Market structure and

Pricing Strategies
4 Market structures Pricing Strategies
1. Perfect Competition 1. Basic pricing strategies
2. Monopolistic Competition 2. Pricing Strategies for firms
3. Oligopoly with market power
4. Monopoly 3. Pricing with special
structure of Cost and
Demand
Reading
•Required: Jones, T. T. (2004). Business economics and
managerial decision making. John Wiley & Sons (Chap 9,10)
•Recommended: Griffiths, A., & Wall, S. (2005). Economics for
business and management. Pearson Education. (Chap 6)
1. Market Structure
A Brief Overview of Four Market Structures
Perfect Competition
1. A very large number of buyers and sellers
2. homogeneous product (standardized)
3. free entry and exit (no barriers)
4. no collusion among the firms
5. complete knowledge of all market information

Each firm views its demand curve as perfectly elastic. We say that pure
competition makes firms price takers.
Monopolistic Competition
1. many buyers and sellers
2. differentiated product
3. free entry and exit
4. no collusion among the firms

Each firm will view its demand curve as declining

in its own price. A monopolistically competitive
firm will have to have a pricing strategy, unlike a
purely competitive firm.
 Oligopoly
1. few firms
2. the products may be differentiated or
standardized
3. there is a noticeable degree of
interdependence among the firms

Many outcomes are possible in oligopolies, ranging

from acting nearly competitively to acting like a
monopoly.
 Monopoly
1. one firm
2. a perfectly differentiated product (low
cross price elasticities with other
products.)
3. substantial barriers to entry, such as
consumer loyalty, scale economies, large
capital requirements, or legal barriers to
entry.
Basics of Perfect Competition (again)
•Large number of firms
•homogeneous product
•complete knowledge
•free entry and exit
•each firm supplies only fraction of industry product
•no influence on price – price taker
Demand Curve is Horizontal
TR = p x q
MR = change TR / change q (dTR/dQ)
AR = TR/q
AR = (p x q)/q
AR = p
MR = p in perfect competition since TR changes by a
constant p with each q
 P TR = p x q
AR = TR/q = (pxq)/q = p
MR = p

D =AR =MR
P1

Q1 Q2 Q3 Q4 Q
 Derivation of a Demand Curve for a Price-taking Firm

S
P Industry P Firm

Po

D = MR = AR

Qo Q q
Choosing Output in SR

•Profit = TR - TC
•slope of TC = slope of TR is point of profit maximization
•MR = MC
 TC
$ Slope of TC = slope of TR
And
Slope of TC = MC and TR
Slope of TR = MR
Therefore
MC = MR for profit max.

Q0 Q1 Q3 Output
Algebraically
Profit = TR - TC
(remember want highest point on profit curve)
change in profit / change in quantity = 0
therefore:
d P/ dQ = dTR / dQ - dTC / dQ
0 = dTR / dQ - dTC / dQ
0 = MR - MC
MR = MC general rule for profit maximization
remember P = MR for the competitive firm
therefore
P = MR = MC
$
P = MC
MC AC

AVC

Pe

Qe Q
P = MC is profit maximization for
the competitive firm
 Costs and Revenues
Q Price TR TC Profit MC MR
0 $40 $0 $50 $-50 -- --
1 40 40 100 -60 $50 $40
2 40 80 128 -48 28 40
3 40 120 148 -28 20 40
4 40 160 162 -2 14 40
5 40 200 180 20 18 40
6 40 240 200 40 20 40
7 40 280 222 58 22 40
8 40 320 260 60 38 40
9 40 360 305 55 45 40
10 40 400 360 40 55 40
11 40 440 425 15 65 40
$
P = MC
MC AC

AVC

P1

AC

Excess
Profit

Q1 Q
$
P = MC
MC AC

AVC

AC

P1
Loss

Q1 Q
Short Run Loss
• Breakeven Point
• P = MC = AC

• Shutdown Point
• P = MC = AVC
$
P = MC
MC AC

AVC

P1

Breakeven Point

Q1
Q
$ AFC not covered

MC AC

AVC

AFC

P1

Shutdown Point

AVC

Q1 Q
 If chose to shutdown rather than operate where P=MC
would have not minimized losses. You are left with your fixed costs. If
$ you had chosen to operate, could have covered part of these fixed
costs.
MC AC

AVC

AFC

P1

Shutdown Point

AVC

Q1 Q
 If chose to operate rather than shutdown, do not minimize losses
because you incur both AFC and part of your AVC. If shutdown, would
$ only incur the AFC

MC AC

AVC

AFC

Shutdown Point
P1

AVC

Q1
Q
Short Run Market Supply Curve for a Firm

Portion of the MC curve lying above

the AVC curve
$

Supply MC AC

AVC

Q
Long Run Competitive Equilibrium

P = LRMC = LRAC
$ D

LRMC
SMC SAC
A
P1
LRAC

C
B

ABCD is profit for firm

In SR; in LR operate
Where P = LRAC

Q
$ $ LRMC
S

LRAC

Q
Q
1. each firm operating where P = LMC
2. no incentive for entry/exit P = LAC
3. combined quantity for output of all firms at the prevailing
price must equal quantity consumers wish to purchase at
that price
4. point of zero economic profit (normal profit)
Eliminating Economic Profit: The Role of Entry
Eliminating Losses: The Role of Exit