PRICING AND OUTPUT DECISIONS

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CHAPTER 8

• PRICING AND OUTPUT DECISIONS
• UNDER
• MONOPOLISTIC COMPETITION
• OLIGOPOLY

Dr. Vasudev P. Iyer
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OBJECTIVES

• Understand the conceptual issues
• Understand how price related decisions are taken
  under monopolistic competition and oligopoly

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The Agenda
The Imperfect Competition
Meaning and features of monopolistic competition
Meaning and features of oligopoly
The Kinked Demand model of oligopoly
CASELET (17) STRATEGY- The fundamental challenge for firms in imperfect competition
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Imperfect Competition

• Imperfect Competition Less Competition, but not
  the absence of the same
• Features
• Some market power but not absolute market power.
• Have the ability to set prices within certain
  constraints
• Mutual Interdependence

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Perfect Monopolistic Comp
etition Monopoly Competition
Oligopoly Market Power? No
Yes, subject to Yes
Yes government
regulation Mutual interdependence No
No No
Yes among competing firms? Non-price
competition? No Optional
Yes Yes Easy market
entry or exit ? Yes No
Yes No,
relatively relatively

easy difficult
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MONOPOLISTIC COMPETITION
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DEFINITION

• Monopolistic competition refers to a market
  structure in which a large number of sellers sell
  differentiated products, which are close
  substitutes of one another.
• Element of competition and monopoly.

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Examples

• Examples of this very common market structure
  include
• Toothpaste
• Soap
• Cold remedies

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PRODUCT DIFFERENTIATION

• By product differentiation we mean the
  modification of a product usually in minor ways,
  to make it more attractive to the target market
  and to differentiate it from competitors'
  products.

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WHAT THE GURU HAS TO SAY ON DIFFERENTIATION ?

• PHYSICAL DIFFERENTIATION
• BRAND DIFFERENTIATION
• RELATIONSHIP DIFFERENTIATION

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THUS SPOKE THE GURU

• PHYSICAL DIFFERENTIATION
• BRAND DIFFERENTIATION
• RELATIONSHIP DIFFERENTIATION

• Sizes, shapes, colours, tastes etc.
• Different brand names
• Customer satisfaction

BE DISTINCT OR EXTINCT TOM PETERS
Source Marketing insights from A to Z by P.
Kotler, John Wiley Sons
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FEATURES

• Product differentiation
• Large number of sellers
• Free entry and free exit
• Selling costs

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OLIGOPOLY
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MEANING

• An oligopoly is a market dominated by a few large
  suppliers.
• The degree of market concentration is very high
  (i.e. a large per centage of the market is taken
  up by the leading firms)
• In case of only two firms Duopoly

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FEATURES

• A few firms selling similar product 
• Each firm produces branded products 
• High barriers to entry.
• Interdependence of decision making
• Importance of non-price competition

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Pricing under rivalry
THE KINKED DEMAND CURVE

• Developed by Prof. Paul Sweezy
• The demand curve has a bend.
• When a firm increases the price above the market
  price, other firms maintain status-quo.
• When a firm decreases the price below the market
  price, others do the same.

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OligopolyPrice Leadership Model

• One firm in the industry (typically the largest
  firm) is the price leader and, as such, takes the
  lead in changing prices.
• The price leader assumes that firms will follow a
  price increase. It assumes that firms may follow
  a reduction in price, but will not go lower in
  order not to trigger a price war.

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Oligopoly Non-price Competition

• Definition
• Any effort made by firms other than a change in
  the price of the product in question in order to
  change the demand for their product.
• Efforts intended to affect the non-price
  determinants of demand

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Non-price Determinants of Demand

• Any factor that causes the demand curve to shift
• Tastes and preferences
• Income
• Prices of substitutes and complements
• Number of buyers
• Future expectations of buyers about the product
  price

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Non-price variables

• Any factor that managers can control, influence,
  or explicitly consider in making decisions
  affecting the demand for their goods and services
• 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
• Pre-emptive new product announcements

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CASELET (17)

• STRATEGY
• The fundamental challenge for firms in imperfect
  competition

MANAGERIAL ECONOMICS KEAT AND YOUNG PG. 477
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Introduction to strategy

• Strategy is important when firms are price makers
  and are faced with price and non-price
  competition as well as threats from new entrants
  into the market.
• More important for firms in imperfectly
  competitive markets than those in perfectly
  competitive markets or monopoly markets.

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Meaning

• Strategy is defined as the means by which an
  organization uses its scarce resources to relate
  to the competitive environment in a manner that
  is expected to achieve superior business
  performance over the long run.
• Managerial Economics is the use of economic
  analysis to make business decisions involving the
  best use of an organizations scarce resources.
  (see Chapter 1)
• Important linkages between managerial economics
  and strategy.

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Division of Linkages

• Linkages are divided into two sections
• Industrial Organization
• Ideas of Michael Porter

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StrategyIndustrial Organization

• Industrial organization studies the way that
  firms and markets are organized and how this
  organization affects the economy from the
  viewpoint of social welfare.
• How does industry concentration affect the
  behaviour of firms competing in the industry?

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StrategyIndustrial Organization

• Structure-Conduct-Performance (S-C-P) Paradigm
• Structure affects conduct which affects
  performance
• Structure
• Demand and supply conditions in the industry.
• Conduct
• Pricing and non-price strategies
• Performance
• Welfare and efficiency results

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StrategyIdeas of Michael Porter

• Economics professor from the Harvard Business
  School.
• Five Forces model illustrates the factors that
  affect the profitability of a firm.

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StrategyIdeas of Michael Porter