Price determination under perfect competition || Monopolistic Competition || Oligopoly || Monopoly Market || Pricing strategies

Price determination under perfect competition

Multiple buyers and sellers are offering homogeneous items in a completely competitive market. No one in the market can affect the market price by his own activities. Because everyone has complete and immediate knowledge of the price at which the transaction is now going place Let's have a look at Pricing in Perfect Competition.

Characteristics of a Market with Perfect Competition

1.     A big number of buyers and suppliers

2.     Commodities that are homogeneous

3.     Unrestricted admission and exit

4.     Factors of production mobility

5.     The lack of transportation costs

6.     Thorough understanding of the market

P rice Determination in Short Period:

A short run is a time in which companies do not adjust their manufacturing size. During this time, neither organisations depart nor new organisations enter the business. During this time, the supply of variable inputs can be increased or decreased. As a result, the supply curve is elastic in character.

The graph depicts price determination in the short run.

In general, businesses must choose the amount of output and price that optimises their profitability. Profit is maximised under ideal competition under the following conditions:

i. MR=MC= Price

ii. MC curve must be rising at the point of equilibrium

Figure-6 (a) depicts the industry's pricing determination at the intersection of the demand and supply curves at price OP1 and quantity OQ1. This pricing is set for all companies in the business. To optimise profit at price OP1, an organisation must modify the output. The MR of the organisation is depicted in Figure-6 (b) by the MR=AR line. When the market price is P1, the profit is maximised at point E, where MR= MC.

Let us introduce the AC curve in Figure-6 to estimate how much profit the firm makes (b). AR (price) minus AC equals profit. Total profits equal EF in Figure-6 (b) since AR = ME and AC equals MF. As a result, the profit area equals P1EFT. These are the organization's above-average profits.

At this level of profit, there is a proclivity for new companies to enter the market. Organizations, on the other hand, cannot enter in the short run. At point E, the organisations in the industry will be balanced, but the industry as a whole will not be.

Consider the instance when the price falls from P1 to P2.

Figure 7 depicts this:

Organizations may be forced to exit the industry as a result of the losses. However, in the short run, it is reasonable for firms to continue producing. This is because if firms continue to generate income, they will be able to pay both fixed and variable costs.

As a result, completely competitive organisations prosper in the short run. However, in some cases, they must experience losses. If the organisation sets a price that is higher than the market price, it may find it difficult to sell its products in a competitive market. On the contrary, it must incur losses if it fixes the price below the market price.

Equilibrium in Long Run:

In the short term, organisations may readily modify variable and fixed components such as labour, machinery, and capital, however, in the long run, the factors are variable.

Organizations can either increase or replace permanent equipment. Furthermore, throughout this time period, firms might simply enter or depart the sector.

The long term AC and MC curves influence pricing and output choices. In the long run, ATC is also a major factor of the equilibrium point. The following two requirements must be met over a lengthy period of time in order to achieve equilibrium.

Price = MC Price = AC

Or, Price = MC = AC

If the price is higher than the AC, companies will generate above-average profits, which will encourage additional organisations to enter the field. More groups will increase the supply of the product, causing the price to decline. This will continue until the price hits AC and all organisations make just regular profits.

Organizations, on the other hand, would suffer losses if the price fell below AC. Organizations begin to depart, resulting in a supply failure. This raises the cost of AC. As a result, the remaining organisations will begin to make typical earnings.

It should be observed that as AC decreases, MC increases, and when AC increases, MC decreases.

Thus, MC=AC at the minimum point of the AC curve, when AC is neither decreasing nor increasing.

As a result, the equilibrium condition may be recast as follows:

Price = MC = Minimum of AC

The long-run equilibrium is depicted in Figure-8:

Organizations can enter and quit the business in the long run. When the price is OP1, equilibrium is at point E' in Figure-8. Profits are made since AR is bigger than AC at this moment. This entices additional companies to join the business. This will cause the industry's supply curve to move from S1 to S2. As a result, the price will reduce from OP1 to OP2.

Organizations begin to lose money at this pricing since AR is cheaper than AC. As a result, the majority of firms will leave the industry. As a result, the product's supply decreases, boosting the price to P0. As a result, complete equilibrium is attained at price OP0 and output ON, where all organisations in the industry make normal profits.

