Market Structure and Pricing

Decision
-How prices of a commodity is
determined in different kinds of
Markets
-By Prof. Jharna Lulla
 Market Structure and Degree of
Competition
• The Theory of Pricing explains pricing
decisions and pricing behavior of the firms in
different kinds of market structures.
• Price of the commodity depends on the
number of sellers and number of buyers.
• It is the number of sellers in any market which
determine the nature and degree of
competition in the market.
 Market Structure and Degree of
Competition
• The nature and degree of competition makes
the structure of the market.
The degree of Competition determines a firm’s
degree of freedom in determining the price of
its products.
The degree of freedom implies the extent to
which a firm is free or independent of the rival
firms in taking its own pricing decisions.
 Market Structure and Degree of
Competition
Market No . Of Firms Control over Method of
Structure and degree of Nature of Price Marketing
product Industry where
differentiation prevalent
Perfect Large No of Financial None Market
Competition Firms with Markets and exchange or
Homogenous some farm auction
Imperfect products Products
Competition
Monopolistic Many Firms Manufacturing Some Competitive
Competition with real or firms like tea, advertising,
Perceived shoes, quality rivalry
product electronics
differentiation goods etc
 Market Structure and Degree of
Competition
(b) Oligopoly Little or no Steel, Some Competitive
product cigarettes, cars advertising,
differentiation etc quality rivalry

© Monopoly A single All PSU Considerable Promotional

producer, but usually Advt if supply
without close regulated is large
substitute
 Market Structure and Degree of
Competition
Note: Depending upon the structure of the
degree of competition varies from “0” to ‘1”
& degree of freedom varies between “1” in the
reserve order of degree of competition.
As a matter of rule “ The higher the degree of
competition, the lower the firm’s degree of
freedom in the pricing decision & control over
the price of its own product and vice versa “
 Market Structure and Degree of
Competition
Degree of Competition affecting pricing
decisions in different Markets:
1)Perfect Competition :
a. The degree of competition is close to ‘1’ since
the market is highly competitive.
b.The price of the product is close to ‘None’,
since price is determined by the market forces
of demand and supply.
 Market Structure and Degree of
Competition
2) Monopolistic Competition:
a)Degree of Competition is high but less than ‘ 1’
b) Firms have some discretion in setting the prices
of their products.
c) Degree of freedom depends upon the no of
sellers and the level of product differentiation.
d) If product differentiation is real, firm discretion &
control over the price is fairly high
and vice versa.
 Market Structure and Degree of
Competition
3) Oligopoly :
a. Degree of competition is quite low, lower than
that under monopolistic competition.
b.Firms have a good deal of control over price of
their products and can exercise their
discretion in pricing decisions.
c. Fewness of the firms gives them an
opportunity to form cartels or make some
settlements among themselves.
 Market Structure and Degree of
Competition
4) Monopoly:
a. Degree of competition is nil.
b.Firms has full control over the prices of its
product, it is free to fix any price but under
certain constraints : 1) the objective of the
firm 2) Demand Conditions
 Price Determination under Perfect
Competition
Perfect Competition: has the following Characteristics

