Chapter 1 Pricing Strategies intro and cost based

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MARKET MORPHOLOGY:

MARKET MORPHOLOGY Market is an arrangement where buyers and sellers Come in close contact with each other directly or indirectly to sell and buy good. They are Divided: Area Wise Time Element Competition

Criteria for Market Classification:

Criteria for Market Classification Classification by the area : Local, Regional, National and International Classification by nature of transactions : Spot and Future market Classification by the volume of business : Wholesale and retail markets Classification on the basis of time: Very short period, short period, long period and very long period Classification by the status of sellers : Primary, Secondary and Terminal Markets Classification by regulation : Regulated and unregulated Classification on the basis of market structure : Characterized by sellers, buyers, products and conditions of entry and exit.

Different Types of Markets:

Different Types of Markets Markets are classified in accordance with the nature of competition among sellers

Slide 4:

Type of Market Definition Pure or Perfect Competition EX: Free software, street vendors, fish market and the vegetable or fruit vendors, stock exchange A market characterized by a large number of independent sellers of st andardized products , free flow of information , and free entry and exit . Each seller is a "price taker" rather than a "price maker". Simple Monopoly Ex: Electricity Dept. Cease Fire (Extinguishers) A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition - which often results in high prices and inferior products. Discriminating Monopoly Early Bird Specials—Restaurants charge special, lower prices for early diners. Matinees—Theaters charge less for earlier shows. Air Fares—Airlines charge less for flyers willing to fly “off peak,” i.e. early morning and late night. A company able to charge different prices for its output in different markets because it has power to influence prices for its goods

Slide 5:

Type of Market Definition Monopolistic Competition Restaurants , cereal , clothing , shoes and service industries A market structure in which several or many sellers each produce similar, but slightly differentiated products . Each p roducer can set its price and quantity without affecting the marketplace as a whole . Monopsony Ex: Wal-Mart, in the United States, functions as a Monopsony in certain market segments, as its buying power for a given item may dwarf the remaining market. A single-payer health care system, in which the government is the only "buyer" of healthcare services. A market form in which only one buyer faces many sellers. It is an example of imperfect competition, similar to a monopoly. Duopoly Ex: Visa and MasterCard , Canon and Nikon, Pepsi and Coca Cola The number of sellers are only 2 and large number of buyers. Price and Output decisions are interdependent. Oligopoly Ex: OPEC Few Sellers supplying either homogenous (Steel/Aluminum/Copper) or differentiated products (Automobile-Passenger Cars). Blocked entry and exit. Imperfect dissemination of information. Interdependence about fixing Price and determining OP.

Slide 6:

Type of Market Definition Bilateral Monopoly Ex: L abor markets of industrialized nations in the 1800s and the early 20th century. Large companies would essentially monopolize all the jobs in a single town and use their power to drive wages to lower levels. Workers, to increase their bargaining power, formed labor unions with the ability to strike, and became an equal force at the bargaining table with regard to wages paid. A market that has only one supplier and one buyer. The one supplier will tend to act as a monopoly power, and look to charge high prices to the one buyer. The lone buyer will look towards paying a price that is as low as possible. Since both parties have conflicting goals, the two sides must negotiate based on the relative bargaining power of each, with a final price settling in between the two sides’ points of maximum profit. Oligopsony Ex: Cocoa, where three firms (Cargill, Archer Daniels Midland, and Callebaut ) buy the vast majority of world cocoa bean production, mostly from small farmers in third-world countries. American tobacco growers face an oligopsony of cigarette makers, where three companies (Altria, Brown & Williamson, and Lorillard Tobacco Company) buy almost 90% of all tobacco grown in the US. the U.S. fast food industry, in which a small number of large buyers (i.e. McDonald's, Burger King, Wendy's) controls the U.S. meat market. Such control allows these fast food mega-chains to dictate the price they pay to farmers for meat and to influence animal welfare conditions and labor standards. A market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in market for inputs where a small number of firms are competing to obtain factors of production. It contrasts with an oligopoly, where there are many buyers but just a few sellers. An Oligopsony is a form of imperfect competition.

