1. UNIT 3 PRODUCT AND
FACTOR MARKET

3. MARKET- MEANING
• An arrangement whereby buyers and sellers
come in close contact with each other directly
or indirectly to sell and buy goods.
• A market consists of all firms and individuals
who are willing and able to buy or sell a
particular product.

4. MARKET - GENERAL TYPES

5. PRODUCT MARKET
• Product Market / Commodity market:
– Arrangement in effecting buying and selling of
commodities. Eg. Cotton market, rice market,
wheat market, tea market, Gold market,fish
market etc.
– Market for precious metals such as gold & silver
are called the Bullion market or Bullion Exchanges.
– Markets for capital change like Govt. securities,
bonds and shares are called as Stock market or
stock exchange.

6. FACTOR MARKETS
• Factors of production such as land, labor and
capital are transacted. These are called as
labor market, land market, and capital
market.

7. TYPES OF MARKET
• Markets can be classified on the basis of different
criteria
• Based on Area:
– a) Local b) Regional C) National and d) International
market.
• Based on Nature of Transaction:
– a) Spot market b) Future market.
• Based on Volume of Business:
– a) Wholesale b) Retail
• Based on User:
– a) B to B market b) Consumer market.

8. …CONTD
• Based on Time:
– a) Very short period market b) Short period c)
Long period d) Very long period market.
• Based on status of sellers:
– a) Primary Market b) Secondary market c)
Tertiary market.
• Based on regulation:
– a) Regulated market b) Unregulated market.
• Based on Market Structure.

9. MARKET STRUCTURE
• Market structure refers to the basic
characteristics of the market environment like
– No. of buyers, sellers, and potential entrants.
– Degree of product differentiation.
– Amount and cost of information about product
price and quality.
– Conditions of entry and exit.

10. …CONTD
• According to Market Structure the markets are
divided as below:
– Perfect Competition
– Imperfect competition
– Monopoly and Monopsony,
– Oligopoly and Oligopsony,
– Monopolistic Competition.

13. FIRMS IN COMPETITIVE
MARKETS

14. PURE & PERFECT COMPETITION
• Competition among the sellers and buyers
prevails in its most perfect form.
– Large Number of Sellers:
• Formed by large no. of actual and potential firms and
sellers. Size of each firm is relatively small and
individual supply has a negligible effect on the total
supply.
– Large Number of Buyers:
• Formed by large no. of actual and potential buyers.
– Product Homogeneity:
• There is no product differentiation. So products can be
readily substituted for each other.

15. …CONTD
• Free Entry and Exit:
– There is no legal, technological, economic, financial
or any other barrier to their entry. Existing firms are
free to quit market.
• Perfect knowledge of Market Conditions:
– All the buyers and sellers possess perfect knowledge
about the existing market conditions.
• Pricing:
– Since individual buyer or seller has no effect in
market demand and supply, they cannot exert any
influence on the ruling market price.

16. ..CONTD
• Perfect Mobility of Factors of Production:
Factor costs are the same for all firms.
• Government Non-intervention:
– No tariffs, subsidies, rationing of goods, control on
supply of raw materials and licensing policy.

17. THE MEANING OF COMPETITION
• A perfectly competitive market has the
following characteristics:
– There are many buyers and sellers in the market.
– The goods offered by the various sellers are
largely the same.
– Firms can freely enter or exit the market.

18. THE MEANING OF COMPETITION
• As a result of its characteristics, the perfectly
competitive market has the following
outcomes:
– The actions of any single buyer or seller in the
market have a negligible impact on the market
price.
– Each buyer and seller takes the market price as
given.
– Thus each buyer and seller is a price taker.

19. REVENUE OF A COMPETITIVE FIRM
• Total revenue for a firm is the selling price
times the quantity sold.
TR = (P X Q)

20. MARGINAL REVENUE OF A
COMPETITIVE FIRM
• Marginal revenue is the change in total
revenue from an additional unit sold.
MR =TR/ Q

21. REVENUE OF A COMPETITIVE FIRM
• For competitive firms, marginal revenue
equals the price of the good.

22. TOTAL, AVERAGE, AND MARGINAL
REVENUE FOR A COMPETITIVE FIRM
QUANTITY PRICE TOTAL AVERAGE MARGINAL
(Q) (P) REVENUE REVENUE REVENUE
TR = P X Q AR = TR /Q MR =∆TR/∆Q
1 6 6 6 -
2 6 12 6 6
3 6 18 6 6
4 6 24 6 6
5 6 30 6 6
6 6 36 6 6
7 6 42 6 6
8 6 48 6 6

23. PROFIT MAXIMIZATION FOR THE
COMPETITIVE FIRM
• The goal of a competitive firm is to maximize
profit.
– This means that the firm will want to produce the
quantity that maximizes the difference between
total revenue and total cost.

