Market Structure Price Decision

Presentation on:
Market structure &

Price decision
MARKET STRUCTURE &PRICE
DECISIONS
MARKET :
In an economic sense ,a
market is a system
By which buyers & sellers bargains for
the price of the
Product ,settle the price and transact
their business .
How the price for the
commodity is determined in
the market?
 Determination of price of a commodity
depends on the number of sellers and
buyers .
 Number of sellers of a product in a
market determines the nature and
degree of competition in the market .
 The nature and degree of competition
makes the structure of the market .
“Rule”:
 “The higher the degree of

competition, the lower firm degree of
freedom. In pricing decision and
control over the price of its own
product.”
 How the degree of competition
affects price decision in different
types of market structure?
Types of market
structure
Market No. of firms Nature of Control Methods of
structure & degree of industries over prices marketing
production where
differentiat prevalent
ions
1.Perfect Large Financial None Market

competition number of market & exchange or
firms with some farm auction
identical products
product
2.Imperfect
competition
a. Many firms Manufacturin some Competitive
Monopolistic with real of g; tea, advertising
competition perceived toothpaste,t. quality
b. Oligopoly Little or no Aluminum, some Competitive
product steel, car advertising
differentiatio etc. quality
n rivalry
c. Monopoly A single Public Considerable Promotional

producer w/o utilities, but usually advertiseme
close electricity regulated. nt if supply is
substitute etc. large.
Types of market
structure
 PERFECT COMPETITION
 IMPERFECT COMPETITION
MONOPOLISTIC
OLIGOPOLY
PERFECT COMPETITION
Objectives
After studying this chapter, you will able to
 Define perfect competition
 Explain how price and output are determined in
perfect competition
 Explain why firms sometimes shut down temporarily
and lay off workers
 Explain why firms enter and leave the industry
 Predict the effects of a change in demand and of a
technological advance
 Explain why perfect competition is efficient
Competition
Perfect competition is an industry in

which:
 Many firms sell identical products to many
buyers.
 There are no restrictions to entry into the
industry.
 Established firms have no advantages over
new ones.
 Sellers and buyers are well informed about
prices.
Competition
How Perfect Competition Arises ?

Perfect competition arises:
 When firm’s minimum efficient scale is
small relative to market demand so there
is room for many firms in the industry.
 And when each firm is perceived to
produce a good or service that has no
unique characteristics, so consumers don’t
care which firm they buy from.
Competition
Price Takers
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the price
of a good or service.
No single firm can influence the price—it must “take”
the equilibrium market price.
Each firm’s output is a perfect substitute for the output
of the other firms, so the demand for each firm’s output
is perfectly elastic.
Competition
Economic Profit and Revenue

The goal of each firm is to maximize
economic profit, which equals total
revenue minus total cost.
Total cost is the opportunity cost of
production, which includes normal profit.
A firm’s total revenue equals price, P,
multiplied by quantity sold, Q, or P × Q.
Competition
A firm’s marginal revenue is the change in total
revenue that results from a one-unit increase in the
quantity sold.
Figure 11.1 illustrates a firm’s revenue curves.
Competition
Figure shows that market demand and supply determine the
price that the firm must take.
Competition
Figure 11.1(b) shows the demand curve for the firm’s product,
which is also its marginal revenue curve.
Competition
Because in perfect competition the price
remains the same as the quantity sold
changes, marginal revenue equals price.
Competition
Figure 11.1(c) shows the firm’s total revenue curve.

