Managerial Economics

Unit - 5
Ms Archana Vijay
Topics to be covered :
Market Structure: Perfect Competition: Features, Determination of Price under Perfect
Competition - Monopoly: Features, Pricing under Monopoly, Price Discrimination - Oligopoly:
Features, Kinked Demand Curve, Cartel, Price Leadership - Monopolistic Competition: Features,
Pricing under Monopolistic Competition, Product Differentiation
Pricing - Descriptive Pricing approaches : Full cost Pricing, Product Line pricing, Product Life cycle
pricing, Pricing strategies - Price Skimming, Penetration Pricing, Loss leader pricing, Peak Load
pricing.
Meaning of Market
Economists understand by the term market not any particular market place in which things are
bought and sold but the whole of any region in which buyers and sellers are in such free
intercourse with one another that the price of the same goods tends to equality easily and
quickly.
Thus the essentials of a market are:
• Commodity which is dealt with
• The existence of buyers and sellers
• A place, be it a certain region, a country or the entire world, and
• Such contact between buyers and sellers that only one price should prevail for the same
commodity at the same time.

Classification of Market Structure:

The popular basis of classifying market structure rests on two crucial elements,

1) The number of firms producing a product and

2) The nature of product produced by firms, that is, whether it is homogeneous or
differentiated.
3) The ease with which new firms can enter the industry.

The price elasticity of demand for a firm’s product depends upon the number of competitive
firms producing the same or similar product as well as on the degree of substitution which is
possible between the product of a firm and other products produced by rival firms. Therefore, a
distinguishing feature of different market structures is the degree of price elasticity of demand
faced by an individual firm.

The table given below is the classification of market structures based on the number of firms, the
nature of product produced by them and whether entry into an industry is free or restricted.

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 Form of structure Number of Nature of product Ease of Entry Price Degree
firms into an Elasticity of
Industry of Demand Control
for a over
product of Price
an
Individual
Firm
(a) Perfect Competition A large Homogeneous Free entry Infinite None
number of product and exit
firms
(b) Imperfect Competition
1- Monopolistic A large Differentiated Free entry in Large Some
competition number of products (which the sense
firms are close that new
substitutes of firms can
each other) produce only
close
substitute
2- Pure Oligopoly Few Firms Homogeneous Barriers to Small Some
(i.e. Oligopoly product Entry
without Product
Differentiation)
3- Differentiated Few Firms Differentiated Barriers to Small Large
Oligopoly (i.e. products (which entry
Oligopoly with are close
product substitutes of
Differentiation) each other)
(C) Monopoly One Unique product Strong Very small Very
without close Barriers to Large
substitutes Entry

The different market conditions prevail in various industries. In some of the market structures
the forces demand and supply do not work freely. In particular, the degree of competition faced
by firms in various categories of market structure greatly differs. In fact, the market structure is
classified into four categories:

1) Perfect Competition
2) Monopoly
3) Monopolistic Competition
4) Oligopoly

Classification of Market Structure

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 Classification of Markets

Area Wise Competition

Local Markets Perfect Competition

Regional Markets Monopoly

National Markets Oligopoly

World Markets Monopolistic Competition

• Local Markets : Markets pertaining to local areas are called local markets. Local market
has a narrow geographical coverage. It is confined to a particular village, town or city only.
Perishable goods like milk, fruits, vegetables etc. have local markets.
• Regional Markets : There are regional markets when goods are sold in particular region
only. For eg. Textbooks sanctioned by Karnataka State SSC Board have a regional market.
• National Markets : When goods are demanded and sold on a nationwide scale, there is a
national market. A large number of items such as TV sets, cars, scooters, fans etc.
produced by big companies have national markets.
• World Markets : When goods are traded internationally, there exist world markets or
international markets. We use the term exports and imports of goods in world markets.

Perfect Competition
Perfect competition refers to the market structures where competition among the sellers and
buyers prevails in its most perfect form. In the perfectly competitive market, single market price
prevails for the commodity, which is determined by the forces of total demand and total supply
in the market. Under perfect competition, every participant is a price taker. Everyone has to
accept the prevailing market price, as individually no one is in a position to influence it.

