Managerial Economics

Unit - 2

By - Anand Kumar

Unit - 2Product Markets – Market Structure, Competitive market, Imperfect competition and barriers to entry, Pricing in different markets – Recourse Markets – Pricing and Employment of inputs under different market structures, Wages and wage differentials.

MarketThe term market has come to signify a public place in which goods and services are bought and sold. It is the act or technique of buying and selling. Market defines, “any area over which buyers and sellers are in such close touch with one another, either directly or through dealers, that the prices obtainable in one part of the market affect the prices paid in other parts.”

MarketTherefore, market in economic sense implies:1. Presence of buyers and sellers (Producers) of the commodity2. Establishment of contract between the buyers and sellers3. Similarity of the product4. Exchange of commodity for a price

Classification of Markets1. Markets on the basis of Area2. Markets on the basis of Time3. Markets on the basis of ‘Nature of

Transactions’4. Markets on the basis of ‘Regulation’5. Markets on the basis of ‘Volume of Business’6. Market on the basis of ‘Position of Sellers’7. Market on the basis of type of ‘Competition’

1. Markets on the basis of AreaOn the basis of geographical area covered, markets are classified into (a) Local Markets, (b) Regional Markets, (c) National Markets, and (d) International Markets. A local market for a product exists when buyers and sellers carry on business in a particular locality or village or area where demand and supply conditions are influenced by local condition only.

2. Markets on the basis of TimeAlfred Marshall conceived the ‘Time’ element in marketing and this is classified into (a) Very short-period market; (b) Short-period market; (c) Long-period market; and (d) Very long-period or Secular market.

3. Markets on the basis of Nature of Transactions

On the basis of nature of transactions, markets are classified into (a) Spot market; and (b) Future market. Spot transaction or spot markets refer to those markets where goods are physically transacted on the spot, whereas Future markets related to those transactions which involve contracts of the future date.

4. Markets on the basis of ‘Regulation’

On the basis of regulation, markets are classified into (a) Regulated market; and (b) Unregulated market. In the former type of markets transactions are statutorily regulated so as to put an end to unfair practices. Such markets may be established for specific products or a group of products. Produce and stock exchanges are suitable examples of the regulated markets. Unregulated markets or free markets are those where there are no restrictions in the transactions.

5. Markets on the basis of ‘Volume of Business’

Based on the volume of business transacted, markets are classified into Wholesale market and Retail market. The wholesale market comes into existence when the commodities are bought and sold in bulk or large quantities. The dealers in this market are known as the wholesalers. The wholesaler acts as an intermediary between the producer and the retailer. Retail market, on the other hand exists when the commodities are bought and sold in small quantities. This is the market for ultimate consumers.

6. Market on the basis of ‘Position of Sellers’

On the basis of the position of the sellers in the chain of marketing, markets are divided into Primary market, Secondary market and the Terminal market. Manufacturers of commodities constitute the primary market who sell the products to the wholesalers. The secondary market consists of wholesalers who sell the products in bulk to the retailers. Retailers along constitute the terminal markets who sell the products to the ultimate consumers.

7. Markets on the basis of type of ‘Competition’

Based on the type of competition, markets are classified into (a) Perfectly Competitive market; and (b) Imperfect market. The broad classification is Perfect Competition and Imperfect Competition. The opposite type of perfect market is ‘Monopoly’. Under imperfect markets, there are many types, viz., oligopoly, Duopoly, Monopolistic competitions, etc. We shall study about the types of competition in greater detail.

CompetitionsCompetition in business connotes the presence of more than one seller and one buyer in a particular market. In competitive markets sellers act independently of other buyers. It is incompatible with those conditions of market where there is only one seller or one buyer. So, the presence of more than one buyer and one seller is a necessary pre-condition for the existence of competitions.

Types of Competition1. Perfect Competition and Pure

Competition2. Imperfect Competition

a. Monopolistic Competitionb. Oligopoly Competition

3. Monopoly Competition

Competition

Perfect CompetitionLarge number of

small firms

OligopolyA few large firms

dominate the industry

MonopolyOne firm comprises the whole industry

1. Perfect Competition

A perfectly competitive market is one in which economic forces operate unimpeded.