Monopolistic Competition

The market has characteristics of both perfect competition and monopoly in monopolistic competition. Monopolies are more prevalent than pure competition or pure monopolies. In this essay, we will look at the monopolistic competition and its characteristics, price-output determination, and equilibrium circumstances.

Monopolistic Competition Characteristics

1.     A large number of vendors

2.     Distinct product distinction

3.     Ease of entry and exit

4.     Non-price competition

The price-output determination under Monopolistic Competition:

Because the product is differentiated amongst businesses under monopolistic competition, each firm does not have a fully elastic demand for its products. In such a market, each business sets its own pricing for its own items. As a result, it confronts a demand curve that slopes downward. Overall, we may argue that the elasticity of demand rises as product differentiation falls.

Figure 1 represents a business confronted with a downward sloping but flat demand curve. It also features a short-run cost curve that is curved like a U.

Conditions for the Equilibrium of an individual firm

The following are the prerequisites for an individual firm's price-output determination and equilibrium:

1.     MC = MR

2.     The MC curve cuts the MR curve from below.

The MC curve intersects the MR curve at point E, as shown in Fig. 1. At this time,

·         Equilibrium price = OP and

·         Equilibrium output = OQ

Now, because the unit cost is BQ, we have

·         Per unit super-normal profit (price-cost) = AB or PC.

·         Total super-normal profit = APCB

The graph below demonstrates a company's short-run earnings losses.

We can observe from Fig. 2 that the per-unit cost is larger than the firm's pricing. Therefore,

·         AQ > OP (or BQ)

·         Loss per unit = AQ – BQ = AB

·         Total losses = ACPB

L ong-run equilibrium

If businesses in a monopolistic rivalry generate above-average profits in the near run, new firms will be encouraged to enter the industry. As more businesses enter, earnings per firm fall as total demand is distributed across a greater number of enterprises. This will continue until all businesses make only reasonable earnings. As a result, enterprises in such a market receive just regular profits in the long run.

As shown in Fig. 3, the average revenue (AR) curve intersects the average cost (ATC) curve at point X. This relates to Q1 quantity and P1 pricing. Because average revenue equals average costs, all super-normal profits are zero at equilibrium (MC = MR). As a result, all enterprises receive either no super-normal profits or just normal profits.

It is vital to highlight that in the long run, a business with surplus capacity is in an equilibrium situation. In other words, it produces less than its maximum capability. We can observe from Fig. 3 that the business may boost output while decreasing average expenses from Q1 to Q2.

It does not, however, since it cuts average income more than average costs. As a result, we may argue that businesses do not behave optimally in monopolistic competition. Each business always has an extra capacity for output.

In the event of a loss in the short run, the businesses that are losing will depart the market. This will continue until the surviving enterprises only generate standard profits.

Oligopoly

Oligopoly, according to Stigler Hads, is "that market scenario in which a business bases its market policy in part on the predicted conduct of a few close rival companies."

"Oligopoly is an industrial structure defined by a few businesses generating all or most of the output of some good that may or may not be distinct," Jackson writes.

Oligopolistic oligopolies can be homogenous or differentiated. When businesses in an oligopolistic industry produce standardised goods such as petroleum, aluminium, and rubber, the industry is said to be operating under oligopolistic circumstances.

If, on the other hand, the businesses provide items that are near-equivalents for one another, differentiate oligopoly is said to dominate. When items are the same, mutual dependency is stronger; when commodities are diverse, mutual interdependence is lower.

P rice and Output Determination Under Oligopoly:

There is no one hypothesis that adequately explains price and output decisions under a duopoly.

The following are the reasons:

      (i)  The number of dominant enterprises in the market varies. Sometimes only two or three companies control the whole market (Tight oligopoly). Alternatively, there may be 7 to 10 enterprises that control 80 per cent of the market (loose oligopoly).

     (ii)  Under oligopoly, items produced may or may not be standardised.

     (iii) Oligopolistic enterprises occasionally cooperate with one another in the setting of prices and the production of goods. They like to operate alone at other times.