Characteristics of Perfect Competition

• Large number of sellers : The number of sellers is sufficiently large and as the size of each
firm is relatively small, so the individual seller’s or firm’s supply is just a fraction of the
market supply. Thus, an individual firm or seller cannot exert any influence on the ruling
market price. In a perfectly competitive market, thus a firm is a price taker.
• Large number of buyers : Each individual buyer’s demand constitutes just a fraction of
the total market demand. Hence, no individual buyer is in a position to exert his influence
on prevailing price of the product.

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 • Product homogeneity : The commodity supplied by each firm in a perfectly competitive
market is homogeneous. That means, the product of each seller is virtually standardized,
i.e., there is no product differentiation.
• Free entry and exit of firms : There is free entry of new firms into the market. There is no
legal, technological, economic, financial or any other barrier to their entry. Similarly,
exiting firms are free to quit the market.
• Perfect knowledge of market conditions : Perfect competition requires that all the buyers
and sellers must possess perfect knowledge about the existing market conditions,
especially regarding the market price, quantities and sources of supply.
• Perfect mobility of factors of production : Perfect mobility of factors alone can ensure
easy entry or exit of the firms.
• Government non-intervention : There is no government intervention in the working of
market economy. That is to say, there are no tariffs, subsidies, rationing of goods, control
on supply of raw materials, licensing policy or other government interference.

Market Demand Curve and Firm’s Demand Curve

The market demand curve for the whole industry is a standard downward sloping curve, which
shows alternative combinations of price and output available to the buyers, such that an
individual buyer is able to get the maximum amount of output at each existing price, at a given
time.
The market supply curve is upward sloping, giving various combinations of price and output. In
fig. market equilibrium is reached at the point of intersection of the market demand and market
supply curves, i.e, at E ; equilibrium output for the industry is given at Q. Since a firm can sell all
it wants at this price, it faces an infinitely elastic demand curve for its product. Such a shape of
the demand curve also implies that the firm can sell not even a single unit of its product at even
a slightly higher price. Hence the demand curve of the firm will be a straight horizontal line,
showing perfect elasticity of demand, and this infinitely elastic demand curve, drawn at market
price, coincides with the AR and MR curves.

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\

Price Determination under Perfect Competition

Under perfect competition, there is a single ruling market price – the equilibrium price,
determined by the interaction of forces of total demand and total supply. To explain the prices
of intersection, consider the table :
Possible price Total demand Total Supply Pressure on price
20 1000 10000 Downward
19 3000 8000 Downward
18 4000 6000 Downward
17 5000 5000 Neutral
16 7000 4000 Upward
15 10000 2000 Upward

When the price is Rs. 20, supply of wheat is 10000 kg. but demand for wheat is only 1000 kg.
Hence 9000 kg of wheat supply remains unsold. This would bring a downward pressure on price,
as the seller would compete and the force will push down the price. This falling of price continues
till the price settles at Rs. 17 per kg. at which the same amount is demanded as well as supplied.
This is termed as equilibrium price.
If however, we begin from a low price, we find that the demand exceeds the supply. Thus there
is a shortage at Rs. 15 per kg. This causes an upward pressure on the price, so the price will tend
to move up. When the price rises, the demand contracts and the supply expands. This process
continues till the equilibrium price is reached.

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MONOPOLY
Monopoly is a form of market structure in which a single seller or firm has control over the entire
market supply, as there are no close substitutes for his products and there are barriers to the
entry of rival producers.

Features of Monopoly
• Single Firm : The monopolist is the single producer in the market. Thus, under monopoly
firm and industry are identical.
• No substitute : There are no closely competitive substitutes for the product. So the buyers
have no alternative or choice.
• Anti-thesis of competition : Being a single source of supply, monopoly is a complete
negation of competition.
• Price-maker : A monopolist is a price maker and not a price taker. He is in a position to fix
the price for the product as he likes. He can vary the price from buyer to buyer. In a
monopoly, there may be price differentiation.
• Downward sloping demand curve : This means it cannot sell more output unless the price
is lowered.
• Entry barriers : There are legal, technological, economic or natural obstacles, which may
block the entry of new firms.
• Price-cum output determination : Since a monopolist has a complete control over the
market supply for his product, he can fix the price as well as quantity of output to be sold
in the market.