a) A large no of sellers : each of whom produces an insignificant

percentage of total market output and thus exercises no control
over the ruling market price.
b) A large no of buyers: none of whom has any control over the
market price – i.e. there is no monopsony power .
c) Homogenous Product: are supplied to the markets that are perfect
substitutes. This leads to each firms being passive “price takers”
and facing a perfectly elastic demand curve for their product
d) Perfect mobility of factors of production: the factors of production
are in a position to move in and out of the industry and from one
firm to another.
 Price Determination under Perfect
Competition
a) Free entry and exist of firms: Firms face no sunk costs
- entry and exit from the market is feasible in the long
run. This assumption ensures all firms make normal
profits in the long run.
b) Perfect Knowledge: consumers have readily available
information about prices and products from
competing suppliers and can access this at zero cost –
in other words, there are few transactions costs
involved in searching for the required information
about prices
c) No externalities :arising from production and/or
consumption which lie outside the market
 Price Determination under Perfect
Competition
Perfect Competition – A PURE MARKET
Perfect competition describes a market structure whose
assumptions are extremely strong and highly unlikely to
exist in most real-time and real-world markets.
Economists have become more interested in pure
competition partly because of the rapid growth of e-
commerce in domestic and international markets as a
means of buying and selling goods and services. And also
because of the popularity of auctions as a rationing
device for allocating scarce resources among competing
ends.
Sometimes a distinction between the two is only a matter
of degree.
 Healthcare Market
• Markets that meet all necessary conditions is
ideal –Perfect Market
• In reality there can be market failures because
necessary conditions for perfect/free markets
are rarely met.
• Structure of healthcare market is not perfect
competitive
• Market failure is obvious in Health care market
( Intervention required by the government )
 Forms of Health Care Markets
• Health care Education Market:
How many doctors, nurses &other professional are trained every year, how
are available to provide services.
The Global Healthcare Education Solution Market size is expected to grow
from USD 8.17 billion in 2023 to USD 13.74 billion by 2028, at a CAGR of
10.95% during the forecast period (2023-2028).
• Health Manpower Market: determines labor prices paid to the
professionals.
• Health Institution Market : determines hospital stays, or stays in nursing
homes.
• Pharmaceutical: prices of medicines are determined
 Characteristics of Health Care Market
• Entry & Exit: Health care Market has barriers to entry & exit
Example: Professional Licensing, long & expensive training,
expensive investment requirement.
• Nature of Competition is Oligopoly , there may be few
hospitals in a city & Monopoly – Patent drugs
• Product Differentiation: Product differentiation is the term for
variations in characteristics of products within the same market. Without
differentiation, products are commodities. The services of one physician
is not like the other.
• Price Discrimination: paying different prices for the same
services based on income and availability of product.
 Role of Government in Health Care

• Government interventions are necessary to

respond to market failure in health
• To address inefficiency in health care market
• Some interventions :
• Taxes, subsidies, Regulations, Operating
control, Providing services directly.
 Price Determination under Perfect
Competition
Price determination under perfect competition
is analyzed under 2 periods:
a. Short-Run
b.Long- Run
 Price Determination under Perfect
Competition
Price Determination in the Short- Run :
 Price Determination under Perfect
Competition
1. The previous diagram shows the short run equilibrium for
perfect competition. In the short run, the twin forces of
market demand and market supply determine the
equilibrium “market-clearing” price for the industry.
2. A market price P1 is established and output Q1 is
produced. This price is taken by each of the firms.
3. The average revenue curve (AR) is their individual demand
curve. Since the market price is constant for each unit
sold, the AR curve also becomes the Marginal Revenue
curve (MR).
4. For the firm, the profit maximising output is at Q2 where
MC=MR
 Price Determination under Perfect
Competition
5.This output generates a total revenue (P1 x Q2). The
total cost of producing this output can be calculated by
multiplying the average cost of a unit of output (AC1)
and the output produced.
6. Since total revenue exceeds total cost, the firm in this
example is making abnormal (economic) profits. This is
not necessarily the case for all firms.
7. It depends on their short run cost curves. Some firms
may be experiencing sub-normal profits if average
costs exceed the market price. For these firms, total
costs will be greater than total revenue.
Price Determination under Perfect
Competition
 Price Determination under Perfect
Competition
Price Determination in the Long- Run :
 Price Determination under Perfect
Competition
1. We are assuming in the diagram above that there has
been no shift in market demand, i.e. we are
considering an outward shift in market supply
brought about by the entry of new competing firms
each of whom is supplying a homogeneous product
to the market.
2. The effect of increased supply is to force down the
market price and cause an expansion along the
market demand curve.
3. But for each supplier, the price they “take” is now
lower and it is this that drives down the level of profit
made towards the normal profit equilibrium.
 Price Determination under
Monopolistic Competition
Monopolistic competition is defined as a market setting in
which a large number of sellers selling differentiated
products.
Monopolistic Competition has the following features:
1. Large no of sellers
2. Free entry and Free exit
3. Perfect Factor Mobility
4. Complete dissemination of market information
5. Differentiated Product.
 Price Determination under
Monopolistic Competition
Monopolistic Competition & Perfect Competition are similar, but
there 3 major differences between the two.
1) Under perfect competition are homogenous, whereas
monopolistic competition products are differentiated.
2) Decision –making under perfect competition is independent
of other firms, in monopolistic competition, firm’s decisions
and business behavior are not absolutely dependent of each
other.
3) The number of sellers in both the markets are different.
 Price Determination under
Monopolistic Competition
1) Pricing and output decisions under this kind
of market are similar to those under
monopoly.
2) The demand curve under this market is
downward sloping curve because (i) a strong
preference of a section of consumers for the
product. (ii) The quasi- monopoly of the
seller over supply .
Monopolistic Competitors in the Short
Run...
(a) Firm Makes a Profit
Price
MC
ATC