The Firm’s Decisions in
Perfect Competition
A perfectly competitive firm faces two
constraints:
 A market constraint summarized by the
market price and the firm’s revenue curves
 A technology constraint summarized by
firm’s product curves and cost curves.
Perfect Competition
The perfectly competitive firm makes
two decisions in the short run:
 Whether to produce or to shut down.
 If the decision is to produce, what quantity
to produce.
A firm’s long-run decisions are:
 Whether to increase or decrease its plant
size.
 Whether to stay in the industry or leave it.
Perfect Competition
Profit-Maximizing Output
A perfectly competitive firm chooses the output
that maximizes its economic profit.
One way to find the profit maximizing output is
to look at the firm’s the total revenue and total
cost curves.
Figure on the next slide looks at these curves
along with the firm’s total profit curve.
The Firm’s Decisions
in Perfect Competition
Part (a) shows the total
revenue, TR, curve.
Part (a) also shows the

total cost curve, TC.
Total revenue minus total
cost is profit (or loss),
shown in part (b).
Profit is
maximized when
the firm produces
9 sweaters a day.
At low output levels, the
firm incurs an economic
loss—it can’t cover its
fixed costs.
At intermediate output
levels, the firm earns
an economic profit.
At high output levels, the

firm again incurs an
economic loss—now it
faces steeply rising costs
because of diminishing
returns.
Perfect Competition
Marginal Analysis
The firm can use marginal analysis to
determine the profit-maximizing output.
Because marginal revenue is constant and
marginal cost eventually increases as output
increases, profit is maximized by producing
the output at which marginal revenue, MR,
equals marginal cost, MC.
Figure on the next slide shows the marginal
analysis that determines the profit-
maximizing output.
Perfect Competition
If MR > MC, economic
profit increases if output
increases.
If MR < MC, economic

profit decreases if output
increases.
If MR = MC, economic
profit decreases if output
changes in either
direction, so economic
profit is maximized.
Perfect Competition
Profits and Losses in the Short Run
Maximum profit is not always a positive
economic profit.
To determine whether a firm is earning an
economic profit or incurring an economic
loss, we compare the firm’s average total
cost, ATC, at the profit maximizing output
with the market price.
Figure 11.4 on the next slide shows the
three possible profit outcomes.
Perfect Competition
In part (a) price equals ATC and the firm earns zero
economic profit (normal profit).
Perfect Competition
In part (b), price exceeds ATC and the
firm earns a positive economic profit.
Perfect Competition
In part (c) price is less than ATC and the firm incurs an
economic loss—economic profit is negative and the firm
does not even earn normal profit.
Perfect Competition
The Firm’s Short-Run Supply Curve
A perfectly competitive firm’s short run supply curve
shows how the firm’s profit-maximizing output varies
as the market price varies, other things remaining
the same.
Because the firm produces the output at which
marginal cost equals marginal revenue, and because
marginal revenue equals price, the firm’s supply
curve is linked to its marginal cost curve.
But there is a price below which the firm produces
nothing and shuts down temporarily.
Perfect Competition
Temporary Plant Shutdown
If price is less than the minimum average
variable cost, the firm shuts down temporarily
and incurs a loss equal to total fixed cost.
This loss is the largest that the firm must bear.
If the firm were to produce just 1 unit of
output at price below average variable cost, it
would incur an additional (and avoidable) loss.
Perfect Competition
The shutdown point is the output and price at
which the firm just covers its total variable
cost.
This point is where average variable cost is at
its minimum.
It is also the point at which the marginal cost
curve crosses the average variable cost
curve.
At the shutdown point, the firm is indifferent
between producing and shutting down
temporarily.
It incurs a loss equal to total fixed cost from
either action.
Perfect Competition
If the price exceeds minimum
average variable cost, the firm
produces the quantity at which
marginal cost equals price.
Price exceeds average variable
cost, and the firm covers all its
variable cost and at least part of its
fixed cost.
Figure shows how the
firm’s short-run supply
curve is constructed.
If price equals
minimum average
variable cost, $17 in
this example, the firm
is indifferent between
producing nothing and
producing at the
shutdown point, T.
If the price is $25,
the firm produces
9 sweaters a day,
the quantity at
which P = MC.
If the price is $31, the firm
produces 10 sweaters a
day, the quantity at which
P = MC.
The blue curve in part (b)
traces the firm’s short-run
supply curve.
Perfect Competition
Short-Run Industry Supply Curve
The short-run industry supply curve
shows the quantity supplied by the
industry at each price when the
plant size of each firm and the
number of firms remain constant.
Perfect Competition
The quantity supplied by