Types of Monopoly
• Legal Monopoly : Some monopolies are created by the laws of a country in the greater
public interest. If the government of the nation feels that private control may lead to
disparity in distribution of wealth, or imbalanced growth of the economy, it may keep the
resources in its own control by imposing legal restrictions on the entry of other players.
For eg. Even today electricity continues to be a State Monopoly in most of the States.

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 • Economic Monopoly : Whenever competition is eliminated due to economic or
managerial inefficiency of other players, or due to superior efficiency of a particular
player, the monopoly thus created is regarded as an economic monopoly. For eg.
Microsoft is now the most popular name in the computer industry as it has acquired a
virtual monopoly status through economic efficiency.
• Natural Monopoly : A natural monopoly exists when a firm acquires control over certain
scarce and key raw materials. For DeBeers has the control over 80% of the world’s
diamond supply.
Sources of Monopoly Power
• Exclusive control on Natural Source
• Exclusive Possession of Technical Knowledge
• Exclusive ownership of raw materials
• Legal sources
• Economies of Large Scale : Big and old firms enjoy economies of large scale on
technological grounds by employing complex capital and thus hold a degree of monopoly
power

Nature of Demand and Marginal Revenue Curves under Monopoly

In the case of monopoly one firm constitutes the whole industry. Therefore, the entire demand
of the consumers for a product faces the monopolist. Since the demand curve of the consumers
for a product slopes downward, the monopolist faces a downward sloping demand curve.
Demand curve facing the monopolist will be his average revenue curve. Thus, the average
revenue curve of the monopolist faces downward throughout its length. Since average revenue
curve slopes downward, marginal revenue curve will lie below it. This follows from usual average-
marginal relationship.
Consider Fig where DD’ is the demand or average revenue curve of the monopolist. At price OP
of the product the quantity OQ is demanded. Now if the monopolist sells more than this, say OQ’,
price falls to OP’. Thus by selling one unit more of the product and with the reduction in price to
OP’ the monopolist’s gain in revenue is equal to the shaded area QTSQ’. Since the previous units
OQ are now sold at the lower price OP’, the loss in revenue on these units is equal to the shaded
area PKTP’. To find the marginal revenue, we have to subtract the loss in revenue PKTP’ incurred
on the previous units from the gain in revenue QTSQ’ by selling an additional unit of output.

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Price and Output under Monopoly
The rational behavior demands that the firm should maximize profits. The equilibrium of the
monopolist regarding price and output is shown. Since a monopolist has a control over the price
of his product , he does not take the price as given and constant. But if he raises the price, the
quantity demanded of it will fall and if he lowers the price, the quantity demanded will increase.
He chooses price-output combination which maximizes his profits. Profits are maximized at the
level of output at which revenue of an extra unit of output (MR) is equal to marginal cost (MC) of
the extra unit. Thus to achieve, maximum profits the monopolist follows the rule,
MR = MC
Thus, monopolist will go on producing additional units of output so long as marginal revenue
exceeds marginal cost.
But price under monopoly is greater than marginal cost. The extent to which price will exceed
marginal cost depends on the price elasticity of demand at the equilibrium level of output.
Price > MC

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Price Discrimination
Price discrimination refers to the practice of a seller of selling the same product at different prices
to different buyers. A seller makes price discrimination between different buyers when it is both
possible and profitable for him to do so. If the manufacturer of a refrigerator of a given variety
sells it at Rs. 5000 to one buyer and at Rs. 5100 to another buyer (all conditions of sale and
delivery being the same in two cases) he is practicing price discrimination.

Degrees of Price Discrimination

Price Discrimination of the First Degree : When the seller is able to charge different prices for
different units of the same product from the same consumer, such a practice is called price
discrimination of first degree. In this case, the firm charges the maximum price from the buyer
for each unit sold in a ‘take it or leave it’ kind of situation and thus takes away the entire
consumer surplus. For eg. Doctor charging different fee to poor and rich people.