Slide 7:

Type of Market Nature of the Product # of Buyers # of Sellers Entry Conditions Pure or Perfect Competition Homogenous for all firms Large Large Free entry, free exit Simple Monopoly Homogenous for all firms Large One Entry Barriers Discriminating Monopoly Homogenous for all firms Large One Entry Barriers Monopolistic Competition Product Differentiation by each firm Large Many Product differentiation acting as Entry Barrier Duopoly Can be homogenous or differentiated Large Two Entry Barriers created by product differentiation and by one of the two firms dominating the market Oligopoly Can be homogenous or differentiated Large A few Entry Barriers due to product differentiation and by a few firms dominating the market Bilateral Monopoly Homogenous One One Entry Barriers Monopsony Homogenous One Large Free Entry Oligopsony Can be homogenous or differentiated A few buyers, while some of them are main buyers Large No Entry Barriers Market Structures

Market Structures:

Market Structures Monopoly Oligopoly Monopolistic competition Perfect Competition “Oligopoly" and "Monopolistic Competition" are often lumped together as "Imperfect Competition."

Perfect Competition:

Perfect Competition Perfect Competition assumes: All firms sell an identical product, homogeneous product (standardized) All firms are price-takers. All firms have a relatively small market share . A very large number of buyers and sellers. Each buyer and seller operates under the conditions of certainty, being endowed with complete knowledge of prices, quantities, costs and demand. Makes distinction between LR and SR. Objective is to maximize its profit in SR. If not seeks to minimize loss. Includes its opportunity cost in operating in a particular market as the part of its total cost of production. The industry is characterized by freedom of entry and exit. (free entry and exit (no barriers)). Sometimes referred to as " pure competition ” when it assumes only 2 conditions - there are large number of buyers and sellers and homogenous units. Perfect competition is a theoretical market structure. It is primarily used as a benchmark against which other market structures are compared. The industry that best reflects perfect competition in real life is the agricultural industry. Accurate in explaining and predicting behavior of the market and the firm under certain circumstances.

Opportunity Costs:

Opportunity Costs Cost of Goods sold 3,00,000 General and Administrative Expenses 1,50,000 Total Accounting Cost 4,50,000 Forgone Salary for being a store manager 45,000 Forgone returns form investments – 10% interest on 50,000 savings (100% return) 5,000 Total Opportunity Cost 50,000 Total Economic Cost (TAC + TOP) 5,00,000

Normal Profit, Economic Profit and Economic Loss:

Normal Profit, Economic Profit and Economic Loss Normal Profit Economic Profit Economic Loss Revenue 5,00,000 5,50,000 4,80,000 Accounting Cost 4,50,000 4,50,000 4,50,000 Opportunity Cost 50,000 50,000 50,000 Economic Profit 0 50,000 -20,000 Accounting Profit 5,00,000 - 4,50,000 = 50,000 5,50,000- 4,50,000 = 1,00,000 4,80,000- 4,50,000 = 30,000 Accounting Profit for 50,000 equals the opportunity cost of 50,000 Accounting Profit of 1,00,000 exceeds the opportunity cost of 50,000. Accounting Profit of 30,000 is less than the opportunity cost of 50,000

Equilibrium of a Perfectly Competitive Firm - SR:

Equilibrium of a Perfectly Competitive Firm - SR Q D P S P Q Market Firm Economic Profit

Total and Per-Unit Short-Run Cost:

