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5 Pricing and Output Decisions: Imperfectly Competitive Markets 5 Pricing and Output Decisions: Imperfectly Competitive Markets.

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Presentation on theme: "5 Pricing and Output Decisions: Imperfectly Competitive Markets 5 Pricing and Output Decisions: Imperfectly Competitive Markets."— Presentation transcript:

1 5 Pricing and Output Decisions: Imperfectly Competitive Markets 5 Pricing and Output Decisions: Imperfectly Competitive Markets

2 Alternative 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

3 Alternative Market Structures The four market structures –perfect competition –monopoly –monopolistic competition –oligopoly The four market structures –perfect competition –monopoly –monopolistic competition –oligopoly

4 Features of the four market structures

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10 Alternative 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

11 Monopoly 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

12 Monopoly 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

13 AR and MR curves for a monopoly Q (units) 12345671234567 P =AR (£) 87654328765432 AR AR, MR (£) Quantity

14 Q (units) 12345671234567 P =AR (£) 87654328765432 TR (£) 8 14 18 20 18 14 MR (£) 6 4 2 0 -2 -4 MR AR, MR (£) Quantity AR AR and MR curves for a monopoly

15 Monopoly 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

16 Profit maximising under monopoly MR £ Q O MC QmQm

17 Monopoly 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

18 Profit maximising under monopoly MR £ Q O MC QmQm

19 £ Q O AC QmQm MR AR AC AR Profit maximising under monopoly

20 Monopoly 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

21 £ Q O MC AC QmQm MR AR AC AR Total profit Profit maximising under monopoly

22 Monopoly 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

23 Monopoly 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

24 AR = D MC MR £ Q O Q1Q1 P1P1 Monopoly Equilibrium of industry under perfect competition and monopoly: with the same MC curve

25 £ Q O MC ( = supply under perfect competition) Q1Q1 MR P1P1 P2P2 Q2Q2 AR = D Comparison with Perfect competition Equilibrium of industry under perfect competition and monopoly: with the same MC curve

26 Monopoly 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

27 Monopoly 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

28 Monopoly 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

29 Monopoly 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

30 Oligopoly 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

31 £ Q O Industry D AR Profit-maximising cartel

32 £ Q O Industry D AR Industry MC Industry MR Q1Q1 P1P1 Profit-maximising cartel

33 Oligopoly 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

34 Oligopoly 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

35 Oligopoly 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

36 Profits for firms A and B at different prices £2.00£1.80 £2.00 £1.80 Xs price Ys price A B C D £10m each £8m each £12m for Y £5m for X £5m for Y £12m for X

37 Oligopoly 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

38 Profits for firms A and B at different prices £2.00£1.80 £2.00 £1.80 Xs price Ys price A B C D £10m each £8m each £12m for Y £5m for X £5m for Y £12m for X

39 Oligopoly 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

40 Oligopoly 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

41 Oligopoly 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

42 Oligopoly 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?

43 Oligopoly 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

44 Oligopoly 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

45 Boeing decides 500 seater 400 seater A decision tree Boeing –£10m Airbus –£10m (1) Boeing +£30m Airbus +£50m (2) Boeing +£50m Airbus +£30m (3) Boeing –£10m Airbus –£10m (4) Airbus decides B2B2 Airbus decides B1B1 A

46 Oligopoly Non-collusive oligopoly: the kinked demand curve theory –assumptions of the model Non-collusive oligopoly: the kinked demand curve theory –assumptions of the model

47 £ Q O P1P1 Q1Q1 Current price and quantity give one point on demand curve Kinked demand for a firm under oligopoly

48 £ Q O P1P1 Q1Q1 D D

49 Oligopoly 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

50 £ Q O P1P1 Q1Q1 MC 2 MC 1 MR a b D AR Stable price under conditions of a kinked demand curve

51 Oligopoly 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

52 Oligopoly 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

53 Oligopoly 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

54 Oligopoly 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

55 Oligopoly 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

56 Alternative 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

57 £ Q O AR MC MR Q1Q1 P1P1 Sales revenue maximising price and output Profit-maximising price and output

58 £ O AR P1P1 MC Q1Q1 MR Q2Q2 P2P2 Sales revenue maximising price and output Q Sales revenue maximising price and output

59 Alternative 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

60 Alternative 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

61 Pricing 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

62 Choosing the output and profit mark-up O AC £ Q D P1P1 Q1Q1 f g P2P2 Q2Q2 j h

63 Pricing 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?

64 Pricing 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

65 Pricing 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

66 Price discrimination P Q O P1P1 D 200

67 O P1P1 D P2P2 150200 P Q Price discrimination

68 Pricing 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

69 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 Practice

70 O Sales per period Time The stages in a products life cycle

71 O (1) Launch (2) Growth (3) Maturity (4) Decline Sales per period Time Product not becoming obsolete Product becoming obsolete


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