Price Discrimination of the Second Degree : In this case, the seller divides consumers into
different groups and from each group a different price is charged which is the lowest demand
price of that group. In this the price is charged based on the volume of usage. The rationale
behind this is that the willingness to pay for more and more units is seen to fall with increase in
consumption of the commodity. For eg. Railway fare for the first few kilometres is high as
compared to subsequent kilometres.

Price Discrimination of the Third Degree : This is said to occur when the seller divides his buyers
into two or more than two sub-markets or groups and charges a different prices in each sub-
market. The price charged in each sub-market need not be the lowest demand price of that sub-
market.The price charged in each sub-group depends upon the output sold in that sub-market
and the demand conditions of that sub-market. For eg. An electric sells electric power at low
price to household consumers and high price to industrial consumers. Different rates of tickets
for different seats in a movie theatre.

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When is Price Discrimination Possible?
Two fundamental conditions are necessary for the price discrimination to become possible. First,
price discrimination can occur only if it is not possible to transfer any unit of the product from
one market to another.
Second essential condition for price discrimination to occur is that it should not be possible for
the buyers in the expensive market to transfer themselves into the cheaper market to buy the
product or service at the lower price.
Price discrimination is possible in the following cases :
• Nature of the commodity : The nature of the commodity or service may be such that
there is no possibility of transference from one market to the other. The surgeons usually
charge different fees from the rich and poor for the same kind of operation.
• Long Distances or Tariff Barriers : Discrimination often occurs when the markets are
separated by large distance or tariff barriers so that it is very expensive to transfer goods
from a cheaper market to be resold in the expensive market.
• Legal sanction : For eg. An electricity company sells electricity at a lower price if it is used
for domestic purposes and a higher price if it is used for commercial purposes.
• Preferences or Prejudices of the Buyers : The same good is generally converted into
different varieties by providing different packings, different labels or names in order to
convince the buyer that certain varieties are superior to others.
• Ignorance and laziness of buyers : If a seller is discriminating between two markets but
the buyers of the dearer market are quite ignorant of that fact that the seller is selling the
product at a lower price in another market, then price discrimination by the seller will
persist.
When is Price Discrimination Profitable?
• Price Discrimination is profitable only if elasticity of demand in one market is different
from elasticity of demand in the other.
Monopolistic Competition
Monopolistic Competition refers to the market organization in which there is keen competition,
but neither perfect nor pure, among a group of a large number of small producers or suppliers
having some degree of monopoly power because of their differential products. Thus,
monopolistic competition is a mixture of competition and a certain degree of monopoly power.

Features of Monopolistic Competition

• Large number of sellers : A market organization characterized by monopolistic
competition must have a sufficiently large number of sellers or firms selling closely related
but not identical products. The large number of firms, in the same line of production,
leads to competition. Since there is no homogeneity of goods supplied, competition tends
to be impure but keen.
• Product Differentiation : It is the most distinguishing feature of monopolistic competition
that the product of each seller is branded and identified. Unlike perfect competition; thus
there is no homogeneity of products.

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 • Large number of buyers : There are a large number of buyers in this type of market.
However, each buyer has a preference for a specific brand of the product.
• Free entry : There are no entry barriers. Firms can enter or quit freely.
• Selling costs : Since products are differentiated and may be varied from time to time,
advertising and other forms of sales promotion become an integral part in marketing the
goods.
• Two-dimensional Competition : Monopolistic competition has two facets : a) price
competition and b) non-price competition. Non price competition is in terms of product
variation and selling costs incurred by each seller to capture his share in the market.

Price and Output Decision in the Short Run

Firms under monopolistic competition will have limited discretion over price, due to the
existence of customer loyalty. Any representative firm in this market follows the MR = MC rule
in order to maximize profits.

