
courses charge membership fee and offer their
 Commodity bundling: Commodity bundling
refers to the practice of bundling two or more
different products together and selling them at a
single ‘bundle price’. For example: The package
deals offered by the tourist companies, airlines
etc.

 Peak load Pricing: During seasonal period when

demand is likely to be higher, a firm may enhance
profits by peak load pricing. The firm’s philosophy
is to charge a higher price during peak times than
is charged during off- peak times
 Cross subsidization: In cases where demand for two
products produced by a firm is interrelated through
demand or costs, the firm may enhance the
profitability of its operation through cross
subsidization. Using the profits generated by
established products, a firm may expand its activities
by financing new product development and
diversification into new product market. For example,
A computer selling both hardware & Software..

 Transfer Pricing: Transfer pricing is an internal

pricing technique. It refers to a price at which inputs
of one department are transferred to another, in order
to maximize the overall profits of the company.
 Price Matching: A firm promises to match a lower
price offered by any competitor, while announcing its
own price. It is necessary that one should be
confident, before adopting this strategy.

 Promoting Brand Loyalty: This is an advertising

strategy where the customers are frequently
reminded by the brand value of a given product or
service. Conviction is to retain the brand loyalty, so
that customers will not slip away when the
competitors come up with lower prices. For example:
Pepsi and Coke spend huge amounts on advertising
campaigns to draw the attention of consumers.
 Time-to-time Pricing: This is also called
randomized pricing strategy where the firm
varies its price from time-to-time, say hour-to-
hour or day-to-day. Customers cannot learn from
experience which firm charges the lowest price
in the market. For ex: Markets of bullion,
currency and bank deposits.

 Promotional Pricing: Promoting the product by

intentionally charging lower price to attract the
customer

 Target Pricing: This is a strategy where

company fixes a price keeping in view a targeted
profit in mind.
 Pricing of a new product.
1.(Methods
Skimming price
andstrategy
strategy)
This is done with a basic idea of gaining a
premium from those buyers who always ready
to pay a much higher price than others.
Accordingly a product is priced at a very high
level due to incurring large promotional
expenses in the early stages. Thus skimming
price refers to the high initial price charged
when a new product is introduced in the
market. Reasons for charging this price are;
1.When the demand of new product is
relatively inelastic.
2.When there is no close substitutes
3.Elasticity of demand is not known.
2. Penetration price strategy
This is the practice of charging a low price right
from the beginning to stimulate the growth of
the market and to capture large share of it.
Since the price is lower, the product quickly
penetrates the market, and consumers with
low income are able to purchase it. Reasons for
adopting this policy are:
1.Product has high price elasticity in the initial
stage.
2.The product is accepted by large number of
customers.
3.Economies of large scale production
available to firm.
Other Kinds of pricing (pricing
strategies)
1.Psychological pricing: Here
manufacturers fix their prices of a product
in the manner that it may create an
impression in the mind of consumers that
the prices are low. E.g. Prices of Bata shoe
as Rs.99.99. This is also called odd pricing.
2.Mark up pricing. This method of
pricing is followed by whole salers and
retailers. When the goods are received,
the retailers add a certain percentage of
the whole saler‟s price.