Unit 4 Part 2 - Revenue Analysis and Pricing Policies

1. Market and Market Structure -

a. Introduction - Market structure refers to how different industries

are classified and differentiated based on their degree and nature

of competition for services and goods.

b. Factors determining market structure

i. Number of Sellers: The number of firms selling a

particular product on the market, determines the level of

competition, ultimately choosing the structure of the market

for that specific product.

ii. Number of Buyers: Buyers decide the demand for a

particular product. A monopsony market has multiple sellers

and a single buyer who influences the price of the product.

iii. Economies of Scale: The size of the firm or the level of

production contributes to a market structure. If the output

 is done on such a large scale that it fulfils the market

demand solely, it may create a monopoly market.

iv. Nature of Product: The product features determine the

type of market structure to which it belongs. If the products

offered by different sellers are homogeneous, it lies in a

perfect competition market. If it is unique and has no other

substitute, it creates a monopoly in the market.

v. Entry Barriers: The profitability of a product invites the

sellers to enter such markets. The market runs on the rule

‘survival of the fittest’ where weak firms exit and strong

ones survive. There are some public utility service markets

which run on monopoly by the government like post offices,

railways, water supply, etc.

vi. The mobility of Goods: Easy transportation of goods from

production place to the market ensures uniform prices by

different sellers.

vii. Government Intervention: Some markets are indirectly

controlled by the government. The government either

imposes heavy taxes or makes the business license

mandatory to restrict the entry of firms.

c. Perfect Competition,

i. Perfect competition may be defined as that market where

infinite number of sellers sell homogeneous good to infinite

number of buyers while buyers and sellers have perfect

knowledge of market conditions. Features;

1. Presence of large number of buyers and sellers

2. Homogeneous product

3. Freedom of entry and exit

4. Perfect knowledge

5. Perfectly elastic demand curve

6. Perfect mobility of factors of production

7. No governmental intervention

8. Price determined by market and Firm is a price taker.

ii. Price-Output Determination under Perfect

Competition - In a perfectly competitive market, the price

and output of a product are determined by the forces of

supply and demand:

1. Price - The price is determined by the intersection of

the demand and supply curves, also known as the

"market clearing price".

 2. Output - In the short run, equilibrium is affected by

demand. In the long run, both demand and supply

affect the equilibrium.

iii. Short-run Industry Equilibrium under Perfect

Competition

1. Market Equilibrium - Industry

2. Abnormal Profits (Super normal profit) - Firm A

3. Normal Profit - Firm B

4. Loss - Firm C
 iv. Long-run Industry Equilibrium under Perfect

Competition,

v. Long-run Firm Equilibrium under Perfect Competition.

d. Pricing Under Imperfect Competition-

i. Monopoly,

1. The product has only one seller in the market.

2. Monopolies possess information that is unknown to

others in the market.

3. There are profit maximization and price discrimination

associated with monopolistic markets. Monopolists are

guided by the need to maximize profit either by

expanding sales production or by raising the price.

 4. It has high barriers to entry for any new firm that

produces the same product.

5. The monopolist is the price maker, i.e., it decides the

price, which maximizes its profit. The price is

determined by evaluating the demand for the product.

6. The monopolist does not discriminate among

customers and charges them all alike for the same

product.

ii. Price Discrimination under

1. Monopoly - There are different types of price

discrimination, including:

a. First degree price discrimination: The

monopolist charges the maximum price a

consumer is willing to pay.

b. Second degree price discrimination: The

monopolist charges different rates for the

product based on the quantity demanded.

c. Third degree price discrimination: The

monopolist divides the market into submarkets

and charges different prices in each submarket.

This is also known as market segmentation.

2. Bilateral Monopoly, - A bilateral monopoly is a

market structure where a single seller (monopoly) and

a single buyer (monopsony) exist.

a. A bilateral monopoly is a market structure

where there is only one buyer and one seller of

a product. The seller, or monopolist, will try to

charge a high price, while the buyer, or

monopsonist, will try to pay as low a price as

possible. The final price is determined by the

bargaining between the two parties, and will be

somewhere between their maximum profit

points.

3. Monopolistic Competition,

a. Many buyers and sellers

b. Products differentiated

c. Relatively free entry and exit

d. Each firm may have a tiny ‘monopoly’ because

of the differentiation of their product

e. Firm has some control over price

f. Price discrimination
i. Price discrimination can be used in a

monopolistic market, where a firm has

more control over suppliers and pricing

than other sellers. In a monopolistic

market, a firm can charge different prices

to different customer segments to earn

more revenue.

Some examples of price discrimination

include:

1. Individual price discrimination -

Charging different prices based on a

consumer's income level, such as a

doctor charging different fees for

rich and poor patients

2. Geographical price

discrimination - Charging

different prices for the same

product in different geographical

locations

3. Price discrimination based on

use - Charging different prices

based on how a product is used,

 such as an electricity board

charging a lower price for domestic

consumption and a higher price for

commercial consumption

4. Oligopoly,

a. Industry dominated by small number of large

firms

b. Many firms may make up the industry

c. High barriers to entry

d. Products could be highly differentiated –

branding or homogenous

e. Non–price competition

f. Price stability within the market - kinked

demand curve

g. Potential for collusion

 h. Abnormal profits

i. High degree of interdependence between firms

j. Price discrimination - Oligopoly price

discrimination is when firms in an oligopoly

market charge different prices to different

groups of customers based on their willingness

to pay. This can happen in a number of ways,

including:

i. Posting public prices and negotiating

discounts: Firms can post public prices

and negotiate discounts with consumers

privately.

ii. Conditioning prices on location: Firms can

condition prices on a consumer's location,

such as when purchasing airline tickets.

iii. Conditioning prices on purchasing history:

Firms can condition prices on a

consumer's purchasing history.

