Pricing and Output Decisions: Imperfectly Competitive Markets 5 Pricing and Output Decisions: Imperfectly Competitive Markets

Alternative Market Structures Classifying markets (by degree of competition) number of firms freedom of entry to industry free, restricted or blocked? nature of product homogeneous or differentiated? nature of demand curve degree of control the firm has over price 2

Alternative Market Structures The four market structures perfect competition monopoly monopolistic competition oligopoly 2

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Alternative Market Structures The four market structures perfect competition monopoly monopolistic competition oligopoly Structure  conduct  performance 2

Monopoly Defining monopoly Barriers to entry importance of market power Barriers to entry economies of scale economies of scope product differentiation and brand loyalty lower costs for an established firm ownership/control of key factors or outlets legal protection mergers and takeovers 8

Monopoly The monopolist's demand curve downward sloping MR below AR the greater the market power, the less elastic the demand curve MR below AR 8

AR and MR curves for a monopoly Q (units) P =AR (£) 1 2 3 4 5 6 7 8 7 6 5 4 3 2 AR, MR (£) AR Quantity

AR and MR curves for a monopoly Q (units) P =AR (£) TR (£) MR (£) 1 2 3 4 5 6 7 8 7 6 5 4 3 2 8 14 18 20 6 4 2 -2 -4 AR, MR (£) AR Quantity MR

Monopoly The monopolist's demand curve Equilibrium price and output downward sloping the greater the market power, the less elastic the demand curve MR below AR Equilibrium price and output Equilibrium output, where MC = MR 8

Profit maximising under monopoly MC £ MR O Qm Q

Monopoly The monopolist's demand curve Equilibrium price and output downward sloping the greater the market power, the less elastic the demand curve MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from D curve 8

Profit maximising under monopoly MC £ MR O Qm Q

Profit maximising under monopoly £ MC AC AR AR AC MR O Qm Q

Monopoly The monopolist's demand curve Equilibrium price and output downward sloping the greater the market power, the less elastic the demand curve MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from D curve Profit Measuring profit 8

Profit maximising under monopoly £ MC Total profit AC AR AR AC MR O Qm Q

Monopoly The monopolist's demand curve Equilibrium price and output downward sloping the greater the market power, the less elastic the demand curve MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from D curve Profit Measuring profit Supernormal profit can persist in long run 8

Monopoly Monopoly versus perfect competition lower short-run output at a higher price supernormal profit not competed away costs under monopoly lack of competition to drive down costs BUT possibility of substantial economies of scale innovation and new products less incentive to innovate BUT greater possibility of innovation through investing ploughed-back profit competition for corporate control 8

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ AR = D MR Monopoly P1 O Q1 Q

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC ( = supply under perfect competition) Comparison with Perfect competition P1 P2 AR = D MR O Q1 Q2 Q

Monopoly Monopoly versus perfect competition lower short-run output at a higher price supernormal profit not competed away 8

Monopoly Monopoly versus perfect competition lower short-run output at a higher price supernormal profit not competed away costs under monopoly lack of competition to drive down costs BUT possibility of substantial economies of scale 8

Monopoly Monopoly versus perfect competition lower short-run output at a higher price supernormal profit not competed away costs under monopoly lack of competition to drive down costs BUT possibility of substantial economies of scale innovation and new products less incentive to innovate BUT greater possibility of innovation through investing ploughed-back profit 8

Monopoly Monopoly versus perfect competition lower short-run output at a higher price supernormal profit not competed away costs under monopoly lack of competition to drive down costs BUT possibility of substantial economies of scale innovation and new products less incentive to innovate BUT greater possibility of innovation through investing ploughed-back profit competition for corporate control 8

Oligopoly Key features of oligopoly Competition versus collusion barriers to entry interdependence of firms Competition versus collusion Collusive oligopoly cartels equilibrium of the industry

Profit-maximising cartel £ Industry D = AR O Q

Profit-maximising cartel £ Industry MC P1 Q1 Industry D = AR Industry MR O Q

Oligopoly Key features of oligopoly Competition versus collusion barriers to entry interdependence of firms Competition versus collusion Collusive oligopoly cartels equilibrium of the industry allocating and enforcing quotas

Oligopoly Collusive oligopoly (cont.) tacit collusion price leadership rules of thumb factors favouring collusion few firms which are open with each other similar cost structures similar products there is a dominant firm significant barriers to entry stable market conditions no government measures to curb collusion

Oligopoly The breakdown of collusion Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games

Profits for firms A and B at different prices X’s price £2.00 £1.80 A B £5m for Y £12m for X £2.00 £10m each Y’s price C D £12m for Y £5m for X £1.80 £8m each

Oligopoly The breakdown of collusion Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium

Profits for firms A and B at different prices X’s price £2.00 £1.80 A B £5m for Y £12m for X £2.00 £10m each Y’s price C D £12m for Y £5m for X £1.80 £8m each

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma more complex non-dominant strategy games

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma more complex non-dominant strategy games the importance of threats and promises

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma more complex non-dominant strategy games the importance of threats and promises are threats seen by rivals as credible?