     (iv)   In oligopoly, there are times when entry barriers are quite high and other times when they are fairly low.

     (v)  An oligopolistic business cannot forecast the reaction of other firms if it raises or lowers the pricing and output of its items. Given the great variety of market settings, a number of models have been created to describe the behaviour of oligopolistic enterprises.

Causes of Oligopoly:

The following are the primary causes of oligopoly:

(i)  Economies of scale

(ii)  Barriers to entry

(iii)  Merger

(iv)  Mutual interdependence

C haracteristics of Oligopoly:

(i)               Small number of firms

(ii)             Interdependence

(iii)          Realization of profit

(iv)           Strategic game

Monopoly Market:

A monopoly market is one in which there are a high number of customers and a single producer or seller of a certain item. There are no near substitutable commodities available in this market. The new firm's ability to enter the sector is completely restricted.

This market is predicated on the following assumptions:

1. A single vendor and a big number of customers

2. There are no commodities that are almost interchangeable.

3. Restriction on the firm's admission

4. The firm sets the price.

P rice and output determination under monopoly market:

A monopolistic corporation is often governed by profit and sales maximisation goals. Because a monopolist is a single vendor, it has complete control over pricing and quantity. It must contend with a downward-sloping demand curve; if it raises the price of its product, sales fall, and vice versa. It will strive to achieve the level of output that yields the most profit, i.e. the equilibrium level of output.

To achieve equilibrium, the company must meet two conditions:

1.     MC = MR

2.     MC must cut MR from below

Ø  We can depict the process of pricing and production determination in a monopolistic market using the provided graphic.

Ø  On the graph above, the output is measured along the x-axis, while P, C, and R are measured along the y-axis. Both requirements for the equilibrium are met at point E, hence E is the equilibrium point. We can get the equilibrium output, OQ, by drawing a straight line from point E to the x-axis. If we draw a straight line from point E to the AR curve, we will have the AR or equilibrium price, which is either CQ or OP. The straight line drawn from point E to the AR curve intersects the AC curve at point B. As a result, the average cost of the company to generate the product is either BQ or OA.

In this case, the monopolist's total revenue is OPCQ and his entire expense is OABQ. As a result, it earns a supernormal profit equal to the area ABCP.

In the short run, a monopolist may achieve supernormal profit or loss. It is determined by the state of the AR and AC curves. However, in the long term, a monopolist always makes a supernormal profit.

Pricing strategies

1.   P rice Skimming Pricing:

·   Price skimming is the practice of selling a product at a high price, typically around the launch of a new product when demand is very inelastic. This strategy is utilised to produce significant earnings within the first few months of a product's debut. A corporation can repay its investment in the product by doing so. However, by indulging in price skimming, a corporation risks foregoing significantly larger unit sales that might be obtained at a lower price point. A corporation that engages in price skimming must eventually lower its pricing when competitors join the market and undercut its rates. As a result, price skimming is often a short-term tactic meant to maximise earnings.

·  Price skimming has a tiny market size since only early adopters are ready to pay the high price. After the product's early adopters have purchased it, sales volume often decreases since the remaining potential buyers are unwilling to purchase at the seller's price. Price skimming can only be extended for a longer period of time if the vendor has also established a strong brand image for which clients are ready to pay a higher price.

Example of Price Skimming

ABC International has created a global positioning system that can lock on to GPS satellite signals even when it is several feet underwater. Because this is a significant advance over previous technology, ABC feels justified in selling the product at $1,000, despite the fact that it only costs $150 to build. ABC maintains this price for the first six months while recouping the $1 million development cost of the product, then reduces it to $300 to dissuade competitors from joining the market.

Advantages of Price Skimming

The following are some of the benefits of employing the price skimming method:

·        A large profit margin: The entire aim of price skimming is to maximise profit margins.

·    Recovery of costs: If a corporation competes in a market where the product life cycle is short or the market niche is narrow, price skimming may be the only realistic option for guaranteeing that the cost of developing items is recovered.

·    Profits for dealers: If a product's price is high, the proportion received by distributors will be high as well, making them pleased to carry the product.

·        High-quality picture: This technique may be used by a corporation to generate a high-quality image for its products, but it must produce a high-quality product to back up the image created by the price.