Product Differentiation
Product Differentiation is a unique feature of monopolistic competition. Differentiating your
product from those of competitors is called product differentiation. There are many ways of
making products different from one another. Branding is the most common and essential aspect
of unique identification of product.
Basis of Product Differentiation
• Quality and Features of the Product : Products of different firms may have real or
physical differences in their functional features – the mode of use and operations, size,
design and style, strength and durability, differences in the quality of materials, chemical
composition etc. For eg. Apple products are known for their unique and innovative
features.
• Service Differentiation : Providing good after sales services to the customer can also be
a differentiating factor. For eg. Terms of trade, such as discount and credit, acceptance
of returned goods, and guarantee of service and repairs etc. For eg. LG provides good
after sales services to its customers. Singapore Airlines has earned good reputation on
account of its service, better food, comfortable seats, safety norms etc.
• Personnel Differentiation : Attitude and courteous approach of the personnel attending
to customers. For eg. Personnel of McDonalds attend the customer with a warm smile
on their faces.
• Product Prestige : Through material differences with brand developments, producers can
create product prestige of the firms in the market. For eg. Sony has created its product
prestige of electronics goods in the markets world over.
• Location : For eg. Petrol Pumps business very much depends on its locational advantage.
• After sales service : In durable goods such as electrical appliances, air conditioners,
refrigerators, TV sets etc. the firms provide after sales service for repairing, replacements
etc. Warranty period is also added to differentiate and compete in the market.

OLIGOPOLY
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It is a market situation comprising only a few firms in a given line of production. Their products
may be standardized or differentiated. The price and output policy of oligopolistic firms are
interdependent. The oligopoly model fits well into such industries as automobile, Petroleum
Industry, Cement Industry etc.

Pure Oligopoly and Differentiated Oligopoly

Market condition of oligopoly in which firms produce identical products is called as Pure
Oligopoly. Eg. Petrol, Cement, Steel etc.
Market condition of oligopoly in which firms produce differentiated products is called
Differentiated Oligopoly. Eg. Automobile.
Features of Oligopoly
• Few sellers : There are a few sellers supplying either homogeneous products or
differentiated products.
• Homogeneous or distinctive product : The Oligopoly firm may be selling a homogeneous
product. For eg. Steel, Cement, Petrol. These can be a unique or distinctive product eg.
Automobile – Passenger Cars.
• Blocked Entry and exit : Firms in the oligopoly market face strong restrictions on entry or
exit.
• Imperfect dissemination of information : Detailed market information relating to cost,
price and product quality are usually not publicized.
• Interdependence : The firms have a high degree of interdependence in their business
policies about fixing of price and determination of output.
• High Cross elasticities : The firms under oligopoly have a high degree of cross elasticities
of demand for their products, so there is always a fear of price war amongst the frims.
• Advertising : Advertising and selling cost have strategic importance to oligopoly firms.
Each firm tries to attract consumers towards its product by incurring excessive
expenditure on advertisements.
• Price rigidity : In an oligopolistic market, each firm sticks to its own price. This is because,
it is in constant fear of retaliation from rivals if it reduces the price.
• Kinked Demand curve : Firms in an oligopolistic market have a kinked demand curve for
their products.

Collusive Oligopoly
An important characteristic of oligopoly is collusion, in which rival firms enter into an agreement
in mutual interest on various accounts such as price, market share etc. Collusion are of two types
: a) Cartels and b) Price Leadership. In a cartel type of collusive oligopoly, firms jointly fix a price
and output policy through agreements. But under price leadership, one firm sets the price and
others follow it. The one which sets the price is a price leader and the others who follow it are its
followers.
Cartel : A cartel is a formal agreement among firms. Cartels usually occur where there are a small
number of sellers and the product is usually homogeneous. Formation of cartel normally involves
agreement on price fixation, total industry output, market share, allocation of customers,

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allocation of territories, establishment of common sales agencies, division of profits, or any
combination of these. The immediate impact of cartelization is a hike in price and a reduction in
supply. Eg. Cartels formed in Cement Industry, Petrol Dealers etc.
Cartels can be of two types : Centralised Cartels and market sharing cartels.
Centralised Cartel : A centralized cartel is one in which cartelization is perfect. It is an
arrangement by all the members, with the objective of maximizing joint profits. In such type of
arrangement the product is essentially homogeneous and a centralized body decides on the
pricing of the product.
Market Sharing Cartel : It is that form of collusion in which members decide to divide the market
share among them and fix the price independently. The basic assumption here is that all the firms
have the same cost functions because they are producing a homogeneous product. They agree
to sell the product in the allotted market segment and to not enter other’s segments. There are
two methods of market sharing : non-price competition and quotas.

