Managerial Economics: Unit Iii

1
MANAGERIAL ECONOMICS
MBAPEM 103
UNIT III - PRICING

DECISIONS
Kalipada Adhikary
Manager/Corp Comp
Service/NLC
Pricing ?
2
Pricing : It’s Importance
3
 Important component of Revenue.

 Very sensitive w.r.t. common goods.
 Much more important for poor and lower-
middle class income group people.
 Change in price has very sharp impact on
profitability.
 Recently, Price is getting more tricky.
Pricing : It’s Importance
4
Pricing and its impact on profitability
Hinterhuber,A, Towards value-based pricing—An integrative framework for decision making, Industrial Marketing
Management 33 (2004) 765– 778
Learning Objectives
5
 Basic Concepts of Pricing

 Four market/competition
structures
 Pure competition and Perfect
competition
 Pricing in Perfect Competition
Pricing Timeline : Short-run
6
pricing
 time horizon of less than one year
 Pricing a one-time-only order
 This include decisions such as:
 Adjusting product mix and output

volume in a competitive market
 High return aim
 Variable Component changes
Pricing Timeline : Long-run
7
pricing
 one year or longer time span
 include decisions such as:
 All factor including fixed costs can be

altered
 Profit margin is set to earn a reasonable
return on investment
Pricing Approaches
8
Market-Based:
 price charged is based on what customers want
and how competitors react. Starts with a target

price.
 Estimated on customers’ perceived value and
how competitors price competing
products/services
Cost-Based:
 price charged is based on what it cost to
produce, coupled with the ability to recoup the
costs and achieve a required rate of return.
Markets and Pricing
9
Approach
 Competitive Markets – use the market-
based approach
 Less-Competitive Markets – can use
either the market-based or cost-based

approach
 Non-competitive Markets – use cost-
based approaches
What pricing model NLC uses ?

Pricing Factors
10
 Pricing ultimately depends on it’s demand

and supply
 Factors those influences the Price
 Customers – their demand for product/service,

based on factors such as quality and product
features.
 Competitors – their pricing schemes, based
on product features, production volume etc
Pricing Factors
11
 Costs – they affect supply (the lower the

cost, the greater the quantity a firm is
willing to supply)
environment/ Govt Policy –

 Regulatory
Taxes/Subisdies
More Tax on some items

Less Tax on some other items
Price Elasticity
12
 price changes impact sales volume

 Demand is elastic if a price increase has a
large negative impact on sales volume.
 Demand is inelastic if a price increase has
little or no impact on sales volume.
Δ𝑄
𝑃𝐸𝐷 =
Δ𝑃
Factors:
Availability of substitute, income level,
Necessity, Duration, Brand loyalty, Who pays!!
For Electricity, Rice & Exceptions ?
Who determines the price?
13
 Price takers – company in competitive

market has no influence on price
 As competition increase, the price becomes
squeezed between the cost of the product
and the lowest price of a competitor.
 Price makers - companies that influence the
price
 Organizations that compete by offering
innovative products/services have a more
difficult pricing decision.
Types of Competition/Market
14
 Perfect competition
 large number of relatively small buyers and
sellers
 standardized product
 very easy market entry and exit
 No non-price competition
Most Free Market Economist advocate for

this type, WHY ?
15
Imperfect Markets
 Monopoly (absolute market power)
 one firm, firm is the industry
 unique product or no close substitutes
 market entry and exit difficult or legally
impossible
 non-price competition not necessary
16
Imperfect Markets
 Monopolistic competition
 large number of small firms acting
independently
 differentiated product
 market entry and exit relatively easy
 non-price competition very important

17
Imperfect Markets
 Oligopoly
 small number of large mutually

interdependent firms
 each firm is affected by the decisions of its
rival
 differentiated or standardized product
 market entry and exit difficult
 non-price competition important

18
19
 Examples: perfect competition

 agricultural products
 financial instruments
 commodities
20
 Examples: monopoly
 pharmaceuticals with patents
 regulated utilities (although this is changing)
 Indian Railway
21
 Examples: monopolistic competition

 Saloon
 restaurants
 Repair/service shops
22
 Examples: oligopoly
 oil refining
 airlines
 internet access and cell phone service

23
What about NLC ?

PSU ?
e-commerce ?
UNIT TOPICS
24
Pure Competition
AND
Perfect Competition
Pure competition
25
 Large no. of firms each produce a tiny

fraction of market supply.
Important Characteristics
 large number of independent sellers
 homogeneous product.
Examples: farm commodities (wheat,

soybean, strawberries, milo)
Perfect Competition
26
 large number of independent, relatively

small sellers and buyers as compared to
the market size,
 no individual buyer or seller has any
influence over the price.

