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7/29/2019 Mrkt Strctr Price Output Reln,Govt. Interv.
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MARKET STRUCTURE
ANDOUTPUT-PRICING DECISIONS
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Firms output and pricing decisions depend on
the current market structure in which the firm
is operating i.e.
How much control over price we have.
whether the firm is competing in perfect
competition, monopoly, monopolistic
competition or oligopoly situation
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Competition vs. Monopoly
One useful way in which issues of competitionand monopoly can be investigated is calledthe Structure, Conduct and PerformanceModel
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Competition vs. Monopoly
Market
Structure Conduct Performance
e.g. number of
buyers and sellers
(the size of firms)
e.g. firm's goals,
pricing and output,
their investments
e.g. efficiency,
profitability and
growth
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MONOPOLY
PRICING& OUTPUT DECISIONS
SHORT RUN & LONG RUN
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Monopoly
Monopoly power refers to cases where
firms influence the market in some waythrough their behaviour determined bythe degree of concentration in the industry
Influencing prices Influencing output
Erecting barriers to entry
Pricing strategies to prevent or stifle competition May not pursue profit maximisation encouragesunwanted entrants to the market
Sometimes seen as a case of market failure
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Underperfect competition, pricing & outputdecision undermonopoly are based on
revenue & cost conditions i.e. AC and MCcurves, in a competitive & monopoly marketare generally identical, revenue conditionsdiffer.
Revenue conditions, I.e. AR and MR curves,
are different under monopoly because, unlike acompetitive firm, a monopoly firm faces a
downward sloping demand curve.
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Monopoly
Costs / Revenue
Output / Sales
AC
MC
ARMR
AR (D) curve for a monopolist
likely to be relatively price
inelastic. Output assumed to be
at profit maximising output (note
caution here not all
monopolists may aim
for profit maximisation!)
Q1
7.00
3.00
MonopolyProfit
Given the barriers to entry,
the monopolist will be able
to exploit abnormal profits
in the long run as entry to
the market is restricted.
This is both the short run and
long run equilibrium position
for a monopoly
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MONOPOLISTIC COMPETITION
PRICE & OUTPUT DECISIONS:
SHORT RUN & LONG RUN
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Pricing and output decisions under this kind of market
are similar to those under monopoly.
Firm under the monopolistic competition faces adownward sloping demand curve like monopolist
faces.
Decision rules regarding optimal output & pricing in
the long run are the same as in the short run.
In the long run, a monopolist get opportunity to expand
the size of its firm with a view to enhance its long-run
profits.
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Implications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
Marginal Cost andAverage Cost will be the
same shape. However,
because the products are
differentiated in some
way, the firm will only be
able to sell extra output
by lowering price.
D (AR)
The demand curve facing
the firm will be downward
sloping and represents the
AR earned from sales.
MR
Since the additional
revenue received from
each unit sold falls, the
MR curve lies under the
AR curve.
We assume that the firm produces
where MR = MC (profit maximising
output). At this output level, AR>AC
and the firm makes abnormal profit
(the grey shaded area).
Q1
1.00
0.60
Abnormal Profit
If the firm produces Q1 and sells
each unit for 1.00 on average with
the cost (on average) for each unit
being 60p, the firm will make 40p x
Q1 in abnormal profit.
This is a short run
equilibrium position for
a firm in a monopolistic
market structure.
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Monopolistic or Imperfect
Competition
Implications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
AR1MR1
This is the long run
equilibrium position
of a firm in
monopolisticcompetition.
Q2
AR = AC
C
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Monopolistic Competition
Firms have some degree of market power
but demand curve typically flatter than in monopolysince there is more competition
Output-pricing decision is defined by MR = MCas always
the absence of entry barriers means that supernormal profits are competed away...
firms end up producing where p = AC, but AC not atits minimum as in perfect competition, also p > MC
Output
DMR
ACMC
FP = AC1
Q1
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Price and Output Decision
in Oligopoly
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Oligopoly Features of an oligopolistic market structure:
Price may be relatively stable across the industrykinked demand curve?
Potential for collusion
Behaviour of firms affected by what they believe their rivals
might do interdependence of firms Goods could be homogenous or highly differentiated
Branding and brand loyalty may be a potent source ofcompetitive advantage
Non-price competition may be prevalent Game theory can be used to explain some behaviour
AC curve may be saucer shaped minimum efficient scalecould occur over large range of output
High barriers to entry
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Significance of Kinked demand curve in
oligopolistic market
Meaning of price rigidity
Why price rigidity arises
Kinked demand curve and price rigidity
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Price rigidity
Peculiar feature related to oligopoly
The tendency of the price to remain fixed orconstant irrespective of changes in price and
cost conditions in the industry.
The price once established remains unchanged
for a long period of time
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Why price rigidity arises
Under non-collusive oligopoly, there is a greater
amount of uncertainty regarding the behavior of
rival firms
The oligopolist does not know how his
competitor will react. Therefore every oligopoly
is confronted with indeterminate demand. One
such price is established, the firm sticks to thatprice, whatever may be the consequences.
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Kinked demand curve
First introduced by Prof. Paul Sameulson
Provides a convincing explanation of price rigidity
It does not explain how prices and output are
determined under oligopoly
Occurs when there is a sudden change in the slope ofdemand curve
Such change leads to a sharp corner in demand curve
Ki k d d d
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Kinked demand curve
D
MC1
MC2
k
D
A
B
MR
QOMR1
P
The principle of the kinked
demand curve rests on
the principle that:
a. If a firm raises its price,its rivals will not follow
suit
b. If a firm lowers its price,
its rivals will all do the
same
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GOVERNMENT INTERVENTION
INPRICE FIXING
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Governments interfere with the normal
process of price determination by fixing priceseither above the equilibrium or below it.
These govt. attempts require intervention withthe forces of supply or demand or both by
elaborate administrative regulations.
Att t t fi i b ilib i l l
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Attempts to fix prices above an equilibrium level
are illustrated by min. wage legislation & price
support policies.
When the govt. steps into fix a minimum price
(say,Rs.375 per quintal for Sugar) much above
the equilibrium price (say, Rs.300 per quintal),
consumers curtail their consumption of sugar
(postpone their purchases at all levels)
On the other hand, farmers are encouraged to
increase their production under the incentive of
higher prices.
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As a result, there is disequilibrium between
the demand and supply.
There are only 2 ways to maintain prices at a
high level
Govt. can buy large quantities to absorb thedifference between the quantity supplied & thequantity demanded
The govt. can ask the farmers to curtail theiroutput.
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Need For Government Intervention
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The need for govt. intervention with thefunctioning of the free market mechanism
has arisen out of the failure of the freemarket economy expected to ensure
That all those who are willing to work at prevailing
wage rate get employment;
That all those who are employed get their living in
accordance with their contribution to the totaloutput;
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That factors of production are optimally
allocated between the various industries
Production & distribution pattern of national
product is such that all get sufficient
income to meet their basic needs- food,
clothing, shelter, education, medical care
etc.
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All the Best for Your Final Exam
REFERENCES:
1.ME by K L Maheshwari
2 ME by D N Dwivedi