Unit 4 – Market Structure

Price is a managerial task that involves establishing pricing objectives, identifying the
factors governing the price ascertaining their relevance and significance determining the
product value in monetary terms and formulation of price policies and the strategies
implementing them and controlling them for the best result.

Thus pricing process is directly related to the value of product, services or idea in term
of money at a particular time which is accessed by the marketing manager with an aim
to sell it to the customer.

Objective of Pricing:

1. Profit Maximization in Short Term: The main aim of any company is to earn
maximum returns in shortest possible time.
2. Profit optimization in Long term: the commonly used philosophy to earn
maximum profit is not suitable in ling term.
3. Facing Competitive situation: Excluding the monopolistic product all products
face competition from their rivals in setting the price of their product.
4. Entry into new market: Diversification is the other way to strengthen the business
potential of a company.
5. Achieving target return: Before launching a product every company estimates a
target of profit over the capital investment and sales return. The pricing policy is
very much dependent upon it.
6. Ability to Pay: The decision on pricing policy cannot be taken without taking into
consideration the pay capacity of customers.

Price determination under perfect competition

A typical market structure is described by large number of buyers and sellers free entry
and exit of the firm. Identical goods and price buyers and sellers having complete
knowledge of market conditions is known as perfect competitive market.
In Figure-3, it can be seen that at price OP1, supply is more than the demand.
Therefore, prices will fall down to OP. Similarly, at price OP2, demand is more than the
supply. Similarly, in such a case, the prices will rise to OP. Thus, E is the equilibrium at
which equilibrium price is OP and equilibrium quantity is OQ.

Price Determination under Monopoly competition

Like a perfect competitive firm, a monopoly firm also aims at earning maximum profit
where a monopolist adjust his output and attains maximum profit by fixing a price.

In this figure LMC and LMR intersect each other at the point E and after that LMC goes
on

rising. Thus OQ production is determined and OP is the price. But average cost is SQ.
So profit per unit is RS and at OQ output the total profit is PTSR.
Under Price Competition AR =MR, where-as under Monopoly MR <AR.

Under perfect competition price is determined by the interaction of total demand and
supply. This price is acceptable to all the firms in the industry. No firm can change this
price. So, average revenue and marginal revenue, at every level of production, will be
constant and equal. Their curves are parallel to X-axis.

Under Monopoly, to sell every additional unit of the commodity price will have to be
lower. In this way, with the sale of every additional unit, average and marginal income
goes on falling. But the decrease in average revenue is relatively less sharp than the
decrease in marginal revenue, It is because marginal revenue is limited to one unit,
whereas in case of average revenue, the decrease price is divided by the number of
units. Therefore, the fall in average revenue has relatively less slope. That is the reason
why marginal revenue is less than average revenue.

Price determination under Monopolistic Competition

As there is product differentiation between firms in the monopolistic competitive market,

a perfect elastic demand not faced by the firm for its product.

Conditions for the equilibrium of a individual firm:

1. Marginal Cost(MC) = Marginal Revenue(MR)

2. There must be intersection of MR curve by MC curve from below.

In a monopolistic competition, since the product is differentiated between firms, each firm
does not have a perfectly elastic demand for its products. In such a market, all firms
determine the price of their own products. Therefore, it faces a downward sloping demand
curve. Overall, we can say that
the elasticity of demand
increases as the differentiation
between products decreases.
Fig. 1 above depicts a firm
facing a downward sloping, but
flat demand curve. It also has a
U-shaped short-run cost curve.
From Fig. 2, we can see that the per unit cost is higher than the price of the firm.
Therefore,

 AQ > OP (or BQ)

 Loss per unit = AQ – BQ = AB

 Total losses = ACPB

Long-run equilibrium

If firms in a monopolistic competition earn super-normal profits in the short-run, then new
firms will have an incentive to enter the industry. As these firms enter, the profits per firm
decrease as the total demand gets shared between a larger number of firms. This
continues till all firms earn only normal profits. Therefore, in the long-run, firms, in such a
market, earn only normal profits.
As we can see in Fig. 3 above, the average revenue (AR) curve touches the average cost
(ATC) curve at point X. This corresponds to quantity Q1 and price P1. Now, at equilibrium
(MC = MR), all super-normal profits are zero since the average revenue = average costs.
Therefore, all firms earn zero super-normal profits or earn only normal profits.

It is important to note that in the long-run, a firm is in an equilibrium position having excess
capacity. In simple words, it produces a lower quantity than its full capacity. From Fig. 3
above, we can see that the firm can increase its output from Q1 to Q2 and reduce average
costs. However, it does not do so because it reduces the average revenue more than the
average costs. Hence, we can conclude that in a monopolistic competition, firms do not
operate optimally. There always exists an excess capacity of production with each firm. In
case of losses in the short-run, the firms making a loss will exit from the market. This
continues until the remaining firms make normal profits only.

Pricing under oligopoly competition

Under oligopoly, there is no definite price output determination theory. This is because of
interdependent oligopolistic firms to make decisions and uncertainty reaction patterns of
rival firms.

Kinked Demand Curve Theory

If the firm lowers its price below OP1, its rivals will follow
Its demand will expand along the relatively inelastic section of the demand curve below
OP1 and total revenue will fall. If the firm raises its price above OP1, none of its
competitors will follow. Its demand for prices above OP1 will contract along the relatively
elastic section of the demand curve and total revenue will fall. As a result of action and
non-reaction to price changes, an oligopolistic is faced with a kinked demand curve at
OP1. Price rigidity is due to the kinked demand curve and the resulting discounting in the
MR curve.