 economic forces operate to full extent
 allows best allocation of resources to

maximize efficiency
Perfect Competition
27
Important Characteristics
 large number of independent sellers
 identical product
 No barriers to entry and exit : no need of
patents, very high capital expenditure,
regulated market, licencing
 complete information, absence of
transport cost, perfect mobility of factors.
stock market, and the foreign exchange

market
Pure and Perfect Competition
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Basic Difference
 Only two conditions in Pure Competition,
which ensures no question of monopoly

control
 Four condition in Perfect competition
Buyers and sellers are price takers in both

cases.
Price & Output Decision :
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business decision questions
 What to Produce and How much to

produce?
 How much profit will be earned?
 If a loss is incurred, will it be worthwhile to

continue in this market in the long run or
should exit ?
30
Perfect Competition
Key assumptions
 Firm is a price taker
 Firm makes the distinction between the short
run and the long run
 Firm’s objective – profit maximization (or
loss minimization) in the short run
 Firm includes its opportunity cost of
operations in its total cost of production
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Perfect Competition
Demand Curve
 Perfectly elastic demand curve: consumers are
willing to buy as much as the firm is willing to

sell at the going market price
 The firm receives the same MR from the sale
of each additional unit of product = P
 No limit to the total revenue that the firm can
gain in a perfectly competitive market

32
Perfect Competition
Demand Curve
33
Perfect Competition
 Only the industry as a whole, which determines the
market demand curve, can affect price by
changing industry output.
Pricing Mechanism: Some Basic
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Concepts
 Total revenue (TR) - total amount received by a
firm from the sale of a product.
TR = P x Q
 Average revenue (AR) - total revenue from the sale
of a product divided by the quantity of that product
sold.
AR = TR ÷ Q
 Marginal revenue (MR) – the change in total
revenue that results from selling 1 more unit of
output.
MR = ( change in TR) ÷ (change in Q)
Pricing Mechanism: Some Basic
35
Concepts
 If MR is constant, each additional unit of
output sold adds the same amount to TR.
Pricing Mechanism
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 Total revenue/Total cost approach:

Compare the TR and TC schedules, find the level of
output that
maximizes the firm’s profits or minimizes its loss.
 Marginal revenue/Marginal cost approach:
Level of output at which the additional revenue received

from
the last unit is equal to the additional cost of producing
that unit
(at MR=MC)
 Both the TR/TC and MR=MC approach lead to the same
price/output decision
Production Levels
37
Case A: economic
profit
The point where
P=MR=MC
is optimal output (Q*)
Profit = TR – TC
Production Levels
38
Case B: economic loss

The firm incurs a loss.
At optimum
output(MR=MC),
P < AC
If P > AVC, the firm
is better off producing in
the short run, b’coz of
fixed costs incurred.
Production Levels
39
Case C: Shutdown point: the lowest price at

which the firm would still produce
 At this point, P = the minimum point on the AVC.
 Price below this point, revenues fail to cover the

fixed costs and the variable costs. The firm
would be better off if it shut down.
Production Levels in Short run :
40
Competitive Market
Profit maximizing output
 individual firm cannot influence the market price,
 horizontal demand curve i.e. perfectly elastic – its
elasticity is infinity at all levels of output.

 Marginal Revenue (MR) curve horizontal and
coincides with AR curve. AR and MR are constant
and equal at all output.
 MR = MC rule
 The firm can adjust its variable resources (but not
fixed resources) to achieve the output level that

maximizes profit.
Production Levels in Long run :
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Competitive Market
 In long run, Price in the competitive market
settle where firms earn a normal profit.
 Economic profit
 Entry of new firms
 Shifts the supply curve to the right
 Puts downward pressure on price
 Reduces profits to normal levels
 Economic loss
 Opposite effect of the above
Perfectly competitive markets in
42
action
 the earlier the firm enters - better chances
of earning above-normal profit – for longer
period
 new firms must find lowest possible
production cost
 Otherwise try competing by product
differentiation
 All firms in the industry have identical cost
curves
Perfectly competitive markets in
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action
 At long-run equilibrium, firms earn zero
economic profit and earn a normal profit.
P (=MR) = MC = minimum ATC
 Firms use the limited resources in a way to
maximize the satisfaction of consumers.
 This leads to higher efficient resource
allocation, more productivity, innovation and
altogether more business.
That’s Why Most Free Market Economist
advocate for Market type.
44
THANK YOU

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1

UNIT III - PRICING

 Important component of Revenue.

Pricing and its impact on profitability

 Basic Concepts of Pricing

 This include decisions such as:

 Adjusting product mix and output

 All factor including fixed costs can be

and how competitors react. Starts with a target

either the market-based or cost-based

What pricing model NLC uses ?

 Pricing ultimately depends on it’s demand

 Customers – their demand for product/service,

 Costs – they affect supply (the lower the

environment/ Govt Policy –

More Tax on some items

 price changes impact sales volume

 Price takers – company in competitive

Most Free Market Economist advocate for

 market entry and exit relatively easy

 non-price competition very important

 small number of large mutually

 market entry and exit difficult

 non-price competition important

 Examples: perfect competition

 Examples: monopolistic competition

 internet access and cell phone service

What about NLC ?

 Large no. of firms each produce a tiny

Examples: farm commodities (wheat,

 large number of independent, relatively

influence over the price.

 allows best allocation of resources to

stock market, and the foreign exchange

which ensures no question of monopoly

Buyers and sellers are price takers in both

business decision questions

 What to Produce and How much to

 If a loss is incurred, will it be worthwhile to

willing to buy as much as the firm is willing to

gain in a perfectly competitive market

 Total revenue/Total cost approach:

Level of output at which the additional revenue received

Case B: economic loss

Case C: Shutdown point: the lowest price at

 Price below this point, revenues fail to cover the

 horizontal demand curve i.e. perfectly elastic – its

elasticity is infinity at all levels of output.

 The firm can adjust its variable resources (but not

fixed resources) to achieve the output level that

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