1 Revenue Analysis. 2 TR= P* Q AR= TR/Q= P Demand curve of the consumer is the AR curve from the...

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Revenue Analysis

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Revenue AnalysisTR= P* QAR= TR/Q= P

Demand curve of the consumer is the AR curve from the seller’s point of view since price paid by the consumer is the revenue of the seller.MR= TR n- TR n-1

Shape of TR, AR and MR curves change according to market situation

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Revenue AnalysisTR= P* QAR= TR/Q= P

Demand curve of the consumer is the AR curve from the seller’s point of view since price paid by the consumer is the revenue of the seller.MR= TR n- TR n-1

Shape of TR, AR and MR curves change according to market situation

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Revenue Structure under Perfect competition

Quantity Price(Rs)

TR AR MR

1 100 100 100 100

2 100 200 100 100

3 100 300 100 100

4 100 400 100 100

5 100 500 100 100

6 100 600 100 100

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• Large no of buyers and sellers buying and selling homogeneous products

• Uniform prices• Producer can sell any quantity of output at

the market price.

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P=AR=MR

Quantity

Pric

e/ R

even

ue

TR

X

Y

O

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• Demand curve is perfectly elastic• Price does not fall if one more unit is sold• Therefore P(AR) remains the same when

one more unit is sold and so AR=MR- so MR and AR curves coincide

• Horizontal line parallel to X axis indicates that P or AR is constant irrespective of quantity sold

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Revenue Structure under Imperfect competition

• Under imperfect competition, producer faces a downward sloping demand curve-

He needs to lower the price to attain higher sales

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Revenue under Imperfect competition

Quantity TR AR MR1 16 16 162 30 15 143 42 14 124 52 13 105 60 12 86 66 11 67 70 10 48 72 9 29 72 8 0

10 70 7 -2

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Revenue Structure under Imperfect competition

• MR is positive as long as TR is increasing• MR becomes negative when TR declines• When quantity sold is increased from 9 to

10 units, TR declines from Rs. 72 to Rs. 70 and MR turns negative

• AR declines as additional units of product are sold

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Revenue Structure under imperfect competition

MR

AR

TR

X

Y

O

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Perfect Competition• Large no of undifferentiated buyers and sellers-

each one is so small as to be insignificant to influence the market--price takers

• Homogeneous products- each competitor offers or seeks exactly a similar thing as others

• The seller is a price-taker• No barriers to entry and exit- survival of the

fittest: Firm will shut down where AVC=AR. At any price lower than the AVC, firm will have to shut down

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Perfect Competition• Markets must be well organised and continuous

and everyone has information (knowledge) on market condition, product and price

• Market prices must be flexible to keep responding to changing conditions of supply and demand

• No transport cost• Perfect mobility of factors of production (raw

materials, labour and capital)-this results in factor price equalisation.

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Perfect Competition

• No Government interference: No rationing, administered prices, subsidies etc.- Underlying presumption that free market operates in social interest- “invisible hand” and self-regulatory mechanism- it provides an effective check on the power of the sellers, safeguards consumer against exploitation and makes it unnecessary for the State to intervene by regulating prices and production in order to protect the consumer

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Perfect CompetitionKey lessons of perfect competition for

managers • Important to enter the market as far ahead of the

competitors as possible-when supply is low and price is high- this requires entrepreneurial skill

• A firm earning an economic profit (as distinguished from normal profits) cant afford to be complacent because economic profit will attract new entrants

• Only way for a firm to survive is to keep costs as low as possible

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Perfect Competition

• With growing globalisation, new competitive cost pressures are being felt by firms around the world- Indian companies have the advantage of low –cost labour but disadvantage of technology lag

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Monopoly• Only one seller of a particular good or service• Rivalry from producers of substitutes is so remote as to

be insignificant: cross elasticity of demand is zero• Monopolist is a price setter- strength of a monopolist’s

power depends on how much he can raise the price without losing all his customers- this depends on elasticity of demand, which in turn depends on availability of substitutes

