Pricing Decisions and Pricing

Strategies
Introduction
• Market structure involves the number of firms in the market and the
barriers to entry.

• Perfect competition, with an infinite number of firms, and monopoly, with a

single firm, are polar opposites.
Introduction
• Monopolistic competition and oligopoly lie between these two
extremes.

– Monopolistic competition is a market structure in which there are many firms

selling differentiated products.

– Oligopoly is a market structure in which there are a few interdependent

firms.
Introduction
• Most industry structures fall almost entirely between monopolistic
competition and oligopoly.

• Perfectly competitive and monopolistic industries are nearly

nonexistent.
 Perfect Competition
Conditions:
• Large number of buyers and sellers
• Homogeneous product
• Perfect knowledge
• Free entry and exit
• No government intervention

Key Implications:
• Firms’ demand determined by market equilibrium price
• Market participants are price takers without any market power to influence prices
(have to charge MR = P = MC)
• In the short run firms earn profits or losses or shut down
• In the long run profit = normal = 0 (firms operate efficiently)
 Monopoly
Conditions:
• Large number of buyers and one sellers
• Product without close substitutes
• Perfect knowledge
• Barriers to entry
• No government intervention

Key Implications:
• Downward sloping firm’s demand is market demand
• Firm has market power and determines market price
(can charge P > MR = MC)
• In the short run monopoly earns profit or loss or shuts down
• In the long run profit > normal is sustainable indefinitely but even with profit =
normal = 0 (monopoly does not operate efficiently)
 Sources of Monopoly Power
Natural:
• Economies of scale and excess capacity
• Economies of scope and cost complementarities
• Capital requirements, sales and distribution networks
• Differentiated products and brand loyalty

Created:
• Patents and other legal barriers (licenses)
• Tying and exclusive contracts
• Collusion (tacit or open)
• Entry limit pricing
Monopolistic Competition
• The four distinguishing characteristics of monopolistic competition
are:

• Many sellers.

• Differentiated products.

• Multiple dimensions of competition.

• Easy entry of new firms in the long run.

Many Sellers
• When there are many sellers as in monopolistic competition, they do
not take into account rivals’ reactions.

• The existence of many sellers also makes collusion difficult.

• Monopolistically competitive firms act independently.

Differentiated Products
• The “many sellers” characteristic gives monopolistic competition its
competitive aspect.

• Product differentiation gives monopolistic competition its

monopolistic aspect.
Differentiated Products
• Differentiation exists so long as advertising convinces buyers that it
exists.

• Firms will continue to advertise as long as the marginal

benefits of advertising exceed its marginal costs.
Multiple Dimensions of Competition

• One dimension of competition is product differentiation.

• Another is competing on perceived quality.

• Competitive advertising is another.

• Others include service and distribution outlets.

Easy Entry of New Firms in the Long Run

• There are no significant barriers to entry.

• Barriers to entry prevent competitive pressures.

• Ease of entry limits long-run profit.

Output, Price, and Profit of a Monopolistic
Competitor

• A monopolistically competitive firm prices in the same manner as a

monopolist—where MC = MR.

• But the monopolistic competitor is not only a monopolist but a

competitor as well.
Monopolistic Competition

Price
MC

ATC
PM

MR D
0 QM Quantity
Comparing Monopolistic Competition with
Perfect Competition

• Both the monopolistic competitor and the perfect competitor

make zero economic profit in the long run.

Comparing Monopolistic Competition with
Perfect Competition

• The perfect competitors demand curve is perfectly elastic.

• Easy entry, zero economic profits, and a uniform product means

that the perfect competitor produces at the minimum of the
ATC curve.
Comparing Monopolistic Competition with
Perfect Competition
• A monopolistic competitor faces a downward sloping demand
curve, and produces where MC = MR.

• The ATC curve is tangent to the demand curve at that level,

which is not at the minimum point of the ATC curve.
Comparing Monopolistic Competition with
Perfect Competition

• Increasing market share is a relevant concern for a

monopolistic competitor but not for a perfect competitor.

Comparing Monopolistic Competition with
Perfect Competition

• In the real world of monopolistic competition, increasing

output and market share lowers average total cost.
Comparing Monopolistic Competition with
Monopoly

• The difference between a monopolist and a monopolistic competitor

is in the position of the average total cost curve in long-run

equilibrium.
Comparing Monopolistic Competition with
Monopoly

• For a monopolist, the average total cost curve can be, but need not
be, at a position below price so that the monopolist makes a long-run
economic profit.
Comparing Monopolistic Competition with
Monopoly

• For a monopolistic competitor, the average total cost curve is tangent

to the demand curve at the price and output chose by the
monopolistic competitor so that there are zero economic profits in the
long run.
Oligopoly

• Oligopoly is a market structure where there are a small number of

mutually interdependent firms.

• Each firm must take into account the expected reaction of other firms

to its profit maximizing output decision.

• No single general model of oligopoly behavior exists