Market Structure Pricing And Output Decision

The firm needs to establish its price and output levels to achieve its business objective of profit
maximization. The pricing and output decision can be decided by considering the framework of basic
types of market :

1. Perfect competition (no market power)

 A large number of relatively small buyers and sellers

 Standardized product

 Very easy market entry and exit

 Nonprice competition not possible.

2. Monopoly (absolute market power subject to government regulation)

 One firm, firm is the industry

 Unique product or no close substitutes

 Market entry and exit difficult or legally impossible

 Nonprice competition not necessary

3. Monopolistic competition (market power based on product differentiation)

 A large number of relatively small firms acting independently

 Differentiated product

 Market entry and exit relatively easy

 Nonprice competition very important

4. Oligopoly (market power based on product differentiation and/or firm’s dominance of the market)

 A small number of mutually interdependent and relatively large firms

 Differentiated or standardized product

 Market entry and exit difficult

In perfect competition, there are so many sellers offering the same product that an individual firm has
virtually no control over the price of its product. The interaction of supply and demand decides the price
for all participants in this type of market structure. The degree of competition in the market is the ability
of firms to control the price and use it as a competitive weapon.

PRICING AND OUTPUT DECISIONS IN PERFECT COMPETITION

The firm should consider the basic question due to no control over the price of the product to enter the
perfectly competitive market. The basic question is related to the amount of the output should produce,
how much the profit will the firm earn, and if a loss, will the worthwhile to continue in this market in the
long run, or should the firm exit from the market?. To develop economic model related to the output
decision in perfect competition, there is a key assumption that used to analyze this model :

 The firm operates in a perfectly competitive market and therefore is a price taker.

 The firm makes the distinction between the short run and the long run.

 The firm’s objective is to maximize its profit in the short run. If one cannot earn a profit, then it
seeks to minimize its loss.

 The firm includes its opportunity cost of operating in a particular market as part of its total cost
of production.

For the economic analysis, the company should have established a single clear objective for a function.
Either the objective is the maximization of the profit in the short run or maximization revenue in the
short run, the model function should differ. The opportunity cost in the cost structure of the firm is
important to decision making. The company must check whether the going market price that probable
to earn a revenue, covers the cost, and the costs incurred by forgoing alternatives activities.

THE TOTAL REVENUE-TOTAL COST APPROACH TO SELECTING THE OPTIMAL OUTPUT LEVEL

To analyze the optimal level of output, the company can compare the total revenue with the total cost
schedules and find that level of output that either maximizes the firm’s profit or minimize its loss. In the
table below, at level output 8, the company earns a maximized profit of $261.6.
The Marginal Revenue–Marginal Cost Approach To Finding The Optimal Output Level

In this analysis method, the company should decide the level point of input that the marginal cost, not
excess marginal revenue. The table shows, at the level input 8 the marginal cost is $103.3 and marginal
revenue is $110 still greater than marginal cost. But if the level input is 9, the marginal revenue of $110
will less than marginal cost $126.9. So the level input 8, results in a level optimum of output.

If the company that wants to maximize its profit or minimize its loss should produce a level of output at
which the additional revenue received from the last unit is equal to the additional cost of producing that
unit.

MR=MC
ECONOMIC PROFIT, NORMAL PROFIT, LOSS, AND SHUTDOWN

In condition revenue of the company going slow down, the company must be careful to decide whether
it is the right time to shut down or it still possible for the company to run the business. The company
should calculate the cost and loss from the shutdown. If the company decides to shutdown it means
there is no variable input and output anymore, but the company should consider the fixed cost that still
exists.

For example, the fixed cost is $100 then the company wants to sell the fixed asset which has a market
value of just $50. So the company will get a loss at this point. In the other condition, if the company
continues the business with 1 input, there will a revenue and result in a profit or maybe a loss that
better from the shutdown condition. The company should analyze and consider any factor to decide the
better timing to make a shutdown.

THE COMPETITIVE MARKET IN THE LONG RUN

In the long run, the market price will settle at the point where these firms earn a normal profit. This is
because, in the long period, prices that enable firms to earn above-normal profit would induce another
firm to enter the market, and prices below the normal level would cause firms to leave the market. An
understanding of the conditions motivating market entry or exit over the long run should lead the firms
to consider the following points:

1. The earlier the firm enters a market, the better its chances of earning an above-normal profit
(assuming strong demand in this market).

