MARKET
STRUCTURES
AND PRICING
STRATEGIES
Econ 124– MANAGERIAL ECONOMICS
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LEARNING OBJECTIVES:
6.1
To learn what is a market structure
6.2
Understand types of market structures
namely, pure and perfect competition,
monopoly and monopolistic competition
6.3
Understand profit maximization under
three market structures described above
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6.0 MARKET STRUCTURES
What is The MARKET STRUCTURE
MARKET – defined as a group of firms and
individuals that are in touch with each other
to buy or sell some goods
Market Structure – those characteristics of a
market that significantly affect the behavior
and interaction of buyers and sellers
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6.0 MARKET STRUCTURES
Determinants of Market Structures
Number and size of sellers and buyers
Type of the product
Conditions of entry and exit
Transparency of information
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6.0 MARKET STRUCTURES
Types of Market Structures
Pure and Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Pure & Perfect Competition
- Free entry and exit to industry
- Homogenous products
- Large number of buyers and sellers
- Buyer & Sellers are price takers
- Perfect information available to buyers and
sellers
- Perfect Mobility of Resources
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Example of Perfect and Pure Competition
Imagine you are living in New York City and you want to
have pizza for lunch. Let’s assume..
There are hundreds of pizza shop in New York City
Everyone of them has cheese pizza on their menu
They all pay their workers minimum wage. They all
buy cheese, dough and tomato paste at the same
prices.
It is cheap and easy to open a pizza shop, just as it is to
shut down one if needed.
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
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6.1 Market Structures: Perfect and PureCompeAAon, Monopoly, MonopolisAc CompeAAon
Advantages of Perfect and Pure Competition
High degree of competition helps allocate resources
to most efficient use
Price=marginal cost
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit
Profit maximizing point-Marginal Revenue=Marginal
Cost
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
What happens in a competitive environment?
- New idea? Firm makes a short term abnormal
profit
- Other firms enter the industry to take advantage of
the abnormal profit
- Supply increases – price supplies
- Long run – normal profit made
- Choice for consumers
- Price sufficient for normal profit to be made
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Monopoly
- A single seller: the firm and industry are synonymous
- Unique product: no close substitute to the firm’s
product
- The firm is the price maker: the firm has
considerable control over the price because it can
control the quantity supplied
- Entry or exit is blocked.
- Pure Monopoly (unique product) and Normal
Monopoly
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
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6.1 Market Structures: Pure and Perfect CompeAAon, Monopoly, MonopolisAc CompeAAon
Advantages and disadvantages of Monopoly
Encourages R&D
Encourages innovation
Development of products that are not likely without
some guarantee of monopoly in production
Economies of scale can be gained – consumer may
benefit
Disadvantage: Exploitation of consumers – higher
prices
Disadvantage: Potential for supply to be limited –less
choice
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Monopolistic Competition
- Large number of small sellers and many
buyers
- Products differentiated (Physical (color, features,
functions, shape, taste), perceived difference
(packaging, branding, patents, copyrights,etc.), after
sales services
- Relatively free entry and exit
- Each firm may have a tiny “monopoly”
because of differentiation of their products
- Firm has some control over the price
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Monopolistic Competition
Product differentiation plays a crucial role in
monopolistic competition.
Tacit collusion is almost impossible when
there are many producers.
Product differentiation is the only way these
firms can acquire some market power.
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Factors of product differentiation
Differentiation by type or style
- sedan versus SUVs
Differentiation by location
- dry cleaner near home vs cheaper dry far
away
Differentiation by quality
- ordinary chocolate versus gourmet
chocolate
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
Advertising and Monopolistic Competition
Advertising is information provided by company
about its products or operation, usually thru media
such as television, radio, newspaper, magazine and the
Internet (social media platforms/e-commerce) to
promote or maintain sales, revenue and profit.
Advertising is frequently used by monopolistic
competition to accomplish two related goals – product
differentiation and market power.
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
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6.1 Market Structures: Perfect and Pure CompeAAon, Monopoly, MonopolisAc CompeAAon
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6.2 PROFIT MAXIMIZATION
Profit Maximization
The goal of a firm is to maximize profits. We could
compare the total revenue and total cost at every level
of output. A best alternative would be to compare
marginal revenue and marginal cost.
Marginal Cost – additional cost of producing one more
unit of output
Marginal Revenue – additional revenue of obtained
from selling one more unit of output
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6.2 PROFIT MAXIMIZATION
Profit Maximization, continuation..
Therefore, as long as the marginal revenue from
selling a unit of output is greater than the marginal
cost of producing that unit of output the firm will
make a profit on that unit of output.
-if MR>MC produce more output to increase profits
-if MR<MC , it will costs more to produce a unit of
output than the firm can sell it for – produce less
output to increase profits
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6.2.1 PROFIT MAXIMIZATION FOR PERFECT AND PURE COMPETITION
Profit Maximization for Perfect and Pure Competition
Since in perfect and pure competition, sellers are price
takers, a perfectly competitive firm has only one major
decision to make – what quantity to produce.