24. PROFIT MAXIMIZATION: A NUMERICAL EXAMPLE
QUANTITY PRICE TOTAL TOTALCOST PROFIT AVERAGE MARGINAL MARGINA
(Q) (P) REVENUE (TC) (TR – TC) REVENUE REVENUE L COST
TR = P X Q AR = TR /Q MR MC
=∆TR/∆Q =∆TC/∆Q
0 0 3 -3
1 6 6 5 1 6 - 2
2 6 12 8 4 6 6 3
3 6 18 12 6 6 6 4
4 6 24 17 7 6 6 5
5 6 30 23 7 6 6 6
6 6 36 30 6 6 6 7
7 6 42 38 4 6 6 8
8 6 48 37 1 6 6 9

26. PROFIT MAXIMIZATION FOR THE
COMPETITIVE FIRM...
Costs The firm maximizes profit
and by producing the quantity
Revenue at which marginal cost
equals marginal revenue.
MC
MC2
ATC
P=MR1 P = AR = MR
AVC
MC1
0 Q1 QMAX Q2 Quantity

27. PROFIT MAXIMIZATION FOR THE
COMPETITIVE FIRM
• Profit maximization occurs at the quantity
where marginal revenue equals marginal
cost.

28. PROFIT MAXIMIZATION FOR THE
COMPETITIVE FIRM
When MR > MC increase Q
When MR < MC decrease Q
When MR = MC Profit is maximized. The
firm produces up to the point where MR=MC

29. THE INTERACTION OF FIRMS AND
MARKETS IN COMPETITION
Price Firm Market
And Price S1
Costs MC
A
a S2
10
P=MR0
B
b ATC
ATC c
=7 P=MR1
AVC
d
D0
q4 q3 q2 q1 Q1 Q2
10 units
qF QM

30. The Marginal-Cost Curve and the
Firm’s Supply Decision...
Costs This section of the firm’s
and MC curve is also the
Revenue firm’s supply curve (long-
run). MC
P2
P1 ATC
AVC
0 Q1 Q2 Quantity

31. THE FIRM’S SHORT-RUN DECISION TO
SHUT DOWN
• A shutdown refers to a short-run decision not
to produce anything during a specific period
of time because of current market conditions.
• Exit refers to a long-run decision to leave the
market.

32. THE FIRM’S SHORT-RUN DECISION TO
SHUT DOWN
• The firm considers its sunk costs when
deciding to exit, but ignores them when
deciding whether to shut down.
– Sunk costs are costs that have already been
committed and cannot be recovered.

33. THE FIRM’S SHORT-RUN DECISION TO
SHUT DOWN
• The firm shuts down if the revenue it gets
from producing is less than the variable cost of
production.
– Shut down if TR < VC
– Shut down if TR/Q < VC/Q
– Shut down if P < AVC

34. THE FIRM’S SHORT-RUN DECISION TO
SHUT DOWN...
Costs
Firm’s short-run supply
curve.
MC
If P > ATC,
keep producing
at a profit.
ATC
If P > AVC,
keep producing AVC
in the short run.
If P < AVC,
shut down.
0 Quantity

35. THE FIRM’S SHORT-RUN DECISION TO
SHUT DOWN
• The portion of the marginal-cost curve that
lies above average variable cost is the
competitive firm’s short-run supply curve.

36. THE FIRM’S LONG-RUN DECISION TO
EXIT OR ENTER A MARKET
• In the long-run, the firm exits if the revenue it
would get from producing is less than its total
cost.
– Exit if TR < TC
– Exit if TR/Q < TC/Q
– Exit if P < ATC

37. THE FIRM’S LONG-RUN DECISION TO
EXIT OR ENTER A MARKET
• A firm will enter the industry if such an action
would be profitable.
– Enter if TR > TC
– Enter if TR/Q > TC/Q
– Enter if P > ATC

38. THE COMPETITIVE FIRM’S LONG-RUN
SUPPLY CURVE...
Costs
MC = Long-run S
Firm enters
if P > ATC
ATC
AVC
Firm exits
if P < ATC
0 Quantity

39. EQUILIBRIUM OF PERFECTLY
COMPETITIVE FIRM
• Short run case:
– In a competitive situation, all firms get the same
price for their homogeneous product regardless of
the quantity sold.
– MR = AR
• Firm may end up with making either profit or
loss.
• Long run case:
– In long run profit or loss will disappear due to free
entry and exit.
– P=AR=MR=AC=MC

40. MONOPOLY

41. MONOPOLY
• While a competitive firm is a price taker, a
monopoly firm is a price maker.
• A firm is considered a monopoly if . . .
– it is the sole seller of its product.
– its product does not have close substitutes.