• 2 conditions are necessary to make a monopolist strong: 1) Gap in the chain of substitutes and 2) possibility of securing control over all the substitutes

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Causes and Forms of Monopoly• Barriers to entry-• Legal: Emerges as a result of statutory regulation by

government: Copy right, trade marks, government regulation, licence, tariffs and non-tariff barriers against import of goods

• Technical; Arises when the technical know-how is available with only one person

• Natural: If a single firm acquires control over supply of raw materials or natural resources such as minerals Oil well in a particular area

• High costs of capital investment or economies of scale

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Causes and Forms of Monopoly

• Joint Monopoly: Through voluntary agreement, business companies jointly acquire monopoly power. e.g., Trusts, syndicates, cartels,

• Public Monopoly: Created for the welfare of the public- e.g., public utilities like water supply, electricity, railways, telephones

• Private Monopoly: Owned an operated by private individuals or organisations- objective is profit maximisation

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Causes and Forms of Monopoly

• Simple Monopoly: Charges uniform or single price for a product to all the consumers- no discrimination between buyers or uses.

• Discriminating Monopoly : Act of selling the same commodity produced under single control, at different prices to different buyers or different uses.

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Discriminating Monopoly/ Price Discrimination

• 3 forms:

• 1st Degree: Different rate for every unit of output. Monopolist forces every consumer to part with his entire consumer surplus- discrimination between buyers is more common than discrimination between units of a homogeneous good

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2nd degree Discrimination

• 2nd Degree: Buyers are divided into different groups and then different rates charged for different blocks or groups: here, consumers enjoy a part of the consumer surplus and monopolist is also able to get a part of the surplus; e,g., electricity charges

• Taxi fare a certain amount or the 1st km, then different for further units

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3rd degree Discrimination

• 3rd degree: Most common type-Seller divides his buyers into sub-markets and charges a different price for each market- Dumping is an example: High price in domestic market and low in international market.

• Reasons: To dispose off surplus; to remove rivals; to take advantage of increasing returns to scale; to create new demand abroad; because demand elastic in international market, he has to reduce price

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Conditions of Price Discrimination

Conditions of Price Discrimination ( When is Price discrimination possible?)

1. Consumers are unaware of the difference in prices charged

2. Price difference so small that consumers don’t bother

3. Price illusion/ irrationality4. Markets are situated far from one another and

so it is expensive to transfer goods from one market to another

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Conditions of Price Discrimination

5) When elasticities of demand in the two markets are different: higher price for low elasticity market and lower price for high elasticity market. Why?

6) Direct personal services such as those of doctors and lawyers where resale is not possible

7) Legal sanction provided by government: e.g., lower prices in army canteen

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Forms of Price discrimination• Personal Discrimination: Occurs when

different prices are charged to different consumers – doctors and lawyers may charge different fees for the rich and the poor

• Local Discrimination: Lower prices in one locality and higher in another. e.g., dumping by charging higher prices in domestic market and lower prices in foreign markets

• Trade Discrimination: Charging different rates, based on use e.g., electricity charges for domestic/ industrial/agricultural uses

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Forms of Price Discrimination• Quality Discrimination: Hard cover

editions being sold at higher prices than paper back editions of books; business class travel vs economy class in air travel

• Time Discrimination: Different charges for the same commodity at different points of time- off-season air tickets; happy hours in restaurants

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• What is the cross elasticity of demand for a monopolist’s product?

• There is only one hospital in Mumbai with an advanced equipment for diagnosis of a certain disease. This is an example of ______________ monopoly.

• BEST and Indian Railways are examples of _________monopoly.

• Downloading music on internet is an example of violation of -------------------------- monopoly.

• 4 powerful traders get together and control supply of vegetables in Mumbai. This is ------------------------------monopoly.

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Monopolistic Competition

‘Most economic situations are composites of both competition and monopoly’- Chamberlin. In reality, monopoly and competition are not mutually exclusive, but markets have both elements in differing degrees

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Characteristics of Monopolistic Competition

Large no of firms/ sellers -Consequently no individual has any significant control over the market

Absence of interdependence: Since the number is large and size of each firm is small, no firm can influence or is influenced by others in the market.