Total and Per-Unit Short-Run Cost Quantity TFC TVC TC AFC AVC AC MC 0 100 0 100 0 0 0 0 1 100 55.70 155.70 100 55.70 155.70 55.70 2 100 105.60 205.60 50 52.80 102.80 49.90 3 100 153.90 253.90 33.33 51.30 84.3 48.30 4 100 204.80 304.80 25 51.30 76.0 50.90 5 100 262.50 362.50 20 52.50 72.50 57.70 6 100 331.0 431.0 1 55.20 71.87 8.70 7 100 415.10 515.10 14.29 59.30 73.59 83.90 8 100 518.40 618.40 12.50 64.80 77.30 103.30 9 100 645.30 745.30 11.11 71.70 82.81 126.90 10 100 800 900 10 80 90 154.70 11 100 986.70 1086.70 9.09 89.70 98.79 186.70 12 100 1209.60 139.60 8.33 100.80 109.13 222.90

Revenue Schedules:

Revenue Schedules Quantity Price TR AR (TR/Q) MR 0 110 0 1 110 110 110 110 2 110 220 110 110 3 110 330 110 110 4 110 440 110 110 5 110 550 110 110 6 110 660 110 110 7 110 770 110 110 8 110 880 110 110 9 110 990 110 110 10 110 1100 110 110 11 110 1210 110 110 12 110 1320 110 110

Price Determination in Perfect Competition:

Price Determination in Perfect Competition Market Price =110 P remains unchanged regardless of the OP. Demand curve is perfectly elastic i.e. customer willing to buy as much as the firm willing to sell at the going market price (Equilibrium of the Market). MR = P for each sale of additional unit of product. D= AR=MR =P A firm now needs to find out the level of OP that maximizes its profit or minimizes the its loss.

TC=TR Approach To Select The Optimal OP Level:

TC=TR Approach To Select The Optimal OP Level Quantity Price TR TFC TVC TC TP 0 110 0 100 0 100 -100 1 110 110 100 55.70 155.70 -45.70 2 110 220 100 105.60 205.60 -14.40 3 110 330 100 153.90 253.90 76.10 4 110 440 100 204.80 304.80 135.20 5 110 550 100 262.50 362.50 187.50 6 110 660 100 331.0 431.0 228.80 7 110 770 100 415.10 515.10 254.90 8 110 880 100 518.40 618.40 261.60 9 110 990 100 645.30 745.30 244.70 10 110 1100 100 800 900 200 11 110 1210 100 986.70 1086.70 123.30 12 110 1320 100 1209.60 139.60 10.40

Determining Optimal OP from the Cost and Revenue Curves- Perfect Competition:

Determining Optimal OP from the Cost and Revenue Curves- Perfect Competition Cost TR TC OUTPUT 8 (Q) With the above given TC and TR schedules, we find the Level of OP that either maximizes profits or minimizes loses. Firm Earns Max at Q= 8 and Profit = 261.60. Max Distance between the TR and TC Curve.

MR=MC Approach To Select The Optimal OP Level- The case of Economic Profit:

MR=MC Approach To Select The Optimal OP Level- The case of Economic Profit Quantity MR=P=AR AFC AVC AC MC Marginal Profit (MR-MC) 0 110 0 0 0 0 0 1 110 100 55.70 155.70 55.70 54.30 2 110 50 52.80 102.80 49.90 60.10 3 110 33.33 51.30 84.3 48.30 61.70 4 110 25 51.30 76.0 50.90 59.10 5 110 20 52.50 72.50 57.70 52.30 6 110 16.6 55.20 71.87 68.70 41.30 7 110 14.29 59.30 73.59 83.90 26.10 8 110 12.50 64.80 77.30 103.30 6.70 9 110 11.11 71.70 82.81 126.90 -16.90 10 110 10 80 90 154.70 -44.70 11 110 9.09 89.70 98.79 186.70 -76.70 12 110 8.33 100.80 109.13 222.90 -112.90

Observations:

Observations Based on the MC and MR columns , the firm must decide on its optimal level of OP. 1 st unit Revenue =110 and cost of additional unit = 55.70 2 nd unit Revenue =110 and cost of additional unit = 49.90 Firm produces more and more till MR>MC. MR+MP- does not change as OP increases, But from the 4 th unit, Law of Diminishes Returns operates and MC increases. Each additional unit costs more to produce. Between 0 to 8 unit MR > MC From 9 th MC> MR. MC=MR occurs between 8 th and 9 th but we take the 8 th unit as the optimizing level of OP.

Graphical MR=MC Approach Indicating the Earning of Economic Profit - Perfect Competition:

Graphical MR=MC Approach Indicating the Earning of Economic Profit - Perfect Competition Price D=MR=AR AVC OUTPUT 8 (Q) Demand Curve of this price-taking firm is perfectly elastic. The OP level is clearly seen as the level at which the firm’s MC line and its MR line (D Line ) intersect. Profit = ABCD. AT OP level Q, AC= CQ TC= ODCQ TR= OABQ Profit = OABQ(TR)-ODCQ (TC) 110 AC 80 120 Economic Profit MC 77.30 B C A D O

MR=MC Approach To Select The Optimal OP Level- The case of Normal Profit:

MR=MC Approach To Select The Optimal OP Level- The case of Normal Profit Quantity MR=P=AR AFC AVC AC MC Marginal Profit Total Profit/Loss (Q(P-AC)) 0 71.87 0 0 0 0 0 -100 1 71.87 100 55.70 155.70 55.70 16.17 -83.83 2 71.87 50 52.80 102.80 49.90 21.97 -61.86 3 71.87 33.33 51.30 84.3 48.30 23.57 -38.28 4 71.87 25 51.30 76.0 50.90 20.97 -17.32 5 71.87 20 52.50 72.50 57.70 14.17 -3.15 6 71.87 16.6 55.2 71.87 68.7 3.17 0 7 71.87 14.29 59.30 73.59 83.90 -12.03 -12.04 8 71.87 12.50 64.80 77.30 103.30 -31.43 -43.44 9 71.87 11.11 71.70 82.81 126.90 -55.03 -98.46 10 71.87 10 80 90 154.70 -82.83 -181.30 11 71.87 9.09 89.70 98.79 186.70 -114.83 -396.12 12 71.87 8.33 100.8 109.13 222.90 -151.03 -447.1

Observations:

Observations D=MR=AR Normal Profit MC B AVC A Q=6 P= 71.87 AC Price = 71.87 TR= PXQ= 71.87X6 = 431.22 TVC= QXAVC = 6X 55.2=330 Profit = 431.2-330= 101.2 Hence in the SR , firm earns normal profits above the fixed costs. Hence can continue.

MR=MC Approach To Select The Optimal OP Level- The case of Economic Loss:

MR=MC Approach To Select The Optimal OP Level- The case of Economic Loss Quantity MR=P=AR AFC AVC AC MC Marginal Profit (MR-MC) Total Profit/Loss (Q(P-AC)) 0 58 0 0 0 0 -100 1 58 100 55.70 155.70 55.70 2.30 -97.70 2 58 50 52.80 102.80 49.90 8.10 -89.60 3 58 33.33 51.30 84.3 48.30 9.70 -79.89 4 58 25 51.30 76.0 50.90 7.10 -7.80 5 58 20 52.5 72.5 57.7 0.30 -72.50 6 58 16.6 55.20 71.87 68.70 -10.70 -83.22 7 58 14.29 59.30 73.59 83.90 -25.90 -109.13 8 58 12.50 64.80 77.30 103.30 -45.30 -154.44 9 58 11.11 71.70 82.81 126.90 -68.90 -223.29 10 58 10 80 90 154.70 -96.70 -320 11 58 9.09 89.70 98.79 186.70 -128.70 -448.69 12 58 8.33 100.8 109.13 222.90 -164.90 -613.56

Observations:

Observations D=MR=AR Economic Loss MC Loss AVC A Q=5 P= 58 AC Price = 58 TR= PXQ= 58*5=290 TVC= QXAVC =52.5*5 =262.5 Amount left over= 27.5 (used for paying Fixed cost) Loss= 27.50-100 = -72.50 Hence in the SR, as the firm incurs the fixed cost of 100 even if it shuts down, it is better to operate than close as at least it is getting contribution margin. Below the Price of 58, if the firm continues to exists, it would incur LOSS of 103.90 > TFC of 100. Hence it is better to shut down in the SR.

PC in the LR:

PC in the LR Regardless of whether the market price in the short run results in economic , normal profit or loss for competing firms, economic theory states that in the LR, the market price will settle at the point where firms earn a normal profit. Because over along period of time, price that enable firms to earn above normal profit would induce Other firms to enter the market, and prices below the normal level would cause firms to leave the market. We assume that the firms in the long run who run into losses should consider shutting down even if they have positive contribution margins. The entry of firms shifts the supply curve to the right driving down the market price. The exiting of firms shifts the supply curve to the left, placing upward pressure on the market price. At normal Profits, the firms neither enter nor exit.

LR EFFECT of Firm’s Entry:

LR EFFECT of Firm’s Entry D=MR=AR AVC FIRM Q1 AC P Economic Profit MC B C A D O D SR Supply LR Supply as new firms enter Market

LR EFFECT of Firm’s EXIT:

LR EFFECT of Firm’s EXIT AVC FIRM Q1 AC P Eco Loss but positive contribution margin MC D O D SR Supply LR Supply as new firms exit Market z Q1

Understanding of LR conditions:

Understanding of LR conditions Firms to consider following points for entry or exit in the long run: The earlier the firm enters a market, the better its chances of earning above-normal profit (assuming strong demand). As new firms enter the market, firms that want to survive and perhaps thrive to find ways to produce at the lowest possible cost or at least at cost levels below those of their competitors. If firms are unable to compete on the basis of cost, then try competing by product differentiation.

Monopoly:

Monopoly A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition - which often results in high prices and inferior products. For a strict academic definition, a monopoly is a market containing a single firm. Monopoly is the extreme case in capitalism. Most believe that, with few exceptions, the system just doesn't work when there is only one provider of a good or service because there is no incentive to improve it to meet the demands of consumers. Monopoly assumes: Only single seller or firm in the market area facing many buyers. Entire supply is controlled by the firm as no close substitutes. Firm itself being the industry is the price maker. No interdependence with other competitors. Substantial entry barriers. The firm attempts to maximize its profits.

Price and OP Determination in Monopoly in SR:

Price and OP Determination in Monopoly in SR In SR there are 2 decisions to make- Determination of the price of his product and the equilibrium/ optimizing level of OP. He cant determine price and OP separately. Either can decide Price on the given D curve and sell the amount demanded by the buyer or Determine the level of OP and has to set the price as per demand condition. Can decide either Price or OP but not both. His aim is to maximize profit and hence follows the behavior rule of equating MC=MR. A monopolistic firm should set its price not at the highest possible level but at right level where MC=MR.

MR=MC Approach to determine Price and OP in Monopoly:

MR=MC Approach to determine Price and OP in Monopoly Quantity Price TR MR ATC TC MC TP 0 180 0 0 0 100 -100 1 170 170 170 155.70 155.70 55.70 14.30 2 160 320 150 102.80 205.60 49.9 114.4 3 150 450 130 84.63 253.90 48.30 196.10 4 140 560 110 76.20 304.80 50.90 255.20 5 130 650 90 72.50 362.50 57.70 287.5 6 120 720 70 71.87 431.20 68.70 288.8 7 110 770 50 73.59 515.10 83.90 254.9 8 100 800 30 77.30 618.40 103.30 181.6 9 90 810 10 82.81 745.30 126.90 64.7 10 80 800 -10 90 900 154.70 -100 11 70 770 -30 98.79 1086.7 186.70 -316.70 12 60 720 -50 109.13 1309.60 222.9 -589.60

Increasing MC in relation to Decreasing MR:

Increasing MC in relation to Decreasing MR Cost MC D MR Q The ability of a monopoly to set its price higher is Limited by the possibility of raising MC of production. At some point the increasing cost of producing additional units of OP will exceed the decreasing MR received by the sale of additional units. This begins at “Q”

Graphical Depiction of MR= MC Rule of Monopoly:

Graphical Depiction of MR= MC Rule of Monopoly MC D MR Q=6 AC P= 120 A D C B Total Profit

Observations in SR:

Observations in SR Price is not equal to MR as the firm is a price setter not taker. Demand schedule = column 1 and 2 (Q and P). TR and MR are those that normally accompany a downward sloping demand curve. As OP increases, MR exceeds MC upto 6 units. Beyond this firm incurs Marginal Loss. As firm moves beyond this level, Total Profit is still positive but not at its maximum. Hence by following MR=MC rule, Profit Maximizing firm would produce 6 units of OP/time period. Therefore Firm has to set its price at 120. Monopolistic firm is not subject to threats of LR. But we cant assume that MPF earns economic profits in SR and LR as it depends on the demand of its product. Suppose a Price setting firm does not maximize its short run profits but wants to maximize its revenue. Then by charging 90 for its product it receives max revenue= 810. Revenue Max Price (90) is < than Profit Max Price (120). Hence in Monopoly there are Pricing for Profit and Pricing for Revenue Strategies.

Observations in LR:

Observations in LR Time is adequate to make all kinds of adjustments in both fixed as well as variable factor inputs. Supply and Demand can be adjusted. The total amount of long run profits will depend on the cost conditions under which the monopolist has to operate and the demand curve he has to face in the long run. He restricts his output in order to maximize his profit. Under Monopoly no doubt Mc=MR but MR is less than AR. Hence, monopoly price = AR only. Price is greater than AC, MC and MR. Thus monopoly price is generally high than the competitive price. If a monopolist earns profits in the short run, it would attract other firms. If entry is permitted in the long run, new firms will enter the market and would capture part of the market along with some of the economic profits earlier earned by the monopolist. Eventually, the monopoly gives way to oligopoly or even approach perfect competition. If outside entry is controlled, the firms will retain monopoly position and profits may persist in the long run.

Monopolistic Competition:

Monopolistic Competition Hybrid of Monopoly and Competition. A type of competition within an industry where: All firms produce similar yet not perfectly substitutable products (Product Differentiation). Hence have limited degree of monopoly power. Large number of buyers and sellers. All firms are able to enter the industry if the profits are attractive (Free Entry and Exit). Selling Costs are unique feature of Mon Comp. Outlays incurred in the form of advertising and sales promotion are termed as selling costs. Two-Dimensional Competition: Price competition and Non Price Competition (product variation, selling costs). The Group: Each firm is an industry itself. In monopolistic competition the products sold by the different firms in the industry group are not homogenous but differentiated. All firms are profit maximizers. All firms have some market power, which means none are price takers. Monopolistic competition differs from perfect competition in that production does not take place at the lowest possible cost. Because of this, firms are left with excess production capacity. This market concept was developed by Chamberlin (USA) and Robinson ( Great Britain ).

Equilibrium OP and Price Determination of a firm in MC:

Equilibrium OP and Price Determination of a firm in MC Firm is a Price Maker. All other producers are in equilibrium with respect to their price, varieties of products and sales outlays. Firm considered has given variety of product and constant sales. Hence only the problem of OP and Price determination.

MC in SR:

MC in SR Firm Seeks to Maximize profit in SR. Quality of Product given. Shape and Degree of Elasticity of D curve depends on 2 factors: Number of Firms Extent of Product Differentiation If the group has large number of firms and product differentiation is weak, then D curve will be highly elastic. If the group is relatively small and the Product differentiation is significant then D curve of each firm is less elastic. MR Curve: D curve = AR curve (downward Sloping curve) MR Curve (downward Sloping curve) = lies below the ARC To maximize profits and minimize losses in SR, the firm produces that level of OP where MC=MR. Thus the equilibrium output is the intersection point of MR= MC.