Price Leadership : Price Leadership is an important oligopoly problem and is similar to collusive
oligopoly model. The competing oligopolists in an informal meeting choose a leader and agree to
follow him in setting price.
Types of Price Leadership
Price Leadership is of various types. Firstly, there is a price leadership by a low-cost firm. In order
to maximize profits the low cost firm sets a lower price than the profit-maximizing price of the
high cost firms. Since the high cost firms will not be able to sell their product at the higher price,
they are forced to agree to the low price set by the low-cost firm. Of course, the low cost price
leader has to ensure that the price which he sets must yields some profits to the high-cost firms
– their followers.
Secondly, there is a price leadership of the dominant firm. Under this one of the few firms in the
industry may be producing a very large proportion of the total production of the industry and
may therefore dominate the market for the product. This dominant firm wields a great influence
over the market for the product, while other firms are small and are incapable of making any
impact on the market. As a result, the dominant firm estimates its own demand curve and fixes
a price which maximizes its own profits. The other firms which are small having no individual
effects on the price, follow the dominant firm and accepting the price set by it adjust their output
accordingly.

Difficulties of Price Leadership

• First, the success of price leadership of a firm depends upon the correctness of his
estimates about the reactions of his followers. If his estimates about the reactions of his
rivals to price changes by it prove to be incorrect, then not only the success of his price
policy but also his leadership in the market will be jeopardized.
• Secondly, when a price leader fixes a higher price than the followers would prefer, there
is a strong tendency for the followers to make hidden price cuts in order to increase their
shares of the market without openly challenging the price leader.
• Another important difficulty of maintaining price leadership is the tendency on the part
of the rivals to indulge in non-price competition to increase sales while go on charging the
price set by the price leader.

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 • Further, there is a great limitation on the price leader to fix a high price of his product.
This is because the high price will induce the rivals to make secret price cuts which will
adversely affect the sales of the price leader.

Kinked Demand Curve

The kinked demand curve hypothesis was given by Paul M Sweezy, an American Economist, and
by Hall and Hitch, Oxford Economist.
It is for explaining price and output under oligopoly with product differentiation, that economists
often use the kinked demand curve hypothesis. This is because when under oligopoly products
are differentiated, it is unlikely that when a firm raises its price, all customers would leave it
because some customers are intimately attached to it due to product differentiation. As a result,
demand curve facing a firm under differentiated oligopoly is not perfectly elastic. On the other
hand, under oligopoly without product differentiation, when a firm raises its price, all its
customers would leave it so that demand curve facing an oligopolist producing homogeneous
product may be perfectly elastic.
Kinked Demand Curve has a special relevance for differentiated oligopoly, but it has also been
applied for explaining price and output under oligopoly without product differentiation.
The demand curve facing an oligopolist, according to the kinked demand curve hypothesis, has a
kink at the level of the prevailing price. The kink is formed at the prevailing price level because
the segment of the demand curve above the prevailing price level is highly elastic and the
segment of the demand curve below the prevailing price level is inelastic. A kinked demand curve
dD with a kink at point K has been shown in Fig.

K
Kinked Demand Curve
P under Oligopoly
Price

Quantity
The prevailing price level is OP and the firm is producing and selling the output OM. Now, the
upper segment dK of the demand curve dD is relatively elastic and the lower segment KD is
relatively inelastic. This difference in elasticities is due to the following competitive reaction :

