PRICING AND OUTPUT DECISIONS MONOPOLISTIC COMPETITION CHAPTER 8 PRICING AND OUTPUT DECISIONS UNDER MONOPOLISTIC COMPETITION & OLIGOPOLY Dr. Vasudev P. Iyer

Understand the conceptual issues OBJECTIVES Understand the conceptual issues Understand how price related decisions are taken under monopolistic competition and oligopoly

The Agenda The Imperfect Competition Meaning and features of monopolistic competition Meaning and features of oligopoly The Kinked Demand model of oligopoly CASELET (17): STRATEGY- The fundamental challenge for firms in imperfect competition

Imperfect Competition Imperfect Competition: Less Competition, but not the absence of the same Features Some market power but not absolute market power. Have the ability to set prices within certain constraints Mutual Interdependence

Perfect Monopolistic Competition Monopoly Competition Oligopoly Market Power? No Yes, subject to Yes Yes government regulation Mutual interdependence No No No Yes among competing firms? Non-price competition? No Optional Yes Yes Easy market entry or exit ? Yes No Yes No, relatively relatively easy difficult

MONOPOLISTIC COMPETITION

DEFINITION Monopolistic competition refers to a market structure in which a large number of sellers sell differentiated products, which are close substitutes of one another. Element of competition and monopoly.

Examples of this very common market structure include: Toothpaste Soap Cold remedies

PRODUCT DIFFERENTIATION By product differentiation we mean the modification of a product usually in minor ways, to make it more attractive to the target market and to differentiate it from competitors' products.

WHAT THE GURU HAS TO SAY ON DIFFERENTIATION ? PHYSICAL DIFFERENTIATION BRAND DIFFERENTIATION RELATIONSHIP DIFFERENTIATION

“” BE DISTINCT OR EXTINCT” THUS SPOKE THE GURU PHYSICAL DIFFERENTIATION BRAND DIFFERENTIATION RELATIONSHIP DIFFERENTIATION Sizes, shapes, colours, tastes etc. Different brand names Customer satisfaction “” BE DISTINCT OR EXTINCT” TOM PETERS Source: Marketing insights from A to Z by P. Kotler, John Wiley & Sons

FEATURES Product differentiation Large number of sellers Free entry and free exit Selling costs

OLIGOPOLY

MEANING An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high (i.e. a large per centage of the market is taken up by the leading firms) In case of only two firms: Duopoly

FEATURES A few firms selling similar product Each firm produces branded products  High barriers to entry. Interdependence of decision making Importance of non-price competition

THE KINKED DEMAND CURVE Pricing under rivalry THE KINKED DEMAND CURVE Developed by Prof. Paul Sweezy The demand curve has a bend. When a firm increases the price above the market price, other firms maintain status-quo. When a firm decreases the price below the market price, others do the same.

Oligopoly Price Leadership Model One firm in the industry (typically the largest firm) is the price leader and, as such, takes the lead in changing prices. The price leader assumes that firms will follow a price increase. It assumes that firms may follow a reduction in price, but will not go lower in order not to trigger a price war.

Oligopoly: Non-price Competition Definition Any effort made by firms other than a change in the price of the product in question in order to change the demand for their product. Efforts intended to affect the non-price determinants of demand

Non-price Determinants of Demand Any factor that causes the demand curve to shift Tastes and preferences Income Prices of substitutes and complements Number of buyers Future expectations of buyers about the product price

Non-price variables Advertising Promotion Any factor that managers can control, influence, or explicitly consider in making decisions affecting the demand for their goods and services Advertising Promotion Location and distribution channels Market segmentation Loyalty programs Product extensions and new product development Special customer services product “lock-in” or “tie-in” Pre-emptive new product announcements

STRATEGY The fundamental challenge for firms in imperfect competition CASELET (17): STRATEGY The fundamental challenge for firms in imperfect competition MANAGERIAL ECONOMICS KEAT AND YOUNG PG. 477

Introduction to strategy Strategy is important when firms are price makers and are faced with price and non-price competition as well as threats from new entrants into the market. More important for firms in imperfectly competitive markets than those in perfectly competitive markets or monopoly markets.

Meaning Strategy is defined as “the means by which an organization uses its scarce resources to relate to the competitive environment in a manner that is expected to achieve superior business performance over the long run.” Managerial Economics is “the use of economic analysis to make business decisions involving the best use of an organization’s scarce resources.” (see Chapter 1) Important linkages between managerial economics and strategy.

Linkages are divided into two sections: Division of Linkages Linkages are divided into two sections: Industrial Organization Ideas of Michael Porter

Strategy Industrial Organization Industrial organization studies the way that firms and markets are organized and how this organization affects the economy from the viewpoint of social welfare. How does industry concentration affect the behaviour of firms competing in the industry?

Strategy Industrial Organization Structure-Conduct-Performance (S-C-P) Paradigm Structure affects conduct which affects performance Structure Demand and supply conditions in the industry. Conduct Pricing and non-price strategies Performance Welfare and efficiency results

Strategy Ideas of Michael Porter Economics professor from the Harvard Business School. “Five Forces” model illustrates the factors that affect the profitability of a firm.

Strategy Ideas of Michael Porter