Example of FMCG product marketFreedom of entry: No barriers to entry- this leads

to occurrence of only normal profits in the long run

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• Product Differentiation: Core of monopolistic competition- Different firms produce similar, but not homogeneous products. It is because of product differentiation that firms enjoy some monopoly power i.e., power to control the price in a narrow circle, but in the wider circle the firm faces competition from rival producers. Firms in effect are competing monopolies

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• Selling Costs: Expenditure incurred on changing the demand and preference of the consumers - Expenditure on advertising, promotion, displays, salaries of salesmen, free samples etc.-

No need or role for selling costs in monopoly of perfect competition

. Under monopolistic competition, firms compete with each other mainly not on the basis of price but on the basis of non price elements. Product differentiation and selling costs are known as non-price competition

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Monopolistic Competition

Wastes of Monopolistic CompetitionExcess capacity- resources are not fully

utilised, leading to higher costsCompetitive advertising ( as opposed to

constructive advertising)worse if consumers regard different products

as substitutes and thus resources are wasted

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Oligopoly: Definition and Features

• Few sellers producing homogeneous or differentiated products

• Automobiles, steel, consumer electronics• Few sellers: Naturally each seller has a

sizeable share of market- • Close interdependence- decision of a single

firm to expand or contract output affects entire market- moves and counter moves- need to predict and analyse every possible reaction of rivals before a firm takes decisions

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Oligopoly: Definition and Features

• Indeterminate demand curve: because of extreme interdependence

• Price Rigidity- Price remains stuck at a certain level-No desire for a departure from prevailing price in either direction- price cutting will be followed by rival but price hike may not be and hence “sticky” prices

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Oligopolistic Pricing• Oligopolistic pricing can take 3 different forms:1. Independent Pricing2. Collusion Model3. Price Leadership• Independent Pricing: Method of pricing its

differentiated product – result of the fact that each firm has a certain monopoly power, but there is fear of retaliation by rivals

• Various possibilities occur: Price wars and price rigidity

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Collusive Oligopoly• Collusion Model: • When there are only a small no of firms in a market, they

have a choice between cooperative and non cooperative behaviour.

• A Cartel agreement represents the most complete form of collusion among oligopolists-here firms are in a cooperative mode and minimise competition among themselves- due to explicit agreement between firms –Joint output and price decisions- has a board of control which determines the market share of each member

• Example: OPEC- decides on output rather than price

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• Sometimes tacit collusion occurs between firms without explicit agreement here they quote identical prices: Indian cement and steel market

• Barriers to collusive oligopoly:-Considered illegal as it converts oligopoly into

monopoly- Firms may cheat by giving secret price

concessions and thereby increasing the market share

- Some cartel members may be political rivals such as Iraq, Kuwait and Iran in OPEC

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Price Leadership• Price Leadership: It is an informal

position in most oligopolistic markets. It may emerge spontaneously due to technical reasons such as size, efficiency, economies of scale or the firm’s ability to forecast market conditions accurately

• Typically, leadership role is played by a dominant firm (largest in the industry) and smaller ones follow-

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• Sometimes price leadership is barometric-Here one of the firms (not necessarily the dominant one) takes lead in announcing a price change, especially when a change is due but is not effected due to uncertainty in the market –The barometric firm is supposed to have a better knowledge of the changing environment of the market than others

• Price leadership often serves as a means to price discipline and price stabilisation

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Comparison of different Market StructuresFeature Perfect

competitionMonopoly Monopolisti

c competition

No of sellers

Many One Large

Nature of goods

Homogeneous

Homogeneous

Differentiated

Entry Free Barriers Unrestricted

Degree of monopoly power

Zero Absolute Limited

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Comparison of different Market Structures

