Revenue Analysis
1
Revenue Analysis
TR= P* Q
AR= TR/Q= P
Demand curve of the consumer is the AR curve
from the seller’s point of view since price paid by
the consumer is the revenue of the seller.
MR= TR n- TR n-1
Shape of TR, AR and MR curves change
according to market situation
2
Revenue Analysis
TR= P* Q
AR= TR/Q= P
Demand curve of the consumer is the AR curve
from the seller’s point of view since price paid by
the consumer is the revenue of the seller.
MR= TR n- TR n-1
Shape of TR, AR and MR curves change
according to market situation
3
Revenue Structure under Perfect
competition
Quantity
TR
AR
MR
1
Price
(Rs)
100
100
100
100
2
100
200
100
100
3
100
300
100
100
4
100
400
100
100
4
Revenue Structure under Perfect
competition
• Large no of buyers and sellers buying and
selling homogeneous products
• Uniform prices
• Producer can sell any quantity of output at
the market price.
5
Revenue Structure under Perfect
competition
TR
Price/ Revenue
Y
P=AR=MR
X
O
Quantity
6
Revenue Structure under Perfect
competition
• Demand curve is perfectly elastic
• Price does not fall if one more unit is sold
• Therefore P(AR) remains the same when
one more unit is sold and so AR=MR- so
MR and AR curves coincide
• Horizontal line parallel to X axis indicates
that P or AR is constant irrespective of
quantity sold
7
Revenue Structure under Imperfect
competition
• Under imperfect competition, producer
faces a downward sloping demand curveHe needs to lower the price to attain higher
sales
8
Revenue under Imperfect
competition
Quantity
1
2
3
4
5
6
7
8
9
TR
16
30
42
52
60
66
70
72
72
AR
16
15
14
13
12
11
10
9
8
MR
16
14
12
10
8
6
4
2
0
9
Revenue Structure under Imperfect
competition
• MR is positive as long as TR is increasing
• MR becomes negative when TR declines
• When quantity sold is increased from 9 to
10 units, TR declines from Rs. 72 to Rs.
70 and MR turns negative
• AR declines as additional units of product
are sold
10
Revenue Structure under imperfect
competition
Y
TR
AR
X
O
MR
11
12
Perfect Competition
• Large no of undifferentiated buyers and sellerseach one is so small as to be insignificant to
influence the market--price takers
• Homogeneous products- each competitor offers
or seeks exactly a similar thing as others
• The seller is a price-taker
• No barriers to entry and exit- survival of the
fittest: Firm will shut down where AVC=AR. At
any price lower than the AVC, firm will have to
shut down
13
Perfect Competition
• Markets must be well organised and continuous
and everyone has information (knowledge) on
market condition, product and price
• Market prices must be flexible to keep
responding to changing conditions of supply and
demand
• No transport cost
• Perfect mobility of factors of production (raw
materials, labour and capital)-this results in
factor price equalisation.
14
Perfect Competition
• No Government interference: No rationing,
administered prices, subsidies etc.- Underlying
presumption that free market operates in social
interest- “invisible hand” and self-regulatory
mechanism- it provides an effective check on the
power of the sellers, safeguards consumer
against exploitation and makes it unnecessary
for the State to intervene by regulating prices
and production in order to protect the consumer
15
Perfect Competition
Key lessons of perfect competition for
managers
• Important to enter the market as far ahead of the
competitors as possible-when supply is low and
price is high- this requires entrepreneurial skill
• A firm earning an economic profit (as
distinguished from normal profits) cant afford to
be complacent because economic profit will
attract new entrants
• Only way for a firm to survive is to keep costs as
low as possible
16
Perfect Competition
• With growing globalisation, new
competitive cost pressures are being felt
by firms around the world- Indian
companies have the advantage of low –
cost labour but disadvantage of
technology lag
17
Monopoly
• Only one seller of a particular good or service
• Rivalry from producers of substitutes is so remote as to
be insignificant: cross elasticity of demand is zero
• Monopolist is a price setter- strength of a monopolist’s
power depends on how much he can raise the price
without losing all his customers- this depends on
elasticity of demand, which in turn depends on
availability of substitutes
• 2 conditions are necessary to make a monopolist strong:
1) Gap in the chain of substitutes and 2) possibility of
securing control over all the substitutes
18
Causes and Forms of Monopoly
• Barriers to entry• Legal: Emerges as a result of statutory regulation by
government: Copy right, trade marks, government
regulation, licence, tariffs and non-tariff barriers against
import of goods
• Technical; Arises when the technical know-how is
available with only one person
• Natural: If a single firm acquires control over supply of
raw materials or natural resources such as minerals Oil
well in a particular area
• High costs of capital investment or economies of scale
19
Causes and Forms of Monopoly
• Joint Monopoly: Through voluntary agreement,
business companies jointly acquire monopoly
power. e.g., Trusts, syndicates, cartels,
• Public Monopoly: Created for the welfare of the
public- e.g., public utilities like water supply,
electricity, railways, telephones
• Private Monopoly: Owned an operated by
private individuals or organisations- objective is
profit maximisation
20
Causes and Forms of Monopoly
• Simple Monopoly: Charges uniform or
single price for a product to all the
consumers- no discrimination between
buyers or uses.
• Discriminating Monopoly : Act of selling
the same commodity produced under
single control, at different prices to
different buyers or different uses.
21
Discriminating Monopoly/ Price
Discrimination
• 3 forms:
• 1st Degree: Different rate for every unit of
output. Monopolist forces every
consumer to part with his entire
consumer surplus- discrimination
between buyers is more common
than discrimination between units of a
homogeneous good
22
2nd degree Discrimination
• 2nd Degree: Buyers are divided into
different groups and then different rates
charged for different blocks or groups:
here, consumers enjoy a part of the
consumer surplus and monopolist is also
able to get a part of the surplus; e,g.,
electricity charges
• Taxi fare a certain amount or the 1st km,
then different for further units
23
3rd degree Discrimination
• 3rd degree: Most common type-Seller divides his
buyers into sub-markets and charges a different
price for each market- Dumping is an example:
High price in domestic market and low in
international market.
• Reasons: To dispose off surplus; to remove
rivals; to take advantage of increasing returns to
scale; to create new demand abroad; because
demand elastic in international market, he has to
reduce price
24
Conditions of Price
Discrimination
Conditions of Price Discrimination ( When is
Price discrimination possible?)
1. Consumers are unaware of the difference in
prices charged
2. Price difference so small that consumers don’t
bother
3. Price illusion/ irrationality
4. Markets are situated far from one another and
so it is expensive to transfer goods from one
market to another
25
Conditions of Price
Discrimination
5) When elasticities of demand in the two
markets are different: higher price for low
elasticity market and lower price for high
elasticity market. Why?
6) Direct personal services such as those of
doctors and lawyers where resale is not
possible
7) Legal sanction provided by government:
e.g., lower prices in army canteen
26
Forms of Price discrimination
• Personal Discrimination: Occurs when
different prices are charged to different
consumers – doctors and lawyers may charge
different fees for the rich and the poor
• Local Discrimination: Lower prices in one
locality and higher in another. e.g., dumping by
charging higher prices in domestic market and
lower prices in foreign markets
• Trade Discrimination: Charging different rates,
based on use e.g., electricity charges for
domestic/ industrial/agricultural uses
27
Forms of Price Discrimination
• Quality Discrimination: Hard cover
editions being sold at higher prices than
paper back editions of books; business
class travel vs economy class in air travel
• Time Discrimination: Different charges
for the same commodity at different points
of time- off-season air tickets; happy hours
in restaurants
28
• What is the cross elasticity of demand for a monopolist’s
product?
• There is only one hospital in Mumbai with an advanced
equipment for diagnosis of a certain disease. This is an
example of ______________ monopoly.
• BEST and Indian Railways are examples of
_________monopoly.
• Downloading music on internet is an example of violation
of -------------------------- monopoly.
• 4 powerful traders get together and control supply of
vegetables in Mumbai. This is -----------------------------monopoly.
29
Monopolistic Competition
‘Most economic situations are composites of
both competition and monopoly’Chamberlin. In reality, monopoly and
competition are not mutually exclusive, but
markets have both elements in differing
degrees
30
Characteristics of Monopolistic
Competition
Large no of firms/ sellers -Consequently no
individual has any significant control over the
market
Absence of interdependence: Since the number
is large and size of each firm is small, no firm
can influence or is influenced by others in the
market.
Example of FMCG product market
Freedom of entry: No barriers to entry- this leads
to occurrence of only normal profits in the long
run
31
Characteristics of Monopolistic
Competition
• Product Differentiation: Core of
monopolistic competition- Different firms
produce similar, but not homogeneous
products. It is because of product
differentiation that firms enjoy some
monopoly power i.e., power to control the
price in a narrow circle, but in the wider
circle the firm faces competition from rival
producers. Firms in effect are competing
monopolies
32
Characteristics of Monopolistic
Competition
• Selling Costs: Expenditure incurred on
changing the demand and preference of the
consumers - Expenditure on advertising,
promotion, displays, salaries of salesmen, free
samples etc.No need or role for selling costs in monopoly of
perfect competition
. Under monopolistic competition, firms compete
with each other mainly not on the basis of price
but on the basis of non price elements. Product
differentiation and selling costs are known as
non-price competition
33
Monopolistic Competition
Wastes of Monopolistic Competition
Excess capacity- resources are not fully
utilised, leading to higher costs
Competitive advertising ( as opposed to
constructive advertising)
worse if consumers regard different products
as substitutes and thus resources are
wasted
34
Oligopoly: Definition and Features
• Few sellers producing homogeneous or
differentiated products
• Automobiles, steel, consumer electronics
• Few sellers: Naturally each seller has a
sizeable share of market• Close interdependence- decision of a single
firm to expand or contract output affects entire
market- moves and counter moves- need to
predict and analyse every possible reaction of
rivals before a firm takes decisions
35
Oligopoly: Definition and Features
• Indeterminate demand curve: because
of extreme interdependence
• Price Rigidity- Price remains stuck at a
certain level-No desire for a departure
from prevailing price in either directionprice cutting will be followed by rival but
price hike may not be and hence “sticky”
prices
36
Oligopolistic Pricing
•
1.
2.
3.
•
•
Oligopolistic pricing can take 3 different forms:
Independent Pricing
Collusion Model
Price Leadership
Independent Pricing: Method of pricing its
differentiated product – result of the fact that
each firm has a certain monopoly power, but
there is fear of retaliation by rivals
Various possibilities occur: Price wars and price
rigidity
37
Collusive Oligopoly
• Collusion Model:
• When there are only a small no of firms in a market, they
have a choice between cooperative and non cooperative
behaviour.
• A Cartel agreement represents the most complete form
of collusion among oligopolists-here firms are in a
cooperative mode and minimise competition among
themselves- due to explicit agreement between firms –
Joint output and price decisions- has a board of control
which determines the market share of each member
• Example: OPEC- decides on output rather than price
38
• Sometimes tacit collusion occurs between firms
without explicit agreement here they quote
identical prices: Indian cement and steel market
• Barriers to collusive oligopoly:
-Considered illegal as it converts oligopoly into
monopoly
- Firms may cheat by giving secret price
concessions and thereby increasing the market
share
- Some cartel members may be political rivals
such as Iraq, Kuwait and Iran in OPEC
39
Price Leadership
• Price Leadership: It is an informal
position in most oligopolistic markets. It
may emerge spontaneously due to
technical reasons such as size, efficiency,
economies of scale or the firm’s ability to
forecast market conditions accurately
• Typically, leadership role is played by a
dominant firm (largest in the industry) and
smaller ones follow40
• Sometimes price leadership is barometric-Here
one of the firms (not necessarily the dominant
one) takes lead in announcing a price change,
especially when a change is due but is not
effected due to uncertainty in the market –The
barometric firm is supposed to have a better
knowledge of the changing environment of the
market than others
• Price leadership often serves as a means to
price discipline and price stabilisation
41
Comparison of different Market
Feature
Perfect
Monopoly Monopolisti
Structures
competition
c
No of
sellers
Nature of
goods
Many
One
Entry
Free
Barriers
Degree of
monopoly
power
Zero
Absolute
competition
Large
Homogene Homogene Differentiat
ous
ous
ed
Unrestricte
d
Limited
42
Comparison of different Market
Structures
Feature
Perfect
Monopoly
competition
Monopolisti
c
competition
Production
cost+
Selling cost
Cost
Elements
Production
cost
Production
cost