Disadvantages of Price Skimming

The following are some of the drawbacks of employing the price skimming method:

·          Competition: There will be a steady stream of rivals with lower-priced items challenging the seller's high price point.

·         Gross sales volume: Price skimming limits a company's revenues, which means it can't reduce expenses by increasing sales volume.

·         Consumer acceptability: If the price remains extremely high for an extended period of time, it may delay or completely preclude the product's acceptance by the general market.

·         Disgruntled customers: Early adopters of the product may be irritated when the corporation eventually reduces the price of the product, resulting in negative press and a low degree of customer loyalty.

·         Inefficiency in cost: Because of the extremely high-profit margins generated by this method, a firm may avoid making the necessary cost cuts to remain competitive when it ultimately reduces its pricing.

  P rice Penetration Pricing:

Penetration pricing is the practice of initially pricing one's goods or services at a low level in order to gain market share. Customers who are price-sensitive are likely to be attracted by the reduced price. The price may be set so low that the vendor will not be able to make a profit. The seller, on the other hand, is not unreasonable.

The purpose of penetration pricing can take any of the following paths:

• Drive competitors out of the market, allowing the company to eventually raise prices without fear of price competition from the few remaining competitors; or

• Gain such a large market share that the seller can drive down manufacturing costs due to extremely high production and/or purchasing volumes; or

• Utilize the seller's extra production capacity; the seller's marginal cost of production employing this excess capacity is so cheap that it can afford to maintain the penetration pricing for an extended period of time.

The Penetration Pricing Calculation

ABC International wishes to join the blue one-armed widget market. A blue one-armed widget costs $10.00 right now on the market. ABC has a considerable quantity of surplus manufacturing capacity, hence the product has an additional cost of only $6.00. As a result, it chooses to join the market at a penetration price of $6.25, which it believes it can sustain for the foreseeable future. Competitors flee the market quickly, and ABC becomes the main vendor of blue one-armed widgets.

Advantages of Penetration Pricing

The following are some of the benefits of employing the penetration pricing method:

• An entry obstacle: If a corporation maintains its penetration pricing strategy for an extended period of time, potential new market entrants will be discouraged by the low prices.

• It lowers competitiveness: Financially weaker rivals will be forced out of the market or into smaller niches.

• Market hegemony: With this technique, it is feasible to attain a dominating market position, albeit the penetration price may need to persist for a long period in order to drive away a significant number of competitors.

Disadvantages of Penetration Pricing

The following are some of the drawbacks of employing the penetration pricing method:

·         Branding protection: Customers may be unwilling to convert to a low-cost option if competitors have such strong product or service branding.

·         Loss of customers: If a firm just uses penetration pricing without also increasing its product quality or customer service, it may discover that when it raises its prices, consumers leave.

·         Perceived worth: When a corporation significantly lowers its pricing, it generates a sense among customers that the product or service is no longer as valuable, which may impede with any subsequent price increases.

• A price war: Competitors may reply with even lower pricing, denying the firm any market share.

1.   P      eak load pricing:

Peak pricing is a type of congestion pricing in which clients pay an extra price at times of high demand. Peak pricing is most commonly used by utilities, which charge higher rates during peak demand periods of the year. The goal of peak pricing is to keep demand within a tolerable range of what can be provided.

H ow Peak Pricing Works

·    If peak demand is not appropriately controlled, it will out outnumber supply. In the case of utilities, this might lead to brownouts. It has the potential to generate traffic congestion on the roads. Brownouts and traffic jams are costly for all users.

·    The alternative is for municipalities to invest in more infrastructure to satisfy peak demand, which is a manner of directly charging customers for these negative repercussions. However, this strategy is typically costly and inefficient since it wastes a significant part of capacity during non-peak demand.

·    Companies will employ a dynamic pricing strategy to develop flexible charges for their products or services that change in response to current market demand.

·  Businesses can change their prices based on algorithms that take into account competitor pricing, supply and demand, and other market variables. Dynamic pricing is commonly employed in a wide range of businesses, including hospitality, travel, entertainment, retail, electricity, and public transit. Each industry approaches pricing differently depending on its demands and the demand for the product.