5. Collusive Oligopoly and Price Leadership,

a. Collusive oligopoly is a form of the market, in

which there are few firms in the market and all

of them decide to avoid competition through a

 formal agreement. They collude to form a cartel,

and fix for themselves an output quota and a

market price.

b. In price leadership, one firm, the leader, sets

a price level or change, and other firms, the

followers, follow suit. This can be a way for firms

to tacitly collude, or coordinate to set higher

prices than they would in a more competitive

market. Examples - Supermarkets colluding to

force suppliers to lower prices is an example of

price collusion.

6. Pricing Power,

a. Duopoly,

i. In a duopoly, two companies have a lot of

control over the pricing and availability of

a product or service. This is because there

are only two companies in the market, so

consumers have limited options.

ii. Bertrand duopoly - In this model,

companies compete on price instead of

quantity. Each company assumes the

other's price is fixed and sets their own

 price to maximize profit. This can lead to

a price war, where prices drop to or below

the cost of production, making it difficult

for companies to make a profit.

iii. Edgeworth cycles - In this model,

companies undercut each other until one

company reaches a lower bound, such as

zero profit. The company then raises

prices to secure future profits.

iv. Monopolization - Companies may agree

to form a sort of monopoly, setting prices

that allow each company to take half of

the market. However, this can be illegal

under antitrust laws.

v. Production quantity - When companies

compete based on production quantity

instead of price, they can avoid legal

issues and share profits.

The carbonated drinks market is an

example of a duopoly, with Coca-Cola and

PepsiCo dominating the industry.

b. Industry Analysis. Industry analysis is the

process of assessing the status of an industry at

large. An industry is a segment of the economy

that consists of companies and enterprises

engaged in similar lines of business — which

may involve the production of goods or the

provision of services. Some examples of

industries include healthcare, financial services,

infrastructure and more.

i. SWOT Analysis

ii. Porter’s 5 Forces Analysis

iii. PEST Analysis
2. Profit Policy:

a. Here are some types of profit in managerial economics:

i. Economic profit - A measure of profitability that includes

opportunity costs and explicit costs. The formula for

economic profit is total revenue minus the sum of explicit

and implicit costs.

ii. Normal profit - The minimum amount of economic profit a

business must make to stay running.

iii. Marginal profit - At profit maximization, marginal profit is

zero because marginal revenue (MR) is equal to marginal

cost (MC).

iv. Net profit - An accounting metric that includes non-cash

expenses like depreciation, amortization, and stock-based

compensation.

b. Economic theory advocates profit maximisation as the chief policy

of a firm. Modem business enterprises do not accept this view and

relegate the profit maximisation theory to the back ground. This

does not mean that modem firms do not aim at profits. They do

aim at maximum profits but aim at other goals as well. All these

constitute the profit policy.

i. Industry Leadership

ii. Restricting Entry

 iii. Political Impact

iv. Customer Goodwill

v. Wage Consideration

vi. Liquidity Concern

vii. Avoid Risk

viii. Sustainability

c. Profit Forecasting.

i. Break Even analysis. - Break-even analysis is a financial

calculation that determines the point at which a business

will neither make a profit nor incur a loss.

1. Calculating the break-even point

a. Units: Break-even point (units) = fixed costs ÷

(sales price per unit – variable cost per unit)

b. Sales dollars: Break-even point (sales dollars)

= fixed costs ÷ contribution margin

 ii. Spot Projection

iii. Environmental Analysis

d. Need for Government Intervention in Markets. - to correct

market failures, promote economic fairness, and maximize social

welfare.

i. Motives

1. Promoting fair competition - Governments can

intervene to prevent monopolies that can set high

prices and underproduce.

 2. Promoting social welfare - Governments can

provide public goods like roads and street lights using

tax revenues.

3. Controlling negative externalities - Governments

can use taxes to make polluters pay for the harm they

cause to society.

4. Promoting equality - Governments can use price

floors like minimum wage to prevent workers from

being taken advantage of.

5. Correcting market failures - Governments can use

market-based policies like subsidies to correct

underproduction.

6. Curbing inflation - Governments can raise interest

rates to counteract inflation.

7. Spurring the economy - Governments can lower

interest rates to make borrowing cheaper and

encourage companies and individuals to buy more.

ii. Type of Intervention

1. Price Controls. Price controls are government-

mandated restrictions on the prices that can be

charged for goods and services. The purpose of price

controls is to manage the affordability of goods and

 services, slow inflation, or ensure a minimum income

for providers. There are two types of price controls:

a. Price ceiling: The highest price that can be

charged for a good or service

b. Price floor: The lowest price that can be

charged for a good or service

2. Support Price. Support price, also known as the

Minimum Support Price (MSP), is the price at which

the government buys commodities, especially farm

produce, to maintain a certain price level.

3. Preventions and Control of Monopolies -

Governments can prevent and control monopolies

through antitrust laws and regulations. the

Competition Act, 2002

4. System of Dual Price. Dual pricing is the practice of

setting different price points for products in different

markets.