Long run
Profits
Normal
Supernormal
Normal
Nature of
Demand
Elastic
Inelastic
Relatively
inelastic
43
Feature
Perfect
Monopoly
competition
Monopolisti
c
competition
Pricing
Price taking Pricemaking:
i) Uniform
ii) Price
discriminati
on
Pricemaking:
Uniform
price
44
Review Questions
• Product differentiation is an important feature of
__________________ competition
(Perfect/monopolistic)
• Duopoly is a market form with just --------------sellers (two/ few)
• If market price is more than the equilibrium price,
it indicates that --------------- is more than ----------(Supply/ demand)
• Break-even point is a _________________
situation (No profit-no loss/ maximum profit)
45
Review Questions
• Price elasticity of demand under perfect
competition is ________
• Under perfect competition, __________ is equal
to AR=MR. (Price/ Total Revenue)
• In the __________ period, both the fixed and
variable factors of production change. (Short/
Long)
• Mergers, acquisitions and take-overs are
common under the _________________ market
structure. (oligopolistic/ monopolistic)
46
• --------------- cost increases continuously with an increase
in production. (Fixed/ variable)
• There is a dichotomy of costs into fixed and variable in
the _________ run. (short/ long)
• --------------------Cost has to be incurred even if production
is nil. (Fixed/ variable)
• The ____________ run cost curve is also known as
planning curve. (long/ short)
• Rent is a _______________ cost (Fixed/ variable)
• Self-owned resources used in business are called
___________________ costs. (imputed/ explicit)
47
• Private cost: Costs incurred by the private
producer/ firm during the process of production.includes both implicit and explicit costs
• Social cost: Costs incurred by society as a whole
as a result of the production process undertaken
of the private firm eg., water/ air/ noise pollution,
congestion, traffic jam, development of slums
48
49
50
Review Questions
•
•
•
•
•
•
•
•
•
•
Define:
Normal profit
Market
Dumping
Barriers to entry
Product differentiation
Monopolistic competition
Oligopoly
Selling cost
Collusive oligopoly
51
Review Questions
52
Review Questions
53
Review Questions
54
Answers to Review Questions
• Product differentiation is an important feature of
__________________ competition
(Perfect/monopolistic)
• Duopoly is a market form with just --------------sellers (two/ few)
• If market price is more than the equilibrium price,
it indicates that --------------- is more than ----------(Supply/ demand)
• Break-even point is a _________________
situation (No profit-no loss/ maximum profit)
55
Answers to Review Questions
• Price elasticity of demand under perfect
competition is ________
• Under perfect competition, __________ is equal
to AR=MR. (Price/ Total Revenue)
• In the __________ period, both the fixed and
variable factors of production change. (Short/
Long)
• Mergers, acquisitions and take-overs are
common under the _________________ market
structure. (oligopolistic/ monopolistic)
56
Answers to Review Questions
• Define:
• Normal profit: Remuneration received by
entrepreneur for his service as a factor of
production. This profit is just enough for him to
exist in the industry.
• Market: A mechanism through which the buyer
and seller interact to determine the price and
quantity of a product. Buyers and sellers can be
individuals, firms, agents or dealers. ( Market is
not a geographical locality.)
57
• Barriers to entry: Hurdles created to
prevent other potential firms from joining
the industry- trade marks, patents,
copyrights
• Dumping: Selling in the international
market at very low rates and in large
quantities such that it affects the domestic
producers
58
Answers to Review Questions
• Product differentiation: Changing designs,
features, packaging or pricing of a product to
give the consumer the perception that the
product under consideration is unique or
superior.
• Price Discrimination: Charging different prices
for the same product to different consumers
• Monopolistic competition: A market condition
lying between perfect competition and monopoly,
selling differentiated products
59
• Oligopoly: A market condition with few sellers,
selling homogeneous or differentiated products
and facing intense rivalry and competition and a
high degree of interdependence.
• Selling cost: Cost incurred on advertising, sales
promotion, after-sales service etc
• Collusive oligopoly: A situation where firms in an
oligopolistic market enter into an explicit
agreement regarding output and price decisions;
Example OPEC. In the case of tacit collusion,
there is no open or formal agreement.
60
Answers to Review Questions
61
Answers to Review Questions
62