SR Equilibrium of the MC Firm:

SR Equilibrium of the MC Firm SMC D SMR Q SAC Price, Cost, Revenue P B C A For the Sake of Simplicity, it is assumed that Demand conditions and cost conditions are identical in all groups. Equilibrium Point E= SMC = SMR. OP = Price. OQ= Output PABC= Profit which is supernormal . E O

MC in LR:

MC in LR New Firms are attracted in LR. D curve shifts to origin and is more elastic. As its share is reduces due to competition. In LR, AR(D Curve) becomes tangent to its AC curve. Hence firms earn only normal profits.

MC in LR:

MC in LR OQ level of OP at LMC=LMR=EQ LMR tangent to LAC at P. PQ= Price = AC OQPA = TR= TC= Normal Profits. Economic profits of SR are competed away. Since LAR is tangent to LAC at P, At OQ level of output. Any output less that that impies AR<AC= Loss. Output more than OQ = Price < AC= Loss. AT E= LMC= LMR and PQ= Price = Normal Profits. Hence firms in MC resort to non-price competition to attain economic profits. MC LR Similar to the Pure or Perfect Competition. Q E Price, Cost, Revenue P LMC LAC LAR LMR A Price = AC

Oligopoly:

Oligopoly Oligopoly assumes: Few Sellers supplying either homogenous (Steel/Aluminum/Copper) or differentiated products (Automobile-Passenger Cars). Blocked entry and exit. Imperfect dissemination of information. Interdependence about fixing Price and determining OP. High Cross Elasticities. Advertising and selling costs have high importance. Constant struggle of rivals against rivals. Lack of uniformity in size. Lack of certainty: to remain independent or to maximize profits Price Rigidity. Each firm sticks to its own Price. Kinked Demand Curve for their products.

Oligopoly:

Oligopoly Few sellers of a product Nonprice competition Barriers to entry Duopoly: Two sellers Pure oligopoly: Homogeneous product Differentiated oligopoly: Differentiated product

Kinked Demand Curve Model:

Kinked Demand Curve Model Proposed by Paul Sweezy If an oligopolist raises price, other firms will not follow, so demand will be elastic If an oligopolist lowers price, other firms will follow, so demand will be inelastic Implication is that demand curve will be kinked, MR will have a discontinuity, and oligopolists will not change price when marginal cost changes

Kinked Demand Curve:

Kinked Demand Curve KDC is made of two segments:Relatively elastic demand curve and relatively inelastic D curve. DK elastic segment. KD inelastic segment. Kink means an abrupt change in the slope of Demand Curve. Before the kink, D curve is flatter. After the Kink it becomes steeper. Seller follows the prevailing Price. No increase or decrease. Price P OUTPUT K D D

Kinked Demand Curve:

Kinked Demand Curve

Determination of OP and Price:

Determination of OP and Price Once General Price level is reached either by collusion or Price leadership or through some formal agreement, it remains unchanged over a period of time. This price rigidity is on the account of conditions of price interdependence is explained by KDC. Firm’s MC curve can fluctuate between MC1 and MC2 with the range of gap in MR curve without disturbing equilibrium Price (OP) or equilibrium output (OQ) despite changes in MC.

Cartels:

Cartels Collusion Cooperation among firms to restrict competition in order to increase profits Market-Sharing Cartel Collusion to divide up markets Centralized Cartel Formal agreement among member firms to set a monopoly price and restrict output Incentive to cheat

Price Leadership:

Price Leadership Price Leadership: Dominance in the market. Initiative Aggressive Pricing Implicit Collusion Price Leader (Barometric Firm) Largest, dominant, or lowest cost firm in the industry Demand curve is defined as the market demand curve less supply by the followers Followers Take market price as given and behave as perfect competitors

Pattern of Behavior in Oligopolistic Markets:

Pattern of Behavior in Oligopolistic Markets Reputation Price Wars. Price Cuts to weed out competition Secret Price Concessions Non-Price Competition

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