MARKET STRUCTURE

AND
OUTPUT-PRICING DECISIONS

 Firms output and pricing decisions depend on

the current market structure in which the firm
is operating i.e.
How much control over price we have.
whether the firm is competing in perfect
competition, monopoly, monopolistic
competition or oligopoly situation

Competition vs. Monopoly

One useful way in which issues of competition
and monopoly can be investigated is called
the Structure, Conduct and Performance
Model

Competition vs. Monopoly

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Monopolistic Competition

P = AC1

MC AC

MR
Q1

D
Output

Firms have some degree of market power

but demand curve typically flatter than in monopoly
since there is more competition

Output-pricing decision is defined by MR = MC as

always
the absence of entry barriers means that super normal
profits are competed away...
firms end up producing where p = AC, but AC not at its
minimum as in perfect competition, also p > MC

MONOPOLY

 Noncompetitive firmssuch as monopoliesdo not make two

separate decisions about price and quantity, but rather one
decision
Once firm determines its output level, it has also determined
its price
When any firmincluding a monopolyfaces a downward
sloping demand curve, marginal revenue is less than price of
output
Therefore, marginal revenue curve will lie below demand
curve
Monopoly will produce at an output level where marginal
revenue is positive

Demand and Marginal Revenue

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The Profit-Maximizing Output Level

To maximize profit, the firm should produce
level of output where MC = MR and
MC curve crosses MR curve from below

For a monopoly, price and output are not

independent decisions
But different ways of expressing the same decision

Significance of Kinked demand curve in

oligopolistic market
Meaning of price rigidity
Why price rigidity arises
Kinked demand curve and price rigidity

Price rigidity
Peculiar feature related to oligopoly
The tendency of the price to remain fixed or
constant irrespective of changes in price and
cost conditions in the industry.
The price once established remains unchanged
for a long period of time

Why price rigidity arises

Under non-collusive oligopoly, there is a greater
amount of uncertainty regarding the behavior of
rival firms
The oligopolist does not know how his
competitor will react. Therefore every oligopoly
is confronted with indeterminate demand. One
such price is established, the firm sticks to that
price, whatever may be the consequences.

Kinked demand curve

First introduced by Prof. Paul Sameulson
Provides a convincing explanation of price rigidity
It does not explain how prices and output are
determined under oligopoly
Occurs when there is a sudden change in the slope of
demand curve
Such change leads to a sharp corner in demand curve

Kinked demand curve

D
MC2
k

MC1

MR
A

D
B

MR1

Evaluation of kinked demand curve

analysis (defects)
Explains how the price remains rigid but
does not explain how the price is
determined. There is no mention of how
the kink is arrived
The kinked price analysis is not applicable
to firms selling differentiated products

Why price rigidity rises?

The existing price has been settled out after a
long battle between different firms is through of
negotiations, conflicts etc. as such no firm is
prepared to change that price. Thus the price
does not change
In case if demand of an oligopoly firm faces a
fall, the firm prefers to pick it up through
advertisement and publicity rather than cutting
prices. Therefore the price remains constant.

Price and Output in Oligopoly

In oligopoly, if one firm in an industry
changes its price the other firms react
This means a shift in the demand curve
(not a change in output or own price)

Oligopoly
Initially, Firm 1 produces Q1
at a price P1 (D1 demand
curve)
Firm 1 cuts price to P2 and
this increases demand for
product to Q2
Other firms respond with
price shift so demand curve
for Firm 1 shifts in (less
demand) and they end up at
P2 and Q3