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