Theory of product pricing

firm and industry

A firm operates within an industry and is a for-profit business organization such

as a corporation, partnership, and limited liability company, but it is typically a
for-profit operation.
An industry consists of all the firms that are involved in the production, and sale
of a specific service or product and can be either retail, service, or wholesale.
Equilibrium of Firm
A firm is in equilibrium when it is satisfied with its existing level of output.
The firm, in this situation produce the level of output which brings in
greatest profit or marginal loss.
When this situation is reached, the firm is said to be in equilibrium.

Perfect competition

Perfect Competition is an idealistic economic theory. Perfect competition is a

unique form of the marketplace that allows multiple companies to sell the same
product or service. Many consumers are looking to purchase those products.
None of these firms can set a price for the product

[ not a price maker but price taker]

Features of Perfect Competition

The main features of perfect competition are as follows:

1. Many Buyers and Sellers – A hallmark feature of perfect competition is

the presence of a multitude of buyers and sellers. There will always be a
huge number of buyers and sellers in this form of marketplace. The
advantage of having a large number of small-sized producers is that they
cannot combine to influence the market price. If the quantity offered by
an individual seller is very small compared to the total market produce,
they cannot influence the market price independently.
a. Similarly, if there are many buyers, then an individual will not have
the power to dictate conditions to the market or influence the
 price by altering demand for a product. The individual demand will
not be large enough to change the price.
2. Homogeneity – The product or service produced by the buyers in a
perfectly competitive market should be homogenous in all respects.
There should be no differentiation between them in terms of quantity,
size, taste, etc., so that the products are perfect substitutes for each
other. If a seller tries to charge a higher price for products that are so
similar, they will lose their customers immediately.
3. Free Entry and Exit – Another condition of a perfectly competitive market
is that no artificial restrictions prevent a firm’s entry, or compel an
existing firm to stay put when they want to leave. Their decision to enter,
stay or leave the market depends purely on economic factors.
4. Transport Cost – In the perfectly competitive market, the costs for
transporting goods, services or factors of production from one place to
another is either zero or constant for all sellers. The assumption is that all
sellers are equally near or farther away from the market. Thus, the
transport cost is uniform for all of them. The result is that the overall
costs for production and the selling price are the same across the board.
5. Absence of Artificial Restrictions – There is no interference from the
government or any other regulatory body to hinder the smooth
functioning of the perfect competition. There are no controls or
restrictions over the supply or pricing and the price can change solely
based on the demand and supply conditions.

***

6. Perfect Knowledge – The buyers and sellers have perfect knowledge

about the market conditions. The buyers are aware of the details of the
product sold as well as its price. At the same time, the sellers know about
the potential sales of their products at different price points. Since the
buyers are already informed about the product, there is no need for
advertising or sales promotion. So firms don’t have to invest a single
penny in these activities. It also helps sellers save on advertising or other
marketing activities, which keeps the price of their products low
7. Perfect Mobility of Factors of Production – The factors of production like
labour, raw materials and capital should have total mobility under perfect
competition. The labour should have the freedom to move from one
place (industry, market or production unit) to another depending on their
 remuneration. Even the raw materials and capital should not have any
restrictions in movement.

Price and output determination under Perfect Competition/ or equilibrium

under Perfect Competition

[ class room activity needs to be incorporated]

Role of time element

[ class room activity needs to be incorporated]

A monopoly is a market where one firm (or manufacturer) is the sole supplier of
certain goods or services. This firm faces no competition due to which it can set
its own prices, thereby exercising full control over the market. The monopolist
aims to generate high profits by selling products (or services) that do not have
close substitutes.

Monopoly – features

Features of a Monopoly Market

Some characteristics of a monopoly market are as follows.

1. Maximizes profits
The monopolist firm aims to maximize its profits owing to no rivalry and
lack of consumer choices. This is the major reason a monopolist firm
wants to continue enjoying its monopoly. The monopolist firms strive to
earn abnormal (or supernormal) profits.
2. Sets prices
The single manufacturer has the power to set the prices of its products or
services. The monopolist firm (price maker) may or may not charge the
same price from all its consumers. The consumers (price takers) have to
 accept the prices set by the firm unless the government intervenes to
impose a maximum price.
3. Poses high entry barriers
The new entrants have to face several challenges while trying to enter a
monopolist market. Such challenges include high startup costs,
specialized technologies, high government restrictions, complex business
contracts, restricted purchase of raw materials, etc.
4. Lacks close substitutes
There are no products (or services) that match the offerings of the
monopolist firm. The absence of close substitutes makes the demand for
monopolist products relatively inelastic. The demand is inelastic when it
does not change much with a change in the price of the product. Inelastic
demand makes it easier to make profits in the market.
5. Becomes the industry
The single firm, being the sole supplier, becomes synonymous with the
industry. This implies that the difference between a firm and an industry
ceases to exist in the case of a monopoly.

Price and output determination under monopoly/ or equilibrium under

monopoly/ [ class room activity needs to be incorporated]
Features of Monopolistic Competition

1. Large Number of Buyers and Sellers:

There are large number of firms but not as large as under perfect
competition.

That means each firm can control its price-output policy to some extent. It is
assumed that any price-output policy of a firm will not get reaction from
other firms that means each firm follows the independent price policy.

If a firm reduces its price, the gains in sales will be slightly spread over many
of its rivals so that the extent to which each of the rival firms suffers will be
very small. Thus, these rival firms will have no reason to react.

2. Free Entry and Exit of Firms:

Like perfect competition, under monopolistic competition also, the firms can
enter or exit freely. The firms will enter when the existing firms are making
super-normal profits. With the entry of new firms, the supply would increase
which would reduce the price and hence the existing firms will be left only
with normal profits. Similarly, if the existing firms are sustaining losses, some
of the marginal firms will exit. It will reduce the supply due to which price
would rise and the existing firms will be left only with normal profit.

3. Product Differentiation:

Another feature of the monopolistic competition is the product

differentiation. Product differentiation refers to a situation when the buyers
of the product differentiate the product with other. Basically, the products
of different firms are not altogether different; they are slightly different
from others. Although each firm producing differentiated product has the
monopoly of its own product, yet he has to face the competition.

This product differentiation may be real or imaginary. Real differences are

like design, material used, skill etc. whereas imaginary differences are
through advertising, trade mark and so on.

4. Selling Cost:

Another feature of the monopolistic competition is that every firm tries to

promote its product by different types of expenditures. Advertisement is the
most important constituent of the selling cost which affects demand as well
as cost of the product. The main purpose of the monopolist is to earn
maximum profits; therefore, he adjusts this type of expenditure accordingly.

5. Lack of Perfect Knowledge:

The buyers and sellers do not have perfect knowledge of the market. There
are innumerable products each being a close substitute of the other. The
buyers do not know about all these products, their qualities and prices.

Therefore, so many buyers purchase a product out of a few varieties which

are offered for sale near the home. Sometimes a buyer knows about a
particular commodity where it is available at low price. But he is unable to
go there due to lack of time or he is too lethargic to go or he is unable to
find proper conveyance.

6. Less Mobility:
Under monopolistic competition both the factors of production as well as
goods and services are not perfectly mobile.

7. More Elastic Demand:

Under monopolistic competition, demand curve is more elastic. In order to

sell more, the firms must reduce its price.

Price and output determination under monopolistic market / or equilibrium

under monopolistic market

[ class room activity needs to be incorporated]

Oligopoly

An oligopoly is a type of market structure in which a small number of firms

control the market. Where oligopolies exist, producers can indirectly or directly
restrict output or prices to achieve higher returns. A key characteristic of an
oligopoly is that no one firm can keep the others from having significant
influence over the market