Price determinants of various market structures

Price determinants of various market structures

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  Unit‐II Sorbent features ofprice determination and various market conditions. 9/27/2016 1NHU 501 Dr N R Kidwai, JIT Barabanki
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  Price determination inMarket 9/27/2016 2NHU 501 Dr N R Kidwai, JIT Barabanki • Market demand curve shows the Quantity demanded vs price. • Market supply curve shows the Quantity supplied vs price. • Equilibrium price at which quantities supplied is equal to quantity demanded in the market. • At the equilibrium price there is no tendency for price change • Excess demand exists when, at the current price, the quantity demanded is greater than quantity supplied. • Excess supply exists when, at the current price, the quantity supplied is greater than the quantity demanded.
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  Price determination inMarket 9/27/2016 3NHU 501 Dr N R Kidwai, JIT Barabanki Demand curve Price Quantity P2 QD2 QS2 P1 Supply curve QS1 QD1 Excess supply Excess demand Equilibrium pointEquilibrium price Pe At P2 there is excess supply in the market , Excess supply = Qs2– QD2 At P1 there is excess demand in the market, Excess demand = Qs1–QD1
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  Price determination inMarket 9/27/2016 4NHU 501 Dr N R Kidwai, JIT Barabanki • When there is EXCESS DEMAND for a good, price will tend to rise towards equilibrium. • When there is EXCESS SUPPLY for a good, price will tend to fall towards equilibrium. • When excess demand is zero, price level must be the equilibrium price, and market is said to be in equilibrium • At the equilibrium price there is no tendency for price to change till a change in either demand or supply occurs
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  How can theprice change? 9/27/2016 5NHU 501 Dr N R Kidwai, JIT Barabanki If Change in demand which can be caused due to changes in income of buyers changes in the price of substitute products changes in the prices of complementary products changes in tastes of consumers If Changes in supply which can be caused due to changes in prices of inputs changes in technology changes in taxes
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  9/27/2016 6NHU 501Dr N R Kidwai, JIT Barabanki • If total supply by industry (output) is equal to the total demand, industry is said to be in equilibrium and the prevailing price is called equilibrium price. • A firm is said to be in equilibrium if the profit of the firm is maximized and it has no incentive (benefit) to expand or contract the production Price determination under perfect competition
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  9/27/2016 7NHU 501Dr N R Kidwai, JIT Barabanki • In perfect competition market, a firms curve is perfectly elastic. i.e it can supply any quantity at the price of the market. Demand curve Price QuantityQ1 Q2 P Demand curve of a firm in perfect competition • How much firm should supply?? • The quantity which maximizes its profit. Price determination under perfect competition
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  9/27/2016 8NHU 501Dr N R Kidwai, JIT Barabanki Conditions for firm to be in equilibrium i.e. Profits are maximized • Marginal revenue (MR)=Marginal cost (MC) • MC curve should cut MR curve from below, ie. MC curve should have a positive slope It has to noted that MC curve of a firm in perfect competition market depicts firm’s supply curve AR/MR Cost/ Revenue QuantityQ1 Q2 P Demand curve of a firm in perfect competition MC Price determination under perfect competition
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  9/27/2016 9NHU 501Dr N R Kidwai, JIT Barabanki In perfect competition market a firm may earn super normal profits, normal profit or losses depending upon its cost conditions The cost components are • Fixed cost Fixed cost is incurred even if there is no production • Variable cost • Managerial services Profits If Average revenue(AR) > Average total cost(AC) ---> Super normal profits If Average revenue(AR) = Average total cost(AC) ---> Normal profits If Average revenue(AR) < Average total cost(AC) ---> Losses (In losses if AR>AVC, the firm may continue its production as part of fixed cost is recovered. If AR<AVC then firm stops production) Price determination under perfect competition
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  Price determination underperfect competition 9/27/2016 10NHU 501 Dr N R Kidwai, JIT Barabanki In perfect competition market, market conditions in the long run lead to optimal allocation of resources. The optimality condition for long run equilibrium are • The output is produced at the minimum feasible cost • Consumers pay minimum possible price. Price of product just covers marginal cost i.e P=MC • Plants are used in full capacity so that AC=MC • Firms earn only normal profit i.e. AC=AR • Firms maximize profit by putting production at the level where MC=MR and profits are normal profit
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  Price determination underperfect competition 9/27/2016 11NHU 501 Dr N R Kidwai, JIT Barabanki Qty Total Fixed Cost Total Variable cost Managerial margin MM Total cost TC AC MC Price Total Revenue TR AR MR Net Profit TR-TC+MM 8 30 42 7 79 9.88 9.88 9 72 9 9 0 9 30 51 8 89 9.89 10 9 81 9 9 0 10 30 59 9 98 9.8 9 9 90 9 9 1 11 30 66 10 106 9.64 8 9 99 9 9 3 12 35 69 10 114 9.5 8 9 108 9 9 4 13 35 77 11 123 9.46 9 9 117 9 9 5 14 35 86 12 133 9.5 10 9 126 9 9 5 15 35 96 13 144 9.6 11 9 135 9 9 4 16 35 106 14 155 9.69 11 9 144 9 9 3