the industry at any given
price is the sum of the
quantities supplied by all
the firms in the industry at
that price.
Perfect Competition
At a price equal to minimum
average variable cost—the
shutdown price—the industry
supply curve is perfectly elastic
because some firms will produce
the shutdown quantity and others
will produces zero.
Output, Price, and Profit
Short-Run Equilibrium
Short-run industry supply and
industry demand determine the
market price and output.
Figure shows a short-run
equilibrium at the intersection of
the demand and supply curves.
A Change in Demand
An increase in
demand bring a
rightward shift of the
industry demand
curve: the price rises
and the quantity
increases.
A decrease in demand
bring a leftward shift of the
industry demand curve:
the price falls and the
quantity decreases.
Long-Run Adjustments
In short-run equilibrium, a firm may earn
an economic profit, earn normal profit, or
incur an economic loss and which of these
states exists determines the further
decisions the firm makes in the long run.
In the long run, the firm may:
 Enter or exit an industry
 Change its plant size
Entry and Exit
New firms enter an industry in
which existing firms earn an
economic profit.
Firms exit an industry in which they
incur an economic loss.
Figure on the next slide shows the
effects of entry and exit.
As new firms enter an

industry, industry supply
increases.
The industry supply curve
shifts rightward.
The price falls, the

quantity increases, and
the economic profit of
each firm decreases.
As firms exit an
industry, industry
supply decreases.
The industry supply
curve shifts leftward.
The price rises, the

quantity decreases, and
the economic profit of
each firm increases.
Changes in Plant Size
Firms change their plant size whenever
doing so is profitable.
If average total cost exceeds the
minimum long-run average cost, firms
change their plant size to lower costs
and increase profits.
Figure on the next slide shows the
effects of changes in plant size.
If the price is $25, firms earn zero
economic profit with the current plant.
But if the LRAC curve is sloping downward at the current
output, the firm can increase profit by expanding the
plant.
As the plant size increases, short-run supply increases, the
price falls, and economic profit decreases.
Long-run equilibrium occurs when the firm is
producing at the minimum long-run average cost and
earning zero economic profit.
Long-Run Equilibrium
Long-run equilibrium occurs in a
competitive industry when:
 Economic profit is zero, so firms neither
enter nor exit the industry.
 Long-run average cost is at its minimum,
so firms don’t change their plant size.
Competition and
Efficiency
Efficient Use of Resources
Resources are used efficiently
when no one can be made better
off without making someone else
worse off.
This situation arises when marginal
benefit equals marginal cost.
Competition and
Efficiency
Choices, Equilibrium, and Efficiency
We can describe an efficient use of resources in
terms of the choices of consumers and firms
coordinated in market equilibrium.
We derive a consumer’s demand curve by finding
how the best (most valued by the consumer) budget
allocation changes as the price of a good changes.
So consumers get the most value out of their
resources at all points along their demand curves,
which are also their marginal benefit curves.
Competition and
Efficiency
We derive a competitive firm’s supply curve by finding
how the profit-maximizing quantity changes as the
price of a good changes.
So firms get the most value out of their resources at all
points along their supply curves, which are also their
marginal cost curves.
In competitive equilibrium, the quantity demanded
equals the quantity supplied, so marginal benefit
equals marginal cost.
All gains from trade have been realized.
Competition and
Efficiency
Competitive equilibrium is efficient
only if there are no external benefits
or costs.
External benefits are benefits that
accrue to people other than the buyer
of a good.
External costs are costs that are
borne not by the producer of a good
or service but by someone else.
Competition and
Efficiency
Figure illustrates an
efficient allocation of
resources in a perfectly
competitive industry.
In part (a), each firm is
producing at the lowest
possible long run average
total cost at the price P*
and the quantity q*.
Competition and
Efficiency
Figure shows the market.
Along the demand curve D = MB
the consumer is efficient.
Along the supply curve S = MC the
producer is efficient.
Competition and
Efficiency
The quantity Q* and
price P* are the
competitive equilibrium
values.
So competitive
equilibrium is efficient.
The consumer gains the

consumer surplus,
and the producer gains the

producer surplus.
& Imperfect Competition
Imperfect Competition
 Imperfectly Competitive Firms

 Have some control over price
 Price may be greater than the marginal
cost of production
 Long-run economic profits are possible
 Imperfectly Competitive Markets

 Reduce economic surplus to varying
degrees
 Are very common
Forms of Imperfect Competition
 Pure Monopoly (most inefficient)

 The only supplier of a unique product
with no close substitutes
 This is the one we’ll pay most attention
to
Forms of imperfect Competition
 Oligopoly (theoretically more

efficient than a monopoly)
 A firm that produces a product for which
only a few rival firms produce close
substitutes
 Collusion is a big problem
 Oil
 Electricity
 Vitamins
Forms of imperfect Competition
 Monopolistic Competition (closest to

perfect competition)
 A large number of firms that produce
slightly differentiated products that are
reasonably close substitutes for one
another
 The Essential Difference Between

Perfectly and Imperfectly
Competitive Firms
 The perfectly competitive firm faces a
perfectly elastic demand for its product.
 The imperfectly competitive firm faces a
downward-sloping demand curve.
 In perfect competition
 Supply and demand determine
equilibrium price. The firm has no
market power.
 At the equilibrium price, the firm sells all
it wishes.
 If the firm raises its price, sales will be
zero.
 The firm’s demand curve is the
horizontal line at the market price.
 With imperfect competition

 The firm has some control over price or
some market power.
 The firm faces a downward sloping
demand curve.
The Demand Curves Facing Perfectly
and Imperfectly Competitive Firms
Perfectly competitive firm Imperfectly competitive firm

$/unit of output
Market D
Price
price
Quantity Quantity
Monopolist
Charecteristics
 They do not have to compete with other
individual participants in the market.
 They are the only sellers in the market.
 For a firm to continue as a monopolist in the long
run, there must be factors that must prevent the
entries of other firms.
 Finally, the product of the firm must be highly
differentiated from other goods
Five Major Sources of Market
Power
Market power = barriers to entry
 Exclusive control over inputs
 Patents and copyrights
 Government licenses or franchises
 Economies of scale (natural
monopolies)
 Networked economies
Profit Maximization for
the Monopolist
 A price taker (perfect competition)

and a price setter (imperfect
competition) share two economic
goals. They want
 To maximize profits
 To select the output level that maximizes
the difference between TR and TC,
where MB= MC.
the Monopolist
 For a producer
 MB = Marginal Revenue (MR) or a
change in a firm’s total revenue that
results from a one-unit change in output
the Monopolist
 Marginal Revenue for the Monopolist

 Perfect competition and monopolies
 Both increase output when MR > MC.
 Calculate MC the same way.
 Do not have the same MR at a given price.
 In perfect competition: MR = P
In monopoly: MR < P
The Monopolist’s Benefit
from Selling an Additional Unit
• If P = $6, then TR = $6 x 2 = $12

• If P = $5, then TR = $5 x 3 = $15
8 • The MR of selling the 3rd unit = $3 (15-12)
• For the 3rd unit, MR = $3 < P = $5
Price ($/unit)
6
5
2 3 8
Quantity (units/week)
Marginal Revenue in
Graphical Form
 Observations
 MR < P
P Q TR MR
 MR declines as quantity
6 2 12
3 increases
5 3 15  MR is the change
1
4 4 16 between two quantities
-1
3 5 15  MR < P because price
must be lowered to sell
an additional unit
Marginal Revenue in
Graphical Form
Price & marginal revenue ($/unit)