Price
Average
total cost
Profit Demand
MR

0 Profit-
Quantity
maximizing quantity
 Monopolistic Competition in the Short
Run
Short-run economic profits encourage new firms
to enter the market. This:
 Increases the number of products offered.
 Reduces demand faced by firms already in the
market.
 Incumbent firms’ demand curves shift to the left.
 Demand for the incumbent firms’ products fall,
and their profits decline.
Monopolistic Competitors in the
Short Run...
(b) Firm Makes Losses ATC
MC
Price
Losses

Average
total cost

Price

Demand
MR

0 Loss- minimizing Quantity

quantity
Monopolistic Competition in the Short
Run
Short-run economic losses encourage firms to
exit the market. This:
 Decreases the number of products offered.
 Increases demand faced by the remaining
firms.
 Shifts the remaining firms’ demand curves to
the right.
 Increases the remaining firms’ profits.
 Price Determination under
Monopolistic Competition
Price/Output Determination in the Short Run:
 The Long-Run Equilibrium

Firms will enter and exit until

the firms are making exactly
zero economic profits.
 A Monopolistic Competitor
in the Long Run...
Price
MC
ATC

P=ATC

Demand
MR
0
Profit-maximizing Quantity
quantity
 Two Characteristics of Long-Run
Equilibrium