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Each oligopolist believes that if he lowers the price below the prevailing level, his competitors will
follow him and will accordingly lower their prices, whereas if he raises the price above the
prevailing level, his competitors will not follow his increase in price.
Each oligopolistic firm believes that though its rival firms will not match his increase in price above
the prevailing level, they will indeed match its price cut. These two different types of reaction of
the competitors to the increase in price on the one hand and to the reduction in price on the other
make the portion of the demand curve relatively inelastic.
a) Price Reduction : If the oligopolist reduces its price below the prevailing price level OP in
order to increase his sales, the competitors will fear that their customers would go away
from them to buy the product from the former oligopolist which has made a price cut.
Therefore, inorder to retain their customers they will be forced quickly to match the price
cut. Because of the competitors quickly following the reduction in price by an oligopolist,
he will gain in sales only very little. Very small increase in sales of an oligopolist following
his reduction in price below the prevailing level means that the demand for him is inelastic
below the prevailing level. Thus the segment KD of the demand curve in Fig which lies
below the prevailing price OP in inelastic showing very little increase in sales by reduction
in price by an oligopolist.
b) Price increase : If an oligopolist raises his price above the prevailing level, there will be a
substantial reduction in his sales. This is because as a result of the rise in his price, his
customers will withdraw from him and will go to his competitors who will welcome the
new customers and will gain in sales. These happy competitors will therefore do not
increase the price. The oligopolist who raises his price will be able to retain only those
customers who are loyal to them. Large reduction in sales following an increase in price
above the prevailing level by an oligopolist means that demand with respect to increase
in price above the existing one is highly elastic. Thus, in Fig the segment dK of the demand
curve, which lies above the current price level OP is elastic showing a large fall in sales if
a producer raises his price.

Examples of Market Structure

Foodgrains : Rice and wheat – Perfect Competition
Stock Market – Perfect Competition
Market for Bus Transport in New Delhi, Railways – Monopoly
Passenger Cars – Oligopoly
Petrol – Oligopoly
Confectionery , FMCG Goods– Monopolistic Competition

Importance of Pricing
 Price is the amount of money charged for a product or service.
 Total value that customers exchange for the benefits of having or using products or
services.
 Of all the elements, price is the only one that generates revenue. All other generates
only cost.
 Most important determinant of the profitability of any company.

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  By manipulating the price, the company adjusts the level of cash flow and funds
available for other elements of the marketing mix.

Pricing Strategies
1. Full Cost Pricing / Mark-up pricing – Add a standard markup for profit to the producer’s
cost.
Variable cost per unit = Rs. 10
Fixed Cost = Rs. 300000
Expected unit sales = 50000
Unit cost is given by = VC + FC
Unit sales = 10 + 300000 = Rs. 16
50000
Earn 20% mark up on sales
Mark up price = Unit cost + .2 * unit Cost
= 16 + .2 * 16 = Rs 19.2
2. Marginal Cost Pricing : When demand is slack and market is highly competitive, full cost
pricing may not be the right choice. An alternative in such a situation is to fix the price
on the basis of variable cost, instead of full cost. The method remains same except that
only variable cost is considered instead of total cost for the purpose of price
determination. Also known as incremental cost pricing.
Marginal Cost Price = Rs. 10 + (.2 * 10) = Rs. 12

3. . Target Return Pricing - Firm determines the price that would yield its target rate of a
ROI. For eg. Invested Rs. 10,00000 in the business and wants to set a price to earn a 20%
ROI, specifically Rs. 200000.

Target Return price = Unit cost + Desired Return x Invested capital

Unit sales

= 16 + 0.20 x 1000000 = Rs. 20

50000

4. Market skimming pricing – Objective is profit maximization and to skim the market and
take the cream, by pricing the new product high and concentrating on market segments
which are not price sensitive. This strategy will bring in high profits which could be
ploughed back for further market development and promotion. It can be undertaken when
the product is innovative and the manufacturer generates the maximum amount of revenue

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 from the various segments until other competitors step in. Then the price is reduced
gradually to attract the next price sensitive layer of customers. Eg Sony charges high price
for Hi-Definition TV in the beginning.

5. Penetration pricing – If the new product is likely to be highly price sensitive and if there
is no wealthy market for it, penetration pricing is restored to. Here the objective is to
penetrate a large market using low prices and to capture the maximum market share. The
large volume of sales generated will bring in economies in unit cost of production and
marketing cost and thus reducing the cost of production. Once the sales volume has been
generated, the marketer slowly increase the price. Eg. When Reliance launched the mobile
services , they charged very reasonable price to capture the market share in the beginning
and gradually raised the prices.

6. Product Line Pricing - The process used by retailers of separating goods into cost
categories in order to create various quality levels in the minds of consumers. Effective
product line pricing by a business will usually involve putting sufficient price gaps between
categories to inform prospective buyers of quality differentials. Also called price lining.
For instance, Marriott Hotels has hotels in various categories based on the facilities and
luxury and are priced differently as Courtyard Marriott, Fairfield Inn, Residence Inn etc.

7. Peak Load Pricing - The Peak Load Pricing is the pricing strategy wherein the high price
is charged for the goods and services during times when their demand is at peak. In other
words, the high price charged during the high demand period is called as the peak load
pricing. For example, cinema halls charged the high ticket price on weekends and low on
weekdays. The peak load pricing is widely used in the case of non-storable goods such as
electricity, transport, telephone, security services, etc. These are the goods which cannot
be stored and hence their production is required to be increased to meet the increased
demand.

For example, during summers, the electricity consumption is highest during the daytime as
several offices and educational institutes are operational during the day time, called as a peak-
load time. While the electricity consumption is lowest during the night as all the office
establishments and educational institutes are closed by this time, called as off-peak time. Thus, a
firm will charge a relatively higher price during the daytime as compared to the price charged at
night.

8. Product Life Cycle Pricing – Each product passes through different stages of the
Product Life Cycle and is priced differently in each stage.

#1 Development

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The initial stage of a product’s life cycle, development, is when the product is first introduced to
the market. Typically, sales are slow during this stage because consumers are unfamiliar with the
new product.

Sales are especially slow when the product is unique because consumers might not have an instant
demand for it. But, there is generally low competition.

Pricing strategy in this stage: Many businesses either price their products low or high, depending
on their industry and financial projections. Pricing products low (market penetration) helps a
business penetrate the market and gain consumer attention. Once the business has a loyal customer
base, it typically increases prices.

Businesses might choose to introduce products with high prices. You might price products high
(price skimming) to try to turn a quick profit and make up for the costs of developing. Pricing
products high is especially good if there is a demand for a product and lack of competition.

#2 Growth

During the growth stage of the life cycle of a product, there is high demand for the product and a
lot of sales. Though this is a really great stage for the product, there are some drawbacks.

You might need to work on getting your customers to choose your product over the competition.
This could require more marketing and lowering your prices. You might try to market to new
customers.

Pricing strategy in this stage: Because of the competition, you might need to lower your prices
and adopt a competitive pricing strategy.

#3 Maturity

In the maturity stage, there isn’t as much sales growth. When the product is mature, most of your
target customers already have the product, so there is not as much demand.

Your sales volume will not be climbing like during the growth stage. Some businesses continue
making additions to their products during this stage.

Pricing strategy in this stage: Many businesses continue using the competitive pricing strategy in
the maturity stage. In fact, competition is usually more fierce than in the growth stage. Consider
cutting your prices to keep customers.

You could also use a discounting pricing strategy so that consumers will prefer your product. With
a discount pricing strategy, you need to mark down the price.

#4 Decline

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The final stage in a product’s life cycle is decline. There is less demand for the product, and
businesses must decide if they want to discontinue the product or keep producing and selling it.

Pricing strategy in this stage: During a product’s decline, many businesses choose to lower its
price. In fact, there are a few different pricing strategies you can try in this stage.

You can try a discount pricing strategy to increase customer traffic. This will help free up space at
your business for new products.

Another pricing strategy option is bundling. With bundling, you could include the declining
product in a deal with other products. This can help get rid of the declining product and increase
sales.

9. Loss Leader pricing - Loss leader pricing is an aggressive pricing strategy in which a store
sells selected goods below cost in order to attract customers who will, according to the loss
leader philosophy, make up for the losses on highlighted products with additional
purchases of profitable goods. Loss leader pricing is employed by retail businesses; a
somewhat similar strategy sometimes employed by manufacturers is known as penetration
pricing. Loss leader pricing is, in essence, a bid to lure customer traffic away from the
businesses of retail competitors. Retail stores employing this pricing strategy know that
they will not make a profit on those goods that are earmarked as loss leaders. But earn
profit on other goods purchased along with loss leader.

Thank You

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