42. MONOPOLY- CHARACTERISTICS
• Only one seller.
• There are many buyers.
• Many entry barriers such as
– natural , economic, technological or legal.
• Monopoly firm is a price maker.
• There is no closely competitive substitutes.
• Monopolist has a complete control over the market supply
and price. According the supply the price is fixed or vice
versa.
• Product is Homogenous.
• No difference between firm and industry.
• Economies of scale

43. WHY MONOPOLIES ARISE
• The fundamental cause of monopoly is
barriers to entry.

44. WHY MONOPOLIES ARISE
• Barriers to entry have three sources:
– Ownership of a key resource.
• This tends to be rare. Example………………?
– The government gives a single firm the exclusive
right to produce some good.
• Patents, Copyrights and Government Licensing.
– Costs of production make a single producer more
efficient than a large number of producers.
• Natural Monopolies .Example………..?

45. TYPES OF MONOPOLY.
• Pure Monopoly
– No close substitutes available.
• Imperfect Monopoly
– Close substitutes are available.
• Legal, Natural(size of the market is too small),
Technological and joint monopolies.
• Private monopoly
• Public or social monopoly.
• Regional monopoly

46. ORIGIN OF MONOPOLY - REASON
• Patent right for products.
• Government Policies such as granting licenses.
• Ownership and control of raw materials.
• Exclusive knowledge of technology by the
firm.
• May be size of market can accommodate only
a single firm.

47. ECONOMIES OF SCALE AS A CAUSE OF
MONOPOLY
Cost
Average
total cost
0 Quantity of Output

48. MONOPOLY VERSUS COMPETITION
• Monopoly Competitive Firm
– Is the sole producer Is one of many
– Has a downward-sloping producers
demand curve Has a horizontal
– Is a price maker demand curve
– Reduces price to Is a price taker
increase sales Sells as much or as
little at same price

49. DEMAND CURVES FOR COMPETITIVE
AND MONOPOLY FIRMS
(a) A Competitive Firm’s (b) A Monopolist’s
Demand Curve Demand Curve
Price Price
Demand
Demand
0 Quantity of 0 Quantity of Output
Output

50. A MONOPOLY’S REVENUE
• Total Revenue
– P x Q = TR
• Average Revenue
– TR/Q = AR = P
• Marginal Revenue
– d TR/ d Q = MR

51. A MONOPOLY’S MARGINAL REVENUE
• A monopolist’s marginal revenue is always less
than the price of its good.
– The demand curve is downward sloping.
– When a monopoly drops the price to sell one
more unit, the revenue received from previously
sold units also decreases.

52. A MONOPOLY’S TOTAL, AVERAGE,
AND MARGINAL REVENUE
QUANTITY PRICE TOTAL AVERAGE MARGINAL
(Q) (P) REVENUE REVENUE REVENUE
TR = P X Q AR = TR /Q MR =∆TR/∆Q
11 0
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4

53. A MONOPOLY’S MARGINAL REVENUE
• When a monopoly increases the amount it
sells, it has two effects on total revenue
(P x Q).
– The output effect
• more output is sold, so Q is higher.
– The price effect
• price falls, so P is lower.

54. DEMAND AND MARGINAL REVENUE
CURVES FOR A MONOPOLY...
Price
11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity
-2
-3
-4

55. PROFIT-MAXIMIZATION FOR A
MONOPOLY...
2. ...and then the demand
Costs and curve shows the price 1. The intersection of the
Revenue consistent with this marginal-revenue curve
quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity...
price
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0 QMAX Quantity

56. COMPARING MONOPOLY AND
COMPETITION (PERFECT)
• For a competitive firm, price equals marginal
cost.
– P = MR = MC
• For a monopoly firm, price exceeds marginal
cost.
– P > MR = MC

57. A MONOPOLY’S PROFIT
• Profit equals total revenue minus total costs.
– Profit = TR - TC
– Profit = (TR/Q - TC/Q) x Q
– Profit = (P - ATC) x Q

58. THE MONOPOLIST’S SUPER NORMAL
PROFIT...
Costs and
Revenue
Marginal cost
Monopoly E
B
price
Average total cost
Average
total cost D C
Demand
Marginal revenue
0 QMAX Quantity

59. THE MONOPOLIST’S NORMAL
PROFIT...
Costs and
Revenue
Marginal cost
Monopoly E
B
price
Average total cost
Average
total cost
Demand
Marginal revenue
0 QMAX Quantity

60. THE MONOPOLIST’S LOSS...
Costs and
Revenue
Marginal cost
Monopoly E Monopoly
B
price LOSS
Average total cost
Average
total cost
Demand
Marginal revenue
0 QMAX Quantity

61. THE MONOPOLIST’S PROFIT
• The monopolist will receive economic profits
as long as price is greater than average total
cost.