As in a monopoly, price exceeds marginal

cost.
 Profit maximization requires marginal revenue
to equal marginal cost.
 The downward-sloping demand curve makes
marginal revenue less than price.
 Price Determination under Pure
Monopoly
The term pure monopoly means an absolute power of a firm to
produce and sell a product that has no close substitutes.
The following are the characteristics:
1. Single Seller - a one producer of a specific product
2. No Close Substitutes - no reasonable alternative products.
3. "Price Maker" - the firm exercises considerable control over
price because it is responsible for the quantity supplied.
4. The demand curve for the firm’s product is downward sloping,
it is known to the firm, so average and marginal revenues for
different quantities of output are measurable at alternative
prices.
 Price Determination under Pure
Monopoly
4. Totally Blocked Entry - no competitors because of economic,
technological, legal obstacles.
5. Advertising - monopolies may or may not advertise
– monopolist selling luxury good can advertise to increase
demand
– monopolist selling utilities/necessities will not advertise
• Examples of Monopoly:
gas/electric companies ,water company ,cable TV ,telephone
company ,professional sports leagues ,monopoly caused by
geographic isolation
 Price Determination under Pure
Monopoly
The emergence and survival of a monopoly firm is
attributed to the factors which prevent the entry of
other firms into the industry & eliminate the existing
one. The barriers to entry are, the major sources of
monopoly power. The main barrier to entry are:
1. Legal Restrictions
2. Control over Key Raw MATERIALS
3. Efficiency in Production
4. Economies of Scale
 Price Determination under Pure
Monopoly
Price/Output Determination in the Short Run:
 Price Determination under Pure
Monopoly
The monopolist, thus, maximizes his short run profits,
when he produces that level of output at which:
• The short run MC is equal to the short-run MR
(MC=MR )
• The MC is rising.
Graphically, the crucial conditions for the short-run
monopoly equilibrium are thus:
• The intersection point between the MC & MR curves
• The SMC curve cuts the SMR curve from below.
Change in Demand
 Price Discrimination
• Price discrimination refers to the practice of a
seller of selling the same product at different
prices to different buyers.
• Prof. Stigler defines the concept of Price
Discrimination as “ the sales of technically
similar goods at prices which are not
proportional to marginal costs”
 Types of Price Discrimination
Price discrimination can be grouped into three
categories or types:
a) First-degree discrimination: where a firm
charges each consumer the maximum they
are prepared to pay for the product. The first
degree is also know as perfect price
discrimination. Price discrimination of the first
degree is said to occur when the monopolist is
able to sell each separate unit of the product
at different price.
 Types of Price Discrimination
b) Second-degree discrimination: where the
prices charged to consumers vary according to
the amount they purchase. This is commonly
seen in the concept of bulk buying, when
greater quantities bought results in lower
prices.
 Types of Price Discrimination
c) Third-degree discrimination: operates when
consumers are grouped into two or more
separate markets with different prices in each
market. This is the most common type of price
discrimination, with student discounts,
pensioner fares and electric power and
imports and exports.
 Natural Monopolies
A natural Monopoly is a market structure where
a single seller supplies the quantity of output
required to meet the entire market demand.
Under natural monopolies the firm
experiences increasing returns to scale. Eg De
Beers diamond trading company.
 Price Determination under Pure
Monopoly
• In perfect competition there can be no long run economic
profits or losses because firms will enter or leave the
market. In monopoly, there are no long-run competitors
unless the industry ceases to be a monopoly - by definition
• Thus long-run equilibrium in a monopoly will be
characterized by economic profits.
•If, on the other hand, a monopoly experiences short-run
losses it will adjust the scale and characteristic of its plant
to eliminate such losses in the long-run
•If this is not possible the monopolist will leave the industry.
Price Determination under Pure
Monopoly
•Assuming short-run profits, in the long-run
the monopolist will adjust its plant to achieve
even larger profits. Output will be provided at
the level at which long-run marginal cost
equals long-run marginal revenue.
 Price Determination under
Oligopoly
It is a market situation comprising only a few firms in given
line of production.
The following are the features :
1. Few Sellers
2. Homogenous Product
3. Blockaded Entry or Exit
4. Imperfect Dissemination of information
5. Interdependence
6. High Cross Elasticities
7. Price Rigidity
 Factors Which Give Rise to
Oligopoly
• Huge Capital Investment
• Economies of Scale
• Patent Rights
• Control over certain raw materials
• Merger and Takeover
 Oligopoly Models
1) Cournot’s Duoploy Model
2) Sweezy’s Kinded Demand Curve Model
3) Price Leadership Model
4) Collusive Model: The Cartel Arrangement
5) The Game Theory Model
6) The Prisoner’ s Dilemma
 Price Determination under
Oligopoly
KINKED DEMAND CURVE :
 Price Determination under
Oligopoly
The Kinked demand curve or the average revenue
curve is made of two segments: (i) the relatively
elastic demand curve (ii) relatively inelastic demand
curve as shown in the figure.
In the figure :
a) There is a kink at point K on the demand curve DD
b) DK is the elastic segment and KD is the inelastic
segment
c) Before the kink point, the demand curve is flatter,
after the kink it becomes steeper.
 Price Determination under
Oligopoly
Above the kink, demand is relatively elastic
because all other firm’s prices remain
unchanged. Below the kink, demand is
relatively inelastic because all other firms will
introduce a similar price cut, eventually
leading to a price war. Therefore, the best
option for the oligopolist is to produce at
point E which is the equilibrium point and the
kink point.
 Price Determination under
Oligopoly
• The kinked demand curve theory suggests
that there will be price stickiness in these
markets and that firms will rely more on non-
price competition to boost sales, revenue and
profits.
 Price Leadership Model
Price Leadership: is a situation in which a market
leader sets the price of a product or service, and
competitors feel compelled to match that price.
When one firm has a dominant position in the market
the oligopoly may experience price leadership. The
firms with lower market shares may simply follow
the pricing changes prompted by the dominant firms.
We see examples of this with the major mortgage
lenders and petrol retailers.
 Price Leadership Model
• It distinguishes the three classes of model
identified by Scherer,1 :
(a) Barometric Price Leadership
(b) Dominant firm and a competitive fringe; and
(c) Collusive price leadership.
 Price Leadership Model
Barometric Price Leadership
• This version postulates that the price leader is a firm
that responds more quickly than its rivals to changing
cost and demand conditions, but does not in itself
have significant market power.
 Price Leadership Model
Barometric Price Leadership
Barometric price leadership exists when
a. one firm in the industry initiates a price change
and the others may or may not follow.
b. one firm imposes its best price on the rest of the
industry.
c. when all firms agree to change prices
simultaneously.
d. when one company forms a price umbrella for all
others.
 Dominant Firm
– As long as the dominant firm has lower costs, it can act like
a monopolist over the residual demand.
 Collusive Oligopoly
• Collusive oligopoly exists when the firms in an
Oligopolistic market charge the same prices
for their products, in affect acting as a
monopoly but dividing any profits that they
make.
• Non collusive oligopoly exists when the firms
in an oligopoly do not collude and so have to
be very aware of the reactions of other firms
when making price decisions.
 Competition, Monopolies, and Cartels
 Collusion/Cartel
 The two firms may agree on the quantity to produce
and the price to charge.
 The two firms may join together and act in unison, in
effect as a monopolist. Examples: OPEC, NCAA.
• Although oligopolists would like to form
cartels and earn monopoly profits, Antitrust
laws prohibit explicit agreements among
oligopolists as a matter of public policy.
 Non-Collusive Oligopoly
Oligopolies pursuing their own self-interest, but
acting independently.
Production is greater than the monopoly
quantity but less than the competitive industry
quantity.
Market prices are lower than monopoly but
greater than competitive price (marginal cost.)
Total profits are less than the monopoly profit.
 Size of Oligopoly & Market Outcome
• When the number of sellers increase, it has two effects:
 The output effect: Because P > MC, selling more at the

