Post on 27-Mar-2015
5Pricing and Output
Decisions: Imperfectly Competitive Markets
5Pricing and Output
Decisions: Imperfectly Competitive Markets
Alternative Market StructuresAlternative Market Structures
• Classifying markets (by degree of competition)
– number of firms
– freedom of entry to industry
• free, restricted or blocked?
– nature of product
• homogeneous or differentiated?
– nature of demand curve
• degree of control the firm has over price
• Classifying markets (by degree of competition)
– number of firms
– freedom of entry to industry
• free, restricted or blocked?
– nature of product
• homogeneous or differentiated?
– nature of demand curve
• degree of control the firm has over price
Alternative Market StructuresAlternative Market Structures
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
Features of the four market structuresFeatures of the four market structures
Features of the four market structuresFeatures of the four market structures
Features of the four market structuresFeatures of the four market structures
Features of the four market structuresFeatures of the four market structures
Features of the four market structuresFeatures of the four market structures
Features of the four market structuresFeatures of the four market structures
Alternative Market StructuresAlternative Market Structures
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• Structure conduct performance
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• Structure conduct performance
MonopolyMonopoly
• Defining monopoly– importance of market power
• Barriers to entry– economies of scale
– economies of scope
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors or outlets
– legal protection
– mergers and takeovers
• Defining monopoly– importance of market power
• Barriers to entry– economies of scale
– economies of scope
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors or outlets
– legal protection
– mergers and takeovers
MonopolyMonopoly
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
AR and MR curves for a monopolyAR and MR curves for a monopolyQ
(units)
1234567
P =AR(£)8765432
ARAR
, MR
(£
)
Quantity
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
Q(units)
1234567
P =AR(£)8765432
TR(£)
8141820201814
MR(£)
6420
-2-4
MR
AR
, MR
(£
)
Quantity
AR
AR and MR curves for a monopolyAR and MR curves for a monopoly
MonopolyMonopoly
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
Profit maximising under monopolyProfit maximising under monopoly
MR
£
Q O
MC
Qm
MonopolyMonopoly
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
Profit maximising under monopolyProfit maximising under monopoly
MR
£
Q O
MC
Qm
£
Q O
MC
AC
Qm
MR
AR
AC
AR
Profit maximising under monopolyProfit maximising under monopoly
MonopolyMonopoly
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit– Measuring profit
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit– Measuring profit
£
Q O
MC
AC
Qm
MR
AR
AC
AR
Total profit
Profit maximising under monopolyProfit maximising under monopoly
MonopolyMonopoly
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit– Measuring profit
– Supernormal profit can persist in long run
• The monopolist's demand curve– downward sloping
• the greater the market power, the less elastic the demand curve
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit– Measuring profit
– Supernormal profit can persist in long run
MonopolyMonopoly
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
– competition for corporate control
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
– competition for corporate control
AR = D
MC
MR
£
Q O Q1
P1
Monopoly
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
£
Q O
MC ( = supply under perfect competition)
Q1
MR
P1
P2
Q2
AR = D
Comparison withPerfect competition
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
MonopolyMonopoly
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
MonopolyMonopoly
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
MonopolyMonopoly
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
MonopolyMonopoly
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
– competition for corporate control
• Monopoly versus perfect competition– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products• less incentive to innovate
• BUT greater possibility of innovation through investing ploughed-back profit
– competition for corporate control
OligopolyOligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly
– cartels
• equilibrium of the industry
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly
– cartels
• equilibrium of the industry
£
Q O
Industry D AR
Profit-maximising cartelProfit-maximising cartel
£
Q O
Industry D AR
Industry MC
Industry MR
Q1
P1
Profit-maximising cartelProfit-maximising cartel
OligopolyOligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly
– cartels
• equilibrium of the industry
• allocating and enforcing quotas
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly
– cartels
• equilibrium of the industry
• allocating and enforcing quotas
OligopolyOligopoly
• Collusive oligopoly (cont.)– tacit collusion
• price leadership
• rules of thumb
– factors favouring collusion• few firms which are open with each other
• similar cost structures
• similar products
• there is a dominant firm
• significant barriers to entry
• stable market conditions
• no government measures to curb collusion
• Collusive oligopoly (cont.)– tacit collusion
• price leadership
• rules of thumb
– factors favouring collusion• few firms which are open with each other
• similar cost structures
• similar products
• there is a dominant firm
• significant barriers to entry
• stable market conditions
• no government measures to curb collusion
OligopolyOligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• The breakdown of collusion
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
Profits for firms A and B at different pricesProfits for firms A and B at different prices
£2.00 £1.80
£2.00
£1.80
X’s price
Y’s price
A B
C D
£10m each
£8m each£12m for Y£5m for X
£5m for Y£12m for X
OligopolyOligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• The breakdown of collusion
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
Profits for firms A and B at different pricesProfits for firms A and B at different prices
£2.00 £1.80
£2.00
£1.80
X’s price
Y’s price
A B
C D
£10m each
£8m each£12m for Y£5m for X
£5m for Y£12m for X
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
– the importance of timing
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
– the importance of timing
OligopolyOligopoly
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
– the importance of timing• decision trees
• Non-collusive oligopoly: game theory– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises• are threats seen by rivals as credible?