62. PUBLIC POLICY TOWARD
MONOPOLIES
• Government responds to the problem of
monopoly in one of four ways.
– Making monopolized industries more
competitive.
– Regulating the behavior of monopolies.
– Turning some private monopolies into public
enterprises.
– Doing nothing at all.

63. MARGINAL-COST PRICING FOR A
NATURAL MONOPOLY...
Price
Average
total cost Average total cost
Loss
Regulated
price Marginal cost
Demand
0 Quantity

64. MONOPOLY SUPPLY CURVE
• There is no definite supply curve for
monopolist.
• Monopoly is a price maker the firm itself sets
the price of the product it sells instead of
taking the price as given.
• MC= MR for profit maximization

65. PRICE DISCRIMINATION
• Price discrimination is the practice of selling
the same good at different prices to different
customers, even though the costs for
producing for the two customers are the
same. In order to do this, the firm must have
market power.

66. PRICE DISCRIMINATION
• Two important effects of price discrimination:
– It can increase the monopolist’s profits.
– It can reduce deadweight loss.
• But in order to price discriminate, the firm
must
– Be able to separate the customers on the basis of
willingness to pay.
– Prevent the customers from reselling the product.

67. PRICE DISCRIMINATION BASES
• Personal
– example -Concessions in tickets
• Geographic
– example - Oils, food items different prices in different
area
• Time
– example - News paper ads, off season discounts,
phone calls
• Purpose of use
– Example – electricity rates .

68. PRICE DISCRIMINATION IN
MONOPOLY
• Reasons:
– Difference in price elasticity :
• Different elasticity with different customers. Eg. Income,
available of substitutes.
– Market segmentation.
– Effective separation of sub markets.
– Legal sanction for price discrimination. Eg. Electricity.
– Difference in quality.
– Ignorance of product knowledge or lack of mobility.

69. DEGREE OF PRICE DISCRIMINATION
• Price discrimination of the first degree :
– This is said t occur when the monopolist is able to
sell each separate unit of the output at a different
price to the same buyer
– Example – reservation .
• Price discrimination of the second degree:
– Seller divides buyer according to their income,
location types of uses of the product.
• Price discrimination of the third degree:
– The goods are divided into different blocks of units
and for each block a different price is charged.
– Example – cinema tickets

70. MONOPOLY POWER
• It refers to the restraints imposed over his
competitors by the price-maker.
• Methods of measuring monopoly power:
– Lerner’s measure: The difference between price and
marginal cost measures the degree of monopoly
power.
– Triffin’s measure: In terms of price cross-elasticity of
demand. If the cross elasticity of demand is zero,
implying the firm has an absolute monopoly power.
– Bain’s measure: Measured in terms of supernormal
profits. i.e. the gap between price and average cost at
equilibrium.
– Rothschild’s measure: Slope of the firm’s demand
curve / slope of the industry’s demand curve.

71. MONOPOLISTIC COMPETITION

72. THE FOUR TYPES OF MARKET
STRUCTURE
Number of Firms?
Many
firms
One Type of Products?
firm
Differentiated Identical
products products
Monopoly Oligopoly Monopolistic Perfect
Competition Competition
• electricity
• solar power • Novels • Wheat
• operating
• Crude oil • Movies • Milk
system

73. TYPES OF IMPERFECTLY COMPETITIVE
MARKETS
• Monopolistic Competition
– Many firms selling products that are similar but
not identical.
• Oligopoly
– Only a few sellers, each offering a similar or
identical product to the others.

74. MONOPOLISTIC COMPETITION
Markets that have some features of
competition and some features of
monopoly.

75. MONOPOLISTIC COMPETITION-
ATTRIBUTES
• Large number of buyers
• Large number of sellers.
• Product differentiation by each firm.
• Free entry. Only product differentiation act as entry
barrier.
• Price will be higher than perfectly competitive firm
but lower than a monopolist.
• May be price Competition or Non price competition.
• Higher elasticity of demand.
• Selