PRICE DETERMINATION

Monopoly

 Elasticity of demand is zero or negative

The industry is a single firm industry Firm and industry are identical in a monopoly

Equilibrium of a firm means equilibrium of the industry

Pricing decision in a monopoly are based on Revenue and Cost.

 A firm under monopoly faces a downward sloping demand curve or average revenue curve.
Further, in monopoly, since average revenue falls as more units of output are sold, the marginal revenue is less than the average revenue. In other words, under monopoly the MR curve lies below the AR curve.

 The Equilibrium level in monopoly is that level of output in which marginal revenue equals marginal cost.
The producer will continue producer as long as marginal revenue exceeds the marginal cost. At the point where MR is equal to MC the profit will be maximum and beyond this point the producer will stop producing.

 It can be seen from the diagram that up till OM output, marginal revenue is greater than marginal cost, but beyond OM the marginal revenue is less than marginal cost.
Therefore, the monopolist will be in equilibrium at output OM where marginal revenue is equal to marginal cost and the profits are the greatest. The corresponding price in the diagram is MP or OP. It can be seen from the diagram at output OM, while MP is the average revenue, ML is the average cost, therefore, PL is the profit per unit.

 Now the total profit is equal to PL (profit per unit) multiply by OM (total output). n the short run, the monopolist has to keep an eye on the variable cost, otherwise he will stop producing. In the long run, the monopolist can change the size of plant in response to a change in demand. In the long run, he will make adjustment in the amount of the factors, fixed and variable, so that MR equals not only to short run MC but also long run MC.

COMPARISON OF PRICE DETERMINATION UNDER PERFECT COMPETITION AND MONOPOLY:The key points of comparison of price determination under Perfect Competition and Monopoly is as below: Perfect Competition Monopoly (i) The demand curve or average revenue curve is perfectly elastic and is a horizontal straight line. (i) The demand curve or average revenue curve is relatively elastic and a downward sloping from left to right. (ii) The firm is in equilibrium at the level of output where MC is equal to MR. Since in perfect competition MR is equal to AR or price, therefore, when MC is equal to MR, it is also equal to AR or price at the equlibrium position, i.e., MC=MR=AR (Price) (ii) The firm is in equilibrium at the level of output where MC is equal to MR. (iii) In equilibrium position, the price charged by the firm equals to MC. position, the price charged by the firm is above MC. (iii) In equilibrium

(iv) The firm is in long-run equilibrium at the minimum point of the long-run AC curve. (iv) The firm is in long-run equilibrium at the point where AC curve is still declining and has not reached the minimum point. (v) The firm is in equilibrium at the level of output at which MC curve is rising, and is cutting MR curve from below. (v) The firm is in equilibrium at the level of output at which MR curve is sloping downwards, and MC curve is cutting it from below or above. (See figure 1) (vi) In the long run, the firm is earning normal profit. There may be super normal profit in the short run but they will be swept away in the long run, as new firms entered into the industry. (vi) The firm can earn abnormal or supernormal profit even in the long run, as there is no competitor in the industry. (vii) Price can be set lower at greater output in case of constant-cost and decreasing-cost industries. (vii) Price is set higher and output smaller by the monopolist. (See Figure 2)

What is Price Discrimination?

While discussing price determination under monopoly, it is assumed that a monopolist charges only one price for his product from all the customers in the market.
But it often so happens that a monopolist, by virtue of his monopolistic position, may manage to sell the same commodity at different prices to different customers or in different markets. The practice on the part of the monopolist to sell the identical goods at the same time to different buyers at different prices when the price difference is not Justified by difference in costs in called price discrimination.

Types and Examples of Price Discrimination

(1)Price discrimination. It is persona!, when separate price is charged from each buyer according to the intensity of his desire or according to the size of his pocket. For instance, a doctor may charge more from a rich person for an operation and very little or no money at all from a poor man for the similar operation.

(2).Trade discrimination. It may take place when a monopolist charges different prices according to the uses to which the commodity is put. For example, an electricity company may charge low rate for electric current used in an industrial concern than for the electricity used for the domestic purpose.

Conditions of Price Discrimination:

1. Segregation by price. There should be no possibility, of transferring a unit of commodity supplied from the low priced to the high priced market. For instance, a rich patient cannot send a poor man to the doctor for his medical cheek up at a cheaper rate for him. Similarly, if you want to send a kilogram of gold by train to a relative of yours, you cannot get it converted into coal or iron simply because these metals are transported at a cheaper rate.

2. Segregation by market. Another essential characteristic of price discrimination is that there should be no possibility of transferring one unit of demand from the high priced to the low priced market. For instance, a banana market is divided on the basis of wealth. The poor are supplied bananas at a concessional rate in one market. The rich people will not like to become poor in order to get the commodity at a cheaper rate. A monopolist will maximize his total revenue by equalizing marginal revenue from all the markets.

3. Segregation by demand. Price discrimination can be possible if there is difference in the elasticity of demand in different markets. If the demand for a certain commodity is elastic in a particular market, the monopolist will charge lower prices. But if the demand is inelastic, the monopolist will fix higher prices for his product.

Degrees of Price Discrimination

(1) First degree price discrimination. The monopolist charges a different price equal to the maximum amount for each unit of the commodity from each consumer separately i.e. he charges the highest price in such a way that those willing to buy can buy at least one unit. The price of each unit is equal to its demand price so that the consumer is unable to enjoy any consumer surplus (the difference between what consumers are willing to pay for a good or service and what they actually pay i.e. the market price.) After extracting the highest price, the price is lowered so that the second unit of consumer is extracted of consumer surplus. ENTIRE CONSUMER SURPLUS IS EXTRACTED.

(2).Second degree price discrimination. Here the monopolist divides his market into different groups of customers and charges each group the highest price which the marginal consumer belonging to that group is willing to pay. The railway, airlines etc., charge the fares from customers in this way. In this degree, a major part of the consumer surplus is extracted rather than the whole of it. The prospective consumers are divided into categories (like rich, middle, poor etc.) This degree is possible only when (i). Number of consumers is large (ii). Demand curve for all consumers is identical (iii). Single rate is applicable for a large number of consumers. Example: Electricity usage charges for various categories .

(3) Third degree price discrimination. In the third degree price discrimination, the monopolist divides the entire market into a few sub-markets and charges different prices for the same commodity in different submarkets. He determines the MR and MC curves for all sub markets. The division here is among classes of consumers and not among individual consumers. Third degree price discrimination is possible only if the classes of consumers can be kept separate. Secondly, the various groups of customers must have different elasticities of demand for his commodity. The segment with a less elastic demand pays a higher price than the segment with a more elastic demand. The consumer faces a single price in each category of consumers. He can purchase as much as desired at that price. It is the most common type of price discrimination. For example, movie theaters, railways, typically charge lower prices to senior citizens, students etc.

PRICE DETERMINATION : OLIGOPOLY

Oligopoly falls between two extreme market structures, perfect competition and monopoly. Oligopoly occurs when a few firms dominate the market for a good or service. This implies that when there are a small number of competing firms, their marketing decisions exhibit strong mutual interdependence. By mutual interdependence we mean that a firm's action say of setting the price has a noticeable effect on its rival firms and they are likely to react in the some way. Each firm considers the possible reaction of rivals to its price and product development decisions.

Explanation of Price and Output Determination

Under Oligopoly: There is not a single theory which satisfactorily explains the pricing and output decisions under oligopoly. The reasons are:
(i) The number of firms, dominating the market vary. Sometimes there are only two or three firms which dominate the entire market (Tight oligopoly). At another time there may be 7 to 10 firms which capture 80% of the market (loose oligopoly). (ii) The goods produced under oligopoly may or may not be standardized.

(iii) The firms under oligopoly sometime cooperate with each other in the fixing of price and output of goods. At another time, they prefer to act independently.
(iv) There are situations also where barriers to entry are very strong in oligopoly and at another time, they are quite loose. (v) A firm under oligopoly cannot predict with certainly the reaction of the rival firms, if it increases or decreases the prices and output of its goods. Keeping in view the wide range of diversity of market situations, a number of models have been developed explaining the behaviour of the oligopolistic firms.

CLASSIFICATION OF OLIGOPOLY
a) Duopoly: If there are two giant firms in an industry it is called duopoly. Duopoly is further classified as below:
(i) Perfect or Pure Duopoly: If the duopolists in an industry are producing identical products it is called perfect or pure duopoly. (ii) Imperfect or Impure Duopoly: If the duopolists in an industry are producing differentiated products it is called imperfect or impure duopoly.

(b) Oligopoly: If there are more than two firms in an industry and each firm takes consideration the reactions of the rival firms in formulating its own price policy it is called oligopoly. Oligopoly is further classified as below: (i) Perfect or Pure Oligopoly: If the oligopolists in an industry are producing identical products it is called perfect or pure oligopoly.(ii) Imperfect or Impure Oligopoly: If the oligopolists in an industry are producing differentiated products it is called imperfect or impure oligopoly.