PRICING & OUTPUT DECISION

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PRICING & OUTPUT
DECISION
- Market Structure
Chapter Organization
• Introduction to Market Structure
• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly
Market Structure
Determinants of market structure
• Freedom of entry and exit
• Nature
of
the
producthomogeneous, differentiated
• Control over supply/output
• Control over price
• Barriers to entry
Classification of market based
on nature of competition
MARKET
Imperfect Competition
Perfect competition
Pure
Perfect
Monopoly
Oligopoly
Monopolistic
Perfect Competition
Assumptions
•
•
•
•
•
•
•
Large number of Buyers & Sellers.
Homogeneous product.
Free entry & exist to industry.
No govt. regulation.
Price takers
Perfect Knowledge of market conditions.
Perfect mobility of factors of production.
• A perfectly competitive market is where
agents in the market (buyer&seller) are
price taker.
• Price taking behaviors: agents believe
that the market price is given and their
actions do not influence the market
price.
• Examples of Perfect Competition
- Financial markets - (stock exchange,
currency market), agriculture
FIRM-PRICE TAKER
Equilibrium of firm in short run
(A) TR and TC approach
TC
TR
C
R
XA
XB
X
(B) MR and MC approach
P
MC
P0
0
e
Xe
P=AR=MR
X
Profit Maximization for a Perfectly
Competitive Firm
• All firms maximization for a Perfectly
Competitive Firm
MR = MC
•Since the perfectly competitive firm is a
price taker, marginal revenue equals price.
MR = P
•Therefore, profits will be maximized where
MR (= P) = MC or P = MC
Profit Maximization
All firms can maximize profits (or minimize
losses) by comparing marginal revenue (MR)
with marginal cost (MC)
• If MR > MC, profits are increasing
• If MR < MC, profits are decreasing
• Therefore, profits must be maximized where
MR=MC
• Since the perfectly competitive
firm is price taker, marginal
revenue equals price.
MR= P
• Therefore,
profits
will
maximized where
MR (=P) = MC or P = MC
be
Is the firm making a profit?
For a price taker, price is also equal to
the average revenue and we need to
compare average total cost with price in
order to tell whether the firm is making
a profit.
• If P > ATC , the firm is making a profit
that is , it is selling its output at mere
than its cost.
•If P < ATC, the firm is losing money
MC
ATC
E
D
Loss
C
F
0
Quantity
P=AR = MR
•If P > ATC, the firm is having super normal profits
MC
ATC
P0
E
Super Normal Profit
A
B
0
Quantity
Xe
P=AR = MR
•If P = ATC, the firm is having normal profits.
MC
C
B
0
Quantity
ATC
P=AR = MR
Shut down point
What if
Money?
the
Firm
is
Losing
• If a firm is losing money, it has to decide whether
to operate at a loss or shut down.
• If a firm shuts down, its loss will be equal to the
amount of its total fixed costs.
• But, if a firm can cover its variable costs, it should
continue to operate even though it’s losing money.
The Shut-Down Condition
•If P < AVCmin , the firm should shut down.
Why? Because it’s not covering its variable costs.
•If P > AVCmin , the firm should continue to
operate at a loss.
Why? Because it will cover its variable costs
•The minimum of average variable cost is called
the shutdown price.
Short run equilibrium of industry
Long Run Equilibrium - Firm
Long Run Equilibrium- Industry
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