going price raises profits.

 The price effect: Raising production lowers the price and

the profit per unit on all units sold.

• As the number of sellers grows, an oligopolistic market looks
more and more like a competitive market.
• The price approaches marginal cost, and the quantity
produced approaches the socially efficient level.
• The profits then tends to be smaller.
 Case Study:OPEC and
World’s Oil Market
 Like any Cartel, OPEC tries to raise price through coordinated
reduction in production.
For example during 2008, OPEC was able to co-ordinate the
cut in production of crude oil and hence charge higher price. As
a result the price of gasoline topped closed to $1.50/L.
 However such coordination may not last or be successful all
the time. The problem is each member is tempted to cheat by
increasing production and capturing a larger share of the
market.
 OPEC was most successful as a cartel between
1973-1985.
 Price Determination under
Oligopoly
Game theory is the study of how people behave in
strategic situations.
Strategic decisions are those in which each
person, in deciding what actions to take, must
consider how others might respond to that action.
Since number of firms in this market are less, each
firms profit depends not only on how much it
produces but also on how much other firms
produce.
 Price Determination under
Oligopoly
• A example of “game” is called Prisoner's
Dilemma.
• Prisoners’ Dilemma: illustrates the difficulty in
maintaining co-operation. Often people (firms)
fail to co-operate with one another even when
co-operation would make them better off.
• The Prisoners’ Dilemma Story: A detective
interrogating two accused of crime in two
different cells..
 Prisoners’ Dilemma
Bonnies’s Decison

Confess Don’t Confess

Bonnie gets Bonnie gets

20 years
8 years

Confess Clyde
Clyde goes Free
gets 8
Years
CLYDE’S
Decision

Bonnie gets
Don’t Bonnie 1 year
goes free
Confess
Clyde Clyde
gets 20 gets 1
years year
 Prisoners’ Dilemma
• Consider Bonnies Decision:
a. I don’t know what Clyde is going to do, if he remains
silent, my best strategy is to confess, since then I’ll
go free rather than spending a year in jail.
b. If he confess my best strategy is still to confess, since
I’II spend 8 years in jail rather than 20. So regardless
of what Clyde does, Iam better off confessing.
c. In the game theory, this is called the dominant
strategy
 Prisoners’ Dilemma
Consider Clyde’s decision:
• He also decides to confess which is his dominant strategy.
• But confessing has made both worse off. Rather keeping
quiet would have made both better off as they would
have got 1 year in jail.
• Self-interest makes it difficult for both of them to
maintain cooperation even though that is best for both
of them.
 Oligopolies and Prisoners’
Dilemma
Prisoners’ Dilemma illustrates the problem
oligopolistic firms face.
Self-interest makes it difficult for the oligopoly to
maintain the co-operative outcome, with low
production, high prices and so high profits.
 Examples:
– International arms race
– Beer Advertising
– Management of Common Resources
– Cheating in Cartel.
The End

Thank You