– the importance of timing• decision trees
Boeingdecides
500
seat
er
500 seater
500 seater
400 seater
400 seater
400 seater
A decision treeA decision tree
Boeing –£10mAirbus –£10m
(1)
Boeing +£30mAirbus +£50m
(2)
Boeing +£50mAirbus +£30m
(3)
Boeing –£10mAirbus –£10m (4)
Airbusdecides
B2
Airbusdecides
B1
A
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
£
QO
P1
Q1
Current priceand quantity
give one pointon demand curve
Kinked demand for a firm under oligopolyKinked demand for a firm under oligopoly
£
QO
P1
Q1
D
D
Kinked demand for a firm under oligopolyKinked demand for a firm under oligopoly
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
£
QO
P1
Q1
MC2
MC1
MR
a
bD AR
Stable price under conditions of a kinked demand curveStable price under conditions of a kinked demand curve
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
– disadvantages
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
– disadvantages
OligopolyOligopoly
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
– disadvantages
– difficulties in drawing general conclusions
• Non-collusive oligopoly: the kinked demand curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
– disadvantages
– difficulties in drawing general conclusions
Alternative Aims to Profit MaximisationAlternative Aims to Profit Maximisation
• Alternative aims– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
• Alternative aims– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
£
Q O
AR
MC
MRQ1
P1
Sales revenue maximising price and outputSales revenue maximising price and output
Profit-maximisingprice and output
£
O
AR
P1
MC
Q1
MRQ2
P2
Sales revenuemaximising
price and output
Q
Sales revenue maximising price and outputSales revenue maximising price and output
Alternative Aims to Profit MaximisationAlternative Aims to Profit Maximisation
• Alternative aims– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
– implications for the consumer
• Alternative aims– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
– implications for the consumer
Alternative Aims to Profit MaximisationAlternative Aims to Profit Maximisation
• Growth maximisation– measuring ‘growth’
– equilibrium for growth maximising firm?
• Multiple aims– satisficing and the setting of targets
• different stakeholders with different aims
• various possible targets
• potential conflicts between targets
– organisational slack• a way of reconciling conflicting aims?
• cutting slack with 'just-in-time' methods
• Growth maximisation– measuring ‘growth’
– equilibrium for growth maximising firm?
• Multiple aims– satisficing and the setting of targets
• different stakeholders with different aims
• various possible targets
• potential conflicts between targets
– organisational slack• a way of reconciling conflicting aims?
• cutting slack with 'just-in-time' methods
Pricing in PracticePricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
Choosing the output and profit mark-upChoosing the output and profit mark-up
O
AC
£
Q
D
P1
Q1
f
gP2
Q2
j
h
Pricing in PracticePricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
Pricing in PracticePricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
– variations in the mark-up
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
– variations in the mark-up
Pricing in PracticePricing in Practice
• Price discrimination
– meaning of price discrimination
• charging different prices to different consumers for reasons unrelated to costs
• the prices depend on price elasticity of demand
• Price discrimination
– meaning of price discrimination
• charging different prices to different consumers for reasons unrelated to costs
• the prices depend on price elasticity of demand
Price discriminationPrice discrimination
P
QO
P1
D
200
O
P1
D
P2
150 200
P
Q
Price discriminationPrice discrimination
Pricing in PracticePricing in Practice
• Price discrimination (cont.)
– conditions for price discrimination
• firm must be able to set its price
• markets must be separate
• demand elasticity must differ between markets
– advantages to the firm
• higher profits
• possibility of cross-subsidisation
• Price discrimination (cont.)
– conditions for price discrimination
• firm must be able to set its price
• markets must be separate
• demand elasticity must differ between markets
– advantages to the firm
• higher profits
• possibility of cross-subsidisation
• Pricing and the product life cycle
– the four stages
• launch
• growth
• maturity
• decline
– competition and pricing in each stage
• Pricing and the product life cycle
– the four stages
• launch
• growth
• maturity
• decline
– competition and pricing in each stage
Pricing in PracticePricing in Practice
O
Sal
es p
er p
erio
d
Time
The stages in a product’s life cycleThe stages in a product’s life cycle
The stages in a product’s life cycleThe stages in a product’s life cycle
O (1)Launch
(2)Growth
(3)Maturity
(4)Decline
Sal
es p
er p
erio
d
Time
Product notbecomingobsolete
Productbecomingobsolete