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma more complex non-dominant strategy games the importance of threats and promises are threats seen by rivals as credible? the importance of timing

Oligopoly Non-collusive oligopoly: game theory alternative strategies optimistic or cautious approach? simple dominant strategy games Nash equilibrium the prisoners’ dilemma more complex non-dominant strategy games the importance of threats and promises are threats seen by rivals as credible? the importance of timing decision trees

A decision tree Airbus decides Boeing decides Airbus decides (1) B1 Boeing –£10m Airbus –£10m (1) 500 seater Airbus decides B1 500 seater 400 seater Boeing +£30m Airbus +£50m (2) Boeing decides A 400 seater Boeing +£50m Airbus +£30m (3) 500 seater Airbus decides B2 400 seater Boeing –£10m Airbus –£10m (4)

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model

Kinked demand for a firm under oligopoly £ Current price and quantity give one point on demand curve P1 Q1 O Q

Kinked demand for a firm under oligopoly £ D P1 D O Q Q1

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices

Stable price under conditions of a kinked demand curve £ MC2 MR MC1 P1 a b D = AR O Q Q1

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices limitations of the model

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices limitations of the model Oligopoly and the consumer

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices limitations of the model Oligopoly and the consumer advantages

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices limitations of the model Oligopoly and the consumer advantages disadvantages

Oligopoly Non-collusive oligopoly: the kinked demand curve theory assumptions of the model stable prices limitations of the model Oligopoly and the consumer advantages disadvantages difficulties in drawing general conclusions

Alternative Aims to Profit Maximisation separation of ownership and control the principal–agent problem managerial utility maximisation profit satisficing Sales revenue maximisation (short run) equilibrium output and price comparisons with short-run profit maximising implications for advertising 2

Sales revenue maximising price and output £ MC Profit-maximising price and output P1 AR O Q1 Q MR

Sales revenue maximising price and output £ MC Sales revenue maximising price and output P1 P2 AR O Q1 Q2 Q MR

Alternative Aims to Profit Maximisation separation of ownership and control the principal–agent problem managerial utility maximisation profit satisficing Sales revenue maximisation (short run) equilibrium output and price comparisons with short-run profit maximising implications for advertising implications for the consumer 2

Alternative Aims to Profit Maximisation Growth maximisation measuring ‘growth’ equilibrium for growth maximising firm? Multiple aims satisficing and the setting of targets different stakeholders with different aims various possible targets potential conflicts between targets organisational slack a way of reconciling conflicting aims? cutting slack with 'just-in-time' methods 3

Pricing in Practice Do firms know their costs and revenues? difficulties in identifying the profit-maximising price and output difficulties in predicting rivals’ behaviour Cost-based pricing the use of a profit mark-up on AC choosing the level of output choosing the mark-up

Choosing the output and profit mark-up £ D f g P1 AC Q1 j h P2 Q2 O Q

Pricing in Practice Do firms know their costs and revenues? difficulties in identifying the profit-maximising price and output difficulties in predicting rivals’ behaviour Cost-based pricing the use of a profit mark-up on AC choosing the level of output choosing the mark-up equilibrium price and output?

Pricing in Practice Do firms know their costs and revenues? difficulties in identifying the profit-maximising price and output difficulties in predicting rivals’ behaviour Cost-based pricing the use of a profit mark-up on AC choosing the level of output choosing the mark-up equilibrium price and output? variations in the mark-up

Pricing in Practice Price discrimination meaning of price discrimination charging different prices to different consumers for reasons unrelated to costs the prices depend on price elasticity of demand 9

Price discrimination P P1 D O Q 200

Price discrimination P P2 P1 D O Q 150 200

Pricing in Practice Price discrimination (cont.) conditions for price discrimination firm must be able to set its price markets must be separate demand elasticity must differ between markets advantages to the firm higher profits possibility of cross-subsidisation 9

Pricing in Practice Pricing and the product life cycle the four stages launch growth maturity decline competition and pricing in each stage

The stages in a product’s life cycle Sales per period O Time

The stages in a product’s life cycle Product not becoming obsolete Sales per period Product becoming obsolete O (1) Launch (2) Growth (3) Maturity (4) Decline Time