Perfect CompetitionPerfect competition is a firm behavior that occurs when many firms produce identical

products and entry is easy. Characteristics of perfect competition:

There are many sellers.The products sold by the firms in the industry are identical. Entry into and exit from the market are easy, and there are many potential entrants.Buyers (consumers) and sellers (firms) have perfect information.

Features of Perfect Competition1. Large number of buyers and Sellers2. Homogeneous Products3. Free entry and exit conditions4. Perfect knowledge on the part of buyers

and sellers5. Perfect mobility of factors of production6. Absence of transport cost7. Absence of Government or artificial

restrictions

Imperfect Competition

Monopolistic Competition

Many, but not too many

Small NoneCorner Shop

Oligopoly Few Medium Some Cars

Monopoly One Large Huge Post Office

Number of firms

Ability to affect price

Entry barriers

Example

Imperfect CompetitionImperfectly Competitive Firms

Have some control over price Price may be greater than the cost of production Long-run economic profits are possible

MonopolyMonopoly is the form of market organization in which there is a single firm selling a commodity for which no close substitutes”. - D. SalvatoreThe price is under the full control of the monopolist but not the demand is determined by purchasers.

Characteristics of Monopoly Only one seller in market and large number of buyers. No Close Substitutes Product totally differentiated No free entry or exit/ Barriers to Entry. Full Control over price Price discrimination (different price to different Consumer)

Imperfect information Where a perfectly competitive firm is a price taker, the monopolist is a price searcher.

Monopolistic Competition Monopolistic competition refers to market situation where there are many firms selling a differentiated products. “ There is competition which is keen, through not perfect, among many firms making very similar products”“ Monopolistic competition is a market structure where there is large number of small sellers, selling differentiated but close substitute products” - J.S Bains“The term monopolistic completion refers to the market structure in which the sellers do have a monopoly (they are the only sellers) of their own product, but they are also subjects to substantial competitive pressures from sellers of substitute products”. - Baumol

Features of Monsopolistic1. Existence of large number (but not too many

large) of firms2. Product Differentiation3. Selling Cost4. Freedom of entry and exit of firms

Oligopoly A market with a few sellers./A few large firms The essence of an oligopolistic industry is the need for each firm to consider how its own actions affect the decisions of its relatively few competitors. A few large firms Products standardized or differentiated Difficult entry Knowledge not available to all firms

Price PolicyFormulating price policies and setting the price are the most important aspects of managerial decision-making. Price, infact, is the source of revenue which the firms seeks to maximise. Again, it is the most important device a firm can use to expand its market. If the price is set too high, a seller may price himself out of the market. If it is too low, his income may not cover costs, or at best, fall short of what it could be. However, setting prices is a complex problem and there is no cut and dried formula for doing so.

Factors influence Price of a Commodity

1. The demand for a commodity 2. Cost of production3. Objectives of the firm4. Competition and 5. Government’s policy

Objectives of Price of a firm1. Achieving a target rate of return on investment2. Accomplishing the target rate of growth3. Maintaining and improving the market share4. Maintaining the prestige of the firm5. Enhancing the goodwill of the company6. Stabilising the prices

Price & Output Determination under Perfect CompetitionIn perfect competition, there are large number of buyers and sellers and, we have studied already that the actions of individual buyers and sellers cannot influence the market price. The prevailing price of the product in the market is taken for granted. The buyers have to make the outlay guided by the price. Similarly the producers have to supply guided by the price. But, how the price in the market has been arrived at? Price under perfect competition is determined by the interaction of two faces, viz., demand and supply.

Price & Output Determination under Perfect CompetitionThough individuals cannot change the price, the aggregate force of demand and supply can change the price. The demand side is governed by the law of demand based on marginal utility of the commodity to the buyers. The supply side is governed by the cost of the production. The law of supply operates. The interaction of demand and supply determines the price of the commodity.

Price & Output Determination under MonopolyWe have studied earlier that ‘Monopoly’ is a market structure where there is only one seller and there is no threat of competition and as such the monopoly producer is a price-maker. He can exercise sufficient control over price or output in order to earn maximum net monopoly revenue. Under monopoly, there is no distinction between the firm and industry. The firm and industry coincide by definition. The monopoly firm partakes all the characteristics of an industry. Therefore, the output of the monopoly firm is compared with that of the industry under pure competition.