P Q TR MR
6 2 12
3
5 3 15
1 3
4 4 16 D
-1 1
3 5 15
-1 2 3 4 5 8
MR
Quantity (units/week)
Short-Run Profit
Maximization for a
Monopolist
the Monopolist
 Profit Maximizing Decision Rule
 When MR > MC, output should be
increased.
 When MR < MC, output should be reduced.
 Profits are maximized at the level of
output for which MR = MC.
 What’s the marginal revenue for a
competitive firm?
Public Policy Toward
Natural Monopoly
 Methods of Controlling Natural
Monopolies
 State ownership and management
 Weighing the benefit of marginal cost
pricing versus the cost of less incentive for
innovation
 Is it true that there is less incentive for
innovation? Anecdotal example of trains
in WWI
 In a democracy, politicians have to provide
public services and keep taxes low to get
re-elected
Methods of Controlling
Natural Monopolies
 State regulation of private
monopolies
 Cost-plus regulation
 High administrative cost
 Less incentive for innovation
 P does not equate to MC
Methods of Controlling
Natural Monopolies
 Exclusive contracting for natural
monopoly
 Competition for the contract theoretically
sets P = MC
 Example of water in Buenos Aires
 Difficulty when fixed costs are high such
as electric utilities
 Vigorous enforcement of anti-trust laws.
The act of selling the same article ,pruduct under a single
control,at different prices to different buyers is known as
price discrimination.
PRINCIPLE FORMS OF PRICE
DISCRIMINATION
 Personal price discrimination
 Group price discrimination
 Product price discrimination
PERSONAL PRICE
DISCRIMINATION
 INCOME OR SERVICE=doctor’s fees
GROUP OF PRICE
DISCRIMINATION
 AGE=children’s/senior citizen fare
 SEX=concessional rates to ladies in
tour.e,g;in railway fare
 MILITARY STATUS=lower admission charge
for men in uniform
 LOCATION=zone prices.lower export
prices
 STATUS OF BUYER=concessions to
students
 USE OF PRODUCT=elec. charges .
PRODUCT OF PRICE
DISCRIMINATION
 QUALITY=better quality,higher prices
 LABLES=higher prices for branded
products .
 Size - large size –higher price
 Time - off-season rates ,excursion
rates in transport .
MARKET SEGMENTATION
 Segmentation of markets on the basis of the nature
of the goods and service .
 Segementation owing to the snobbish out look of
the consumer
 Segmentation by graphical location
 Segmentation on the basis of the use of product or
service .
 Segmentation on the basis of the time of purchase .
 Segmentation by the size of purchase order .
DEGREES OF PRICE
DISCRIMINATION
1ST degree –it is also known as perfect
price discrimination .price
discrimination of the first degree is
said to occur when the monopolist is
able to sell each separate units of
the output at different price ..
 2nd degree –In price discrimination of
the second degree bias are divided
in to different groups and from each
group a different prize is charged
which is the lowest demand price of
that group ,means maximum is
charged for some given minimum
block of output .
 3rd degree – In price discrimination of
the third degree ,profit maximizing
monopolist set different prizes in
different markets having demand
curves with different elasticties .

Market Structure Price Decision

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Market Structure Price Decision

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Presentation on:

Market structure &

 “The higher the degree of

1.Perfect Large Financial None Market

c. Monopoly A single Public Considerable Promotional

Perfect competition is an industry in

How Perfect Competition Arises ?

Economic Profit and Revenue

Figure 11.1(c) shows the firm’s total revenue curve.

Part (a) also shows the

At high output levels, the

If MR < MC, economic

The quantity supplied by

As new firms enter an

The price falls, the

The price rises, the

The consumer gains the

and the producer gains the

 Imperfectly Competitive Firms

 Imperfectly Competitive Markets

 Pure Monopoly (most inefficient)

 Oligopoly (theoretically more

 Monopolistic Competition (closest to

 The Essential Difference Between

 With imperfect competition

Perfectly competitive firm Imperfectly competitive firm

 A price taker (perfect competition)

 Marginal Revenue for the Monopolist

• If P = $6, then TR = $6 x 2 = $12

Price & marginal revenue ($/unit)

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