The profit maximizing for a perfectly competitive
firm will occur at the level of output where marginal
revenue is equal to marginal cost – that is where,
MC=MR
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6.2.1 PROFIT MAXIMIZATION FOR PERFECT AND PURE COMPETITION
Consider the following data for a firm:
q
TFC
TVC
MC
P=MR
0
Php55
Php0
Php
Php40
1
55
45
40
2
55
65
40
3
55
70
40
4
55
80
40
5
55
95
40
6
55
120
40
7
55
155
40
8
55
200
40
9
55
255
40
TR
TC
TR=TC
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6.2.1 PROFIT MAXIMIZATION FOR PERFECT AND PURE COMPETITION
Consider the following data for a firm:
q
TFC
TVC
MC
P=MR
TR
TC
TR=TC
0
Php55
Php0
Php--
Php40
Php--
Php55
Php-55
1
55
45
45
40
40
100
-60
2
55
65
20
40
80
120
-40
3
55
70
5
40
120
125
-5
4
55
80
10
40
160
135
25
5
55
95
15
40
200
150
50
6
55
120
25
40
240
175
65
7
55
155
35
40
280
210
70
8
55
200
45
40
320
255
65
9
55
255
55
40
360
310
50
Profit maximizing level of output
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6.2.1 PROFIT MAXIMIZATION FOR PERFECT AND PURE COMPETITION
The Shutdown Point
- The firm will shut down once it cannot cover
average variable cost.
- The shutdown point is the point by at which the firm
will gain more by shutting down than it will by
staying in business.
- As long as total revenue is more than total variable
cost, firm’s opted to temporarily operate in a loss
rather than shutdown.
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6.2.1 PROFIT MAXIMIZATION FOR PERFECT AND PURE COMPETITION
The Shutdown Point
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6.2.2 PROFIT MAXIMIZATION FOR MONOPOLY
Profit Maximization for Monopoly
Like a competitive firm, the monopolist maximizes
profit by producing the quantity where MR=MC.
- Once the monopolist identifies this quantity, it sets
the highest price consumers are willing to pay for that
quantity.
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6.2.2 PROFIT MAXIMIZATION FOR MONOPOLY
What is a patent?
Patent is a government grant of exclusive
ownership of an innovation.
A patent is a source of monopoly power.
Government franchise is a monopoly granted by a
government license.
- Includes local power, telephone, and cable companies
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6.2.2 PROFIT MAXIMIZATION FOR MONOPOLY
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6.2.2 PROFIT MAXIMIZATION FOR MONOPOLY
Price Discrimination
Price discrimination is the business practice of selling
the same good at different prices to different buyers.
- The characteristic used in price discrimination is
willingness to pay (WTP).
- A firm can increase profit by charging higher price
to buyers with a higher WTP.
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6.2.2 PROFIT MAXIMIZATION FOR MONOPOLY
Price Discrimination in reality
In the real world perfect price discrimination is not
possible:
- no firm knows every buyer’s WTP
- buyers do not announce it to sellers
So firms divide customers into groups based on some
observable traits that is likely related to WTP, such as
age
- samples are discount coupons, age discounts
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION
Profit Maximization for Monopolistic Competition
A monopolistically competitive firm decides on its
profit maximizing price in the same way as a
monopolist, where MC=MR.
A monopolistic competitor, like a monopolist, faces a
downward-sloping demand curve, and so it will choose
a combination of price and quantity along its
perceived demand curve.
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION
Consider the following data of an authentic chinese pizza store,
Quan/ty
Price
Total Revenue
Marginal
Revenue
Total Cost
Marginal Cost
10
Php23
Php230
Php-
Php340
Php-
20
20
400
17
400
6
30
18
540
480
40
16
640
580
50
14
700
700
60
12
720
840
70
10
700
1020
80
8
640
1280
90
6
540
1540
100
4
400
1760
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION
Consider the following data of an authentic chinese pizza store,
Quan/ty
Price
Total Revenue
Marginal
Revenue
Total Cost
Marginal Cost
Profit
10
Php23
Php230
Php-
Php340
Php-
Php-110
20
20
400
17
400
6
0
30
18
540
14
480
8
60
40
16
640
10
580
10
60
50
14
700
6
700
12
0
60
12
720
2
840
14
-120
70
10
700
-2
1020
18
-320
80
8
640
-6
1280
26
-640
90
6
540
-10
1560
28
-1020
100
4
400
-14
1910
35
-1510
P r o f i t
maximizing
level of output
and price
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETTION
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION
Is Monopolistic Competition efficient?
A monopolistic competitive firm is not productively
efficient because it does not produce at a minimum of
its average cost curve, where P=MC.
Thus, a monopolistically competitive firm will tend to
produce a lower quantity at a higher cost and charge a
higher price than perfectly competitive firm.
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6.2.3 PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETTION
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“Economics is
everywhere, and
understanding
economics can help
you make better
decisions and lead
happier life”
-Tyler Cowen
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