2. As new firms enter the market, firms that want to survive and maybe succeed must find ways to
produce at the lowest possible cost, or at least at cost levels below those of their competitors.
 3. Firms that find themselves incapable to compete based on cost might want to try competing
based on product differentiation instead, although this is extremely difficult in this type of
market.

PRICING AND OUTPUT DECISIONS IN MONOPOLY MARKETS

A monopoly market is consists of one market, the company is the market. In the absence of regulatory
constraints, the monopoly stands in counterpoint to the perfectly competitive company. The key point is
that a monopoly firm’s ability to set its price is limited by the demand curve for its product and the price
elasticity of demand for its product. This ability is further limited by the possibility of the rising marginal
cost of production.

At some point, the increasing cost of production of additional units of output will exceed the decreasing
marginal revenue received from the sale of additional units. So thefirm that exercises monopoly power
over its price should not set its price at the highest possible level. It should set at the right level or
MR=MC.

THE IMPLICATION OF PERFECT COMPETITION AND MONOPOLY FOR MANAGERIAL DECISION MAKING

The most important thing that managers can learn from this perfectly competitive market analysis is
that it is extremely difficult to make money in a highly competitive market. The only way for a company
to survive in perfect competition is to be cost-efficient as possible because there is absolutely no way to
control the price. In the competitive market, the company can move into the market before others start
to enter. Enter the market even before the demand is high enough to support an above-normal price. In
monopoly markets not sanctioned by the government via regulations or patent laws, a monopoly
present manager with somewhat of a paradox.
Pricing Strategy Monopolistic And Oligopoly

Monopolistic competition and oligopoly are considered “imperfect” competition because the company
in these markets have the power to set their prices within the limits of certain constraints. Monopolistic
competition is a market in which there are many firms and relatively easy entry. What enables firms to
set their prices is product differentiation. The monopolistic company somehow selling a product to the
customer differs from the offering of other firms in the market.

A monopolistic competitor can set its price established by the forces of supply and demand under
conditions of perfect competition. Oligopoly is a market dominated by a relatively small number of large
firms.

The differentiation and standardized product is part of the control that a firm in oligopoly markets
exercise over price and output. Market power also comes from their sheer size and market dominance.

Pricing Strategy In An Oligopolistic Market: Rivalry And Mutual Interpendence

In the oligopolistic market, the price behavior is mutual interdependence. This means that each seller is
setting its price while explicitly considering the reaction by competitors to the price that it establishes.

In the 1930s, economist Paul Sweezy presented an initial insight into the pricing dynamics of mutual
interdependence among oligopoly firms by developing a kinked demand curve model.

The basic assumption of the Sweezy model is that a competitor (or competitors) will follow a price
decrease but will not make a change in effect to a price increase. If a firm lowers its price, this may have
a critical impact on the competition.

This Firm takes its action to increase sales by bringing customers away from the higher-priced
competitors, but when competitors realize what is happening (i.e., their sales are declining), they will
swiftly follow the price cut to maintain their market share.
If this firm engages the opposite action—a price increase—incorrectly assuming competitors will follow
suit, its sales will drop markedly if competitors fail to do so.

COMPETING IN IMPERFECTLY COMPETITIVE MARKETS

Nonprice competition is any effort made by firms other than a change in the price of the product
question to influence the demand for their product. This includes include any factor that causes the
demand curve to shift, the factors are taste and preference, income, prices of substitutes and
complements, number of buyers, and future expectations of buyers about product price.

Nonprice variables are those factors that managers can control, influence, or explicitly consider in
making decisions affecting the demand for their goods and services.

The nonprice variables :

 Advertising

 Promotion,

 Location and distribution channels

 Market segmentation

 Loyalty programs

 Product extensions and new product development

 Special customer services

 Product “lock-in” or “tie-in” and preorder new product announcements.

STRATEGY: THE FUNDAMENTAL CHALLENGE FOR FIRMS IN IMPERFECT COMPETITION

The fundamental link between managerial economics and strategy is the decision regarding the
allocation of a company’s scarce resources. The tools of this strategic analysis are Porter’s “Five Forces”
model and his differentiation versus cost leadership approach is linked to the economic study of
industrial organization and the economic models of a firm’s behavior in different market settings.