Price & Output Determination under MonopolyIt would be a mistake to suppose that the monopolist will always push up his prices higher and higher. If he does so, he must consider the effect of such a procedure on demand which will shrink as prices rise. The very important point to be borne in mind is that unlike competitive firm, a monopolist firm will have a sloping down demand curve and his average revenue will dwindle, as the output is increased, because the buyers will take up large quantities only at a lower price.

Price & Output Determination under OligopolyPrices once established in oligopolistic industries, often tend to remain constant not only for months, but also for years. The quoted wholesale price of such a commodity remains unchanged for a long period. However it should be remembered that the constancy of prices is different from the rigidity of prices. The former indicates that prices do not change with changes in demand and costs. The latter indicates the lack of movement when changes occur in demand or in costs or in both. The kinky demand curve offers better explanation of price rigidity under oligopoly.

Concept of Price DiscriminationA monopolist is in a position to fix the price of his product. He enjoys the control of supply of the product. A monopolist is able to charge different price for his products to the different customers. This is known as price discrimination. According to Mrs. John Robinson, the act of selling the same article, produced under single control at different prices to different buyers is known as price discrimination. This is also known as differential pricing

Pricing Methods1. Cost-Plus or Full-Cost Pricing Method2. Target Pricing or Pricing for a rate of return3. Marginal Cost Pricing4. Going-Rate Pricing5. Customary Pricing6. Differential Pricing

1. Cost-Plus or Full-cost Pricing The Full-Cost Pricing method is generally adopted by many of the firms for simple and easy procedure. This method is also called Cost-plus pricing, margin pricing and Mark-up pricing. Under this method, the price is set to cover all costs (material, labour and overhead) and a predetermined percentage for profit. This means the selling price of the product is computed by adding a certain percentage to the average total cost of the product.

2. Target Pricing or Pricing for a rate of returnThis method of pricing is only a refinement of the full-cost pricing. According to this method, the manufacturer considers a pre-determined target rate of return on capital investment. In the case of full-cost pricing, the percentage of profit is marked up arbitararily. In the case of rate of return method, the companies determine the average make-up on costs necessary to produce a desired rate of return on the company’s investment. In this case the company estimates future sales, future costs, and arrives at a mark-up that will achieve a target return on the company’s investment.

3. Marginal Cost PricingIn the first two methods, i.e., full-cost pricing and the rate of return pricing, prices are fixed on the basis of total costs comprising of fixed costs and variable costs. Under marginal pricing method, the price of a product is determined on the basis of the marginal or variable costs. In this method fixed costs are totally ignored and only variable costs are taken into account. This is done on the assumption that fixed costs are caused by outlays which are historical and sunk. Their relevance to pricing decision is limited, as pricing decision requires planning the future.

4. Going-Rate PricingThis method of pricing conforms with the system of pricing in oligopoly where a firm initiates price changes and the other firms in the industry merely follow the pattern set by the leader. Other firms accept the leadership. The emphasis here is on the market. Firms make necessary price adjustment to suit the general price structure in the industry. Hence this going-rate pricing method is also called Acceptance-pricing. Normally, under this method, the industry tries to determine the lowest price that the seller can afford to accept considering various alternatives.

5. Customary PricingPrices of certain goods become more or less fixed for a considerable period of time, not by deliberate action on the seller’s part, but as a result of their having prevailed for a considerable period of time. Only when the costs change significantly, the customary prices of these goods are changed. While changing the customary price, it is necessary to study the pricing policies and practices adopted by the competing firms. Another approach is to effect price change only in a limited market segment and know the customer reaction to decide whether any change would be digested by the market.

6. Differential Pricing Implementation of a marketing strategy to reach a particular sector of the market through price differentials. Market differential prices help in achieving profitable market segmentation when legal and competitive considerations permit price discrimination Market expansion: Differential pricing may be designed to encourage new uses or to attract new customers. Competitive Adaption: Differential prices are major device for selective adjustment to competitive situation.

Market Structure and Pricing Decisions

1. Price Determination Under Perfect Competition2. Price Determination Under Pure Monopoly3. Monopoly Pricing and Output Decision in the Long-Run

1. Price Determination Under Perfect CompetitionIn a perfectly competitive market, commodity prices are determined by the market forces of demand and supply. In other words, market prices are determined by the market demand and market supply, where the market demand refers to the industry demand as a whole: this is the sum of quantity demanded by each individual consumer or user of the product at different prices. Similarly, market supply is the sum of quantity supplied by individual firms in the industry. The market price is determined for the industry and the individual firms and consumers take the market price as given. This is the reason sellers under a perfectly competitive market is referred to as price takers.The determination of commodity as well as services price under perfectly-competitive conditions are often analysed under three different time periods:(i) the market period or very short-run; (ii) short-run; and(iii) long-run.

2. Price Determination Under Pure MonopolyThe term pure monopoly connotes absolute power to produce and sell a product with no close substitute. A monopoly market is one in which there is only on seller of a product having no close substitute. The cross-elasticity of demand for a monopolist’s product is either zero or negative. A monopolized industry refers to a single-firm industry.

3. Monopoly Pricing and Output Decision in the Long-RunThe decision rules guiding optimal output and pricing in the long-run is same as in the short-run. In the long-run however, a monopolist gets an opportunity to expand the size of its firm with the aim of enhancing the long-run profits. Expansion of the plant size may, however, be subject to such conditions as:

(a) the market size;(b) expected economic profit; and,(c) risk of inviting .

Risk And Uncertainty Entrepreneur is always working under uncertainty and has to bear risks. In economic parlance profit is considered as a reward for risk taking. Only when an entrepreneur understands the nature of risks he can secure himself from the risks and uncertainty. Certainty is what is prevalent today and we can see or realize it., But uncertainty is a situation where one is unsure of what will happen tomorrow. For instance even the meteorological department may not be a able to say with any amount of certainty when the south west monsoon, will set in and how much rain fall it may bring. Therefore the managers will have to safeguard institutions by making sufficient precautions the measures.

RESOURCE MARKETA market used to exchange the services of resources labour, capital, and natural resources. The value of services exchanged through resource markets each year is measured as national income. Compare financial market, product market.Markets that exchange the services of the four factors of production-labour, capital, land, and entrepreneurship. The buyer of factor services is business sector. The seller of these services is the household sector. The study of macroeconomics is concerned with imbalances in the resource markets, especially surpluses and the resulting unemployment of resources. The resource markets, also termed factor markets, are one of three primary sets of macroeconomic markets. The other two are product markets and financial markets.

WAGES

The term ‘wages’ means payments made for the services of labour. A wage may be as a sum of money paid under contract by an employer to a worker for services rendered.A wage is a form of remuneration paid by an employer to an employee calculated on some piece or unit basis. Compensation in terms of wages is given to workers and compensation in terms of salary is given to employees. Compensation is a monetary benefit given to employees in return for the services provided by them.

NOMINAL WAGES

The term 'nominal wage', however, simply refers to the amount of money that a worker may be getting. In economics a nominal value is an economic value expressed in historical nominal monetary terms. This term is used in contrast to nominal wages or unadjusted wages.

REAL WAGES

Real wage refers to the purchasing power or buying capacity of money wage. It is the amount of necessaries, comforts, and luxuries which the worker can command in return for his remuneration. Thus real wage is expressed in terms of goods and services. It is the amount of goods and services or benefits that a worker enjoys against of his job. The real wage is said to be high when a laborer obtains larger quantity of goods and services with his money income.

FACTORS INFLUENCING ON REAL WAGE

1. Purchasing Power of Money2. Additional Facilities3. Extra Income4. Conditions of Work5. Nature of Job6. Future Prospects7. Social Prestige8. Occupational Expenses9. Timely Payment

WAGE DIFFERENTIALSWhile analysis of the general wage level is important for comparing different countries and times, we often want to understand wage differentials. In practice, wage rates differ enormously. The average wage is as hard to define as the average person. There are major differences in earnings among broad industry groups. Sectors with small firms such as farming, retail trade, or private households tend to pay low wages, while the larger firms in manufacturing pay twice as much.

WAGE DIFFERENTIALSBut within major sectors there are large variations that depend on worker skills and market conditions-fast-food workers make much less than doctors even though they all provide services.There has to be a difference in the wage of men/women in the same organization/firm based on their work experience and rank. It is essential to maintain a wage difference to indicate that with more wage come more responsibility in the organization/firm.

CAUSES WHICH CREATE DIFFERENCES IN WAGES IN DIFFERENT EMPLOYMENTS

1. Difference in efficiency 2. Future Prospects3. Collective Bargaining4. Sex5. Firm size6. Occupation7. Age8. Education