Feature Perfect competition

Monopoly Monopolistic competition

Cost Elements

Production cost

Production cost

Production cost+ Selling cost

Long run Profits

Normal Super- normal

Normal

Nature of Demand

Elastic Inelastic Relatively inelastic

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Feature Perfect competition

Monopoly Monopolistic competition

Pricing Price taking Price-making:i) Uniform ii) Price discrimination

Price-making:Uniform price

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Review Questions• Product differentiation is an important feature of

__________________ competition (Perfect/monopolistic)

• Duopoly is a market form with just --------------- sellers (two/ few)

• If market price is more than the equilibrium price, it indicates that --------------- is more than -----------(Supply/ demand)

• Break-even point is a _________________ situation (No profit-no loss/ maximum profit)

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Review Questions• Price elasticity of demand under perfect

competition is ________• Under perfect competition, __________ is equal

to AR=MR. (Price/ Total Revenue)• In the __________ period, both the fixed and

variable factors of production change. (Short/ Long)

• Mergers, acquisitions and take-overs are common under the _________________ market structure. (oligopolistic/ monopolistic)

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• --------------- cost increases continuously with an increase in production. (Fixed/ variable)

• There is a dichotomy of costs into fixed and variable in the _________ run. (short/ long)

• --------------------Cost has to be incurred even if production is nil. (Fixed/ variable)

• The ____________ run cost curve is also known as planning curve. (long/ short)

• Rent is a _______________ cost (Fixed/ variable)• Self-owned resources used in business are called

___________________ costs. (imputed/ explicit)

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• Private cost: Costs incurred by the private producer/ firm during the process of production.- includes both implicit and explicit costs

• Social cost: Costs incurred by society as a whole as a result of the production process undertaken of the private firm eg., water/ air/ noise pollution, congestion, traffic jam, development of slums

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Review Questions• Define:• Normal profit• Market• Dumping• Barriers to entry• Product differentiation • Monopolistic competition• Oligopoly• Selling cost• Collusive oligopoly

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Review Questions

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Review Questions

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Review Questions

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Answers to Review Questions• Product differentiation is an important feature of

__________________ competition (Perfect/monopolistic)

• Duopoly is a market form with just --------------- sellers (two/ few)

• If market price is more than the equilibrium price, it indicates that --------------- is more than -----------(Supply/ demand)

• Break-even point is a _________________ situation (No profit-no loss/ maximum profit)

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Answers to Review Questions• Price elasticity of demand under perfect

competition is ________• Under perfect competition, __________ is equal

to AR=MR. (Price/ Total Revenue)• In the __________ period, both the fixed and

variable factors of production change. (Short/ Long)

• Mergers, acquisitions and take-overs are common under the _________________ market structure. (oligopolistic/ monopolistic)

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Answers to Review Questions• Define:• Normal profit: Remuneration received by

entrepreneur for his service as a factor of production. This profit is just enough for him to exist in the industry.

• Market: A mechanism through which the buyer and seller interact to determine the price and quantity of a product. Buyers and sellers can be individuals, firms, agents or dealers. ( Market is not a geographical locality.)

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• Barriers to entry: Hurdles created to prevent other potential firms from joining the industry- trade marks, patents, copyrights

• Dumping: Selling in the international market at very low rates and in large quantities such that it affects the domestic producers

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Answers to Review Questions• Product differentiation: Changing designs,

features, packaging or pricing of a product to give the consumer the perception that the product under consideration is unique or superior.

• Price Discrimination: Charging different prices for the same product to different consumers

• Monopolistic competition: A market condition lying between perfect competition and monopoly, selling differentiated products

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• Oligopoly: A market condition with few sellers, selling homogeneous or differentiated products and facing intense rivalry and competition and a high degree of interdependence.

• Selling cost: Cost incurred on advertising, sales promotion, after-sales service etc

• Collusive oligopoly: A situation where firms in an oligopolistic market enter into an explicit agreement regarding output and price decisions; Example OPEC. In the case of tacit collusion, there is no open or formal agreement.

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Answers to Review Questions

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Answers to Review Questions

1 Revenue Analysis. 2 TR= P* Q AR= TR/Q= P Demand curve of the consumer is the AR curve from the...

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