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  Price determination underMonopoly 9/27/2016 12NHU 501 Dr N R Kidwai, JIT Barabanki • In Monopoly, a firm has complete control over price and supply. • How much firm should supply and at what price?? • The quantity/ price which maximizes its profit. AR/Demand Curve Cost/ Revenue QuantityQ1 Q2 P Demand curve of a firm in perfect competition MR
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  Price determination underMonopoly 9/27/2016 13NHU 501 Dr N R Kidwai, JIT Barabanki Conditions for firm to be in equilibrium i.e. Maximum Profits • Firm should supply the quantity corresponding to the point where MC=MR and where MC curve cuts MR curve from below • The shaded region (where P > AC for quantity Q at equilibrium point) shows the profit of the monopoly firm AR/Demand Curve Cost/ Revenue QuantityQ Q2 P Demand curve of a firm in perfect competition MR MC AC
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  Price determination undermonopoly 9/27/2016 14NHU 501 Dr N R Kidwai, JIT Barabanki A monopolist may earn profits or may suffer losses. If Average revenue(AR) > Average total cost(AC) ---> Super normal profits If Average revenue(AR) = Average total cost(AC) ---> Normal profits If Average revenue(AR) < Average total cost(AC) ---> Losses (In losses if AR>AVC, the firm may continue its production as part of fixed cost is recovered as it has already incurred. If AR<AVC then firm stops production)
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  Price determination underMonopoly 9/27/2016 15NHU 501 Dr N R Kidwai, JIT Barabanki Qty Total Fixed Cost Total Variable cost Managerial margin MM Total cost TC AC MC Price =AR Total Revenue TR MR Net Profit TR-TC+MM 0 2 2.2 0.4 2.5 2 10 0 10 -2 1 2 2.1 0.4 4.5 4.5 4.5 9.5 9.5 9.5 5.4 2 2 2 0.4 8.8 4.4 4.3 9 18 8.5 9.6 3 2 2 0.4 13.2 4.4 4.4 8.5 25.5 7.5 12.7 4 2 2.1 0.4 18 4.5 4.8 8 32 6.5 14.4 5 2 2.3 0.4 23.5 4.7 5.5 7.5 37.5 5.5 14.4 6 2 2.5 0.5 30 5 6.5 7 42 4.5 12.5 7 2.5 2.5 0.5 38.5 5.5 8.5 6.5 45.5 3.5 7.5 8 2.5 2.6 0.5 44.8 5.6 6.3 6 48 2.5 3.7 9 2.5 2.7 0.5 51.3 5.7 6.5 5.5 49.5 1.5 -1.3 10 2.5 2.8 0.5 58 5.8 6.7 5 50 0.5 -7.5 11 2.5 2.9 0.5 64.9 5.9 6.9 4.5 49.5 -0.5 -14.9
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  Price determination underMonopoly 9/27/2016 16NHU 501 Dr N R Kidwai, JIT Barabanki Why Electricity supply company charges home consumers less than Industrial consumers? The reasons are not associated with cost. It is price discrimination between two sub markets. Price discrimination cannot persist in perfect competition market as firms have no control over prices. Conditions of price discrimination: • Seller should have some degree of control over prices. • Various submarkets of the product exists. • Price elasticity should be different in submarkets. • Reselling of product from buyers of low priced submarket to higher priced submarket is not possible.
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  Price determination underMonopoly 9/27/2016 17NHU 501 Dr N R Kidwai, JIT Barabanki A monopolist charge higher price in the submarket which has relatively in-elastic demand. Ex. Price of a monopoly product is 40. In two submarkets (A & B) of the product the elasticity of demand is 2 and 5 respectively. MR in submarket A= AR(e-1)/e = 40 x 1/2 =20 MR in submarket B= AR(e-1)/e = 40 x 4/5 =32 Thus if supply of one unit product is reduced in ‘A’ , it will result is loss of 20 and if that unit is added in ‘B’ it will result in profit of 32, resulting in net profit of 12. Transfer of products from ‘A’ to ‘B’ will result in price rise in ‘A’ and fall in ‘B’. i.e Monopolist is discriminating between two markets. Once the MR in two sub markets are equal further transfer of product will not be beneficial.
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  Price determination under Monopolisticcompetition 9/27/2016 18NHU 501 Dr N R Kidwai, JIT Barabanki Monopolistic competition has feature of both; perfect competition and monopoly. This market has large number of firms but each firm enjoy some element of monopoly due to brand loyalty or brand association. In this market as the products have some differentiation, each firm does not have a perfectly elastic demand and is a price maker up to some extent. Conditions for firms to be in equilibrium i.e. Profits are maximized • Marginal revenue (MR)=Marginal cost (MC) • MC curve should cut MR curve from below, ie. MC curve should have a positive slope
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  Price determination underOligopoly 9/27/2016 19NHU 501 Dr N R Kidwai, JIT Barabanki Oligopoly is “competition among few”, when there are few sellers in market (2-10) selling homogeneous or heterogeneous products Due to less number of firms, they have interdependence . So It can not be assumed that other firms will remain prices and supply constant when a firm is changing prices Therefore an oligopolistic firm can not have a definite demand curve Oligopolistic believe if lowers the prices, rival firms will react with similar price change to retain its customers. However if it raises prices, rivals may not react in similar way to fetch customers from first firm and it may loose customers. Therefore oligopolistic sticks to the prevailing prices and fiersly compete on all fronts other than price.