Price and Output determination

Under various market structures

Importance of pricing
Price affects profit position of the business.
How??
It influences cost and revenue
Total revenue realized by the firm depends on the price per
unit and the total units sold
The quantity sold changes with variations in price
Total cost depends on output produced.


Factors influencing pricing
Demand for a commodity
Cost of production
Objectives of the firm
Competition
Govt. policy
Price and Output determination under perfect
competition
Features
Price is determined by the market forces: demand and supply
Equilibrium price
Effect of shift in equilibrium
Illustration
Change in price due to change in demand/supply



Role of time in pricing
Very short period


Supply is fixed
Demand plays a decisive role
Perishables


D
D
D
S
S
D2
D
D1
Q2
Q
Q1
P
R
I
C
E

P2
P
P1
QUANTITY
So, in the very short period, demand decides price as
supply is fixed.
Market supply depends on nature of the product,
sellers anticipation of prices, availability of storage
facilities and cost of production

Role of time in pricing
Short period
Supply of commodities is alterable
Commodities are durable and reproduceable
Sellers are not willing to sell below a minimum price
Hence Supply decides the price in the short period
Sellers are willing to sell the entire stock at a maximum price
Beyond the minimum price, demand has a decisive influence
Below the minimum price, demand doesnt influence supply
3 phases of supply curve
Demand plays a major role
Output cannot be increased beyond OM2




Short period
D1
D1
D
D
P
R
I
C
E

P2
P1
P
O
M M1
M2
Long period equilibrium

P
r
i
c
e

Output
S
Q
Q2
Q1
D
D1
D
D1 S
S1
S1
M1 M2 M
O
Long period
Price in the long period: normal price
Determined by demand and supply
Cost of production plays a decisive role(decides supply)
If the normal price remains above the cost of production,
profits will accrue. Hence production will increase(how?)
If normal price is below cost of production , production will be
curtailed.
For a given output, normal price must be equal to cost of
production.

Equilibrium of the Firm
Equilibrium is a condition which brings maximum profit.
MR=MC
Firms under perfect competition has no choice regarding the
price policy. It has no control over the price. Price is
determined by demand and supply.
Demand curve that the firm faces is perfectly elastic
It can sell any quantity at the existing price
Demand curve itself is the AR curve.
When all the units of the product are sold at the same price,
AR=price.
Since AR is neither rising nor falling, AR=MR
Firm arrives at equilibrium at a point E , where MR=MC and
the equilibrium output is OM.

At equilibrium production, OM, average cost is only FM and
the average revenue is EM. Profit per unit of output is EF.
Total profit earned by the firm is profit per unit multiplied by
the number of units sold which is equal to PEFH.
In short run, all firms will be earning supernormal profits.
Industry is not in equilibrium as entry of firms continue.
In the long run, firms will earn only normal profits.
In the long run, P=MC=MR=AR. Profits of the firm will be
normal. Now the industry will be in equilibrium.
Short run equilibrium
y
MC
AC
AR/MR/PRICE
P
H
O M
X
OUTPUT
C
O
S
T

A
N
D

P

R
I
C
E

E
F
Long run equilibrium
y
LMC
LAC
AR=MR=PRICE
P
O M
X
OUTPUT
C
O
S
T

A
N
D

P

R
I
C
E

E
Price and Output determination under
Monopoly
Monopoly producer is a Price maker
Sufficient control over price or output in order to earn
maximum net monopoly revenue .
Monopolist firm will have a sloping down demand curve and
his average revenue will dwindle as the output is increased.
MR curve will be falling , steeper and at a lower level than AR
curve. Since AR is falling, the extra units sold will fetch lesser
and lesser revenue in the market.

Principle of profit maximization, MC=MR.
Monopolist will be in equilibrium, where he gets the
maximum profit.
He will go on producing until every unit sold adds up revenue
than cost. He will stop at the point beyond which additional
units cost him more than the revenue realized.

MONOPOLY EQUILIBRIUM AND PRICE FIXATION
R
E
V
E
N
U
E


/


C
O
S
T

Y
MR
M
R
AC
PROFIT
O
OUTPUT
P
E
X
S
AR
Q
MC
The monopolist comes to equilibrium at E where MR=MC
and produces OM units of the commodity at price OP.
At this price and output, the monopolist realizes the
maximum profit shown by the rectangle PQRS.
Upto OM output, the MR is greater than MC and beyond
that, MR is less than MC. Hence equilibrium output is OM.
The output OM can be sold in the market at a price OP
according to the demand curve (AR curve).
Profit average is QR and total profit is PQRS(average
profit*output)
The equilibrium for the short period is also same for the long
period under monopoly, as there will not be any competitor
entering the field.

Price and Output determination under
Monopolistic competition
Product differentiation is the fundamental feature.
Hence there is no unique price.
Each firm enjoys a monopoly position for its product.
Demand for the product will be highly elastic, not perfectly
elastic.
Each firm is faced with a downward sloping demand curve.
Price and output determination under monopolistic
competition is governed by the cost and revenue curves of
the firm.
Cost curves are governed by laws of production.
AR curve(demand) of the firm will be sloping down.


Equilibrium of the individual firm
The monopolistic competitive firm will come to equilibrium
when MR=MC.
Short period marginal cost and average cost curves SMC and
SAC.
The sloping down average revenue and marginal revenue
curves are AR and MR.
Equilibrium point is E where MR=MC.
The equilibrium output is OM and the price is fixed at OP.
The difference between AC and AR is RQ, output is OM, so the
supernormal profit of the firm is PQRS.
The firm, by producing OM units and selling at a price of OP
per unit realizes the maximum profit in the short run.
EQUILIBRIUM OF INDIVIDUAL FIRM UNDER
MONOPOLISTIC COMPETITION IN THE SHORT PERIOD
P
R
I
C
E

Y
MR
M
R
SAC
PROFIT
O
OUTPUT
P
E
X
S
AR
Q
SMC
The different firms in monopolistic competition may be
making either abnormal profits or losses in the short period
depending on their cost and revenue curves.
Price of commodity of different firms will be different.
Based on consumer preference and cost of production , each
firm will be fixing its price which may be different from the
price of other firms.
Established firms will be making abnormal profits in the short
period.
Newly started firms may have to fix the price at low level to
establish themselves. The profit may not be very high.
Abnormal profits earned in a short period will attract
newcomers to the group. Newcomers will fix lower prices
than the prices charged by existing firms. This will compel the
existing firms to reduce prices. Prices will fall.
AR curve will shift to a lower position.
AC curve will shift to a higher position.
Distance between AR curve and AC curve will be narrowed
down and the abnormal profits will be removed.
Ultimately the firms will earn only normal profits.



GROUP EQUILIBRIUM IN THE LONG RUN UNDER
MONOPOLISTIC COMPETITION
R
E
V
E
N
U
E

A
N
D

C
O
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Y
LPMR
M
LPAC
O
OUTPUT
P
E
X
LPAR
K
LPMC
Price and Output determination under Oligopoly
Price rigidity under oligopoly is explained by the kinky
demand curve.
Kinked demand model represents a condition in which the
firm has no incentive either to increase the price or to
decrease the price , but to keep the price rigid at a particular
level.
The firm believes that the rival firm does not follow suit if it
increases the price . But if it cuts down the price, the rival
firms will follow suit. Only in the event of any drastic changes
in demand and cost conditions, the firm could think of
changing the price.
Under such a condition, the demand curve of the firm] as
anticipated by the firm would be kinked(Kink at the present
price).
KINKED DEMAND CURVE IN OLIGOPOLY
P
R
I
C
E

A
N
D

C
O
S
T

Y
MR
N MR1
K
B
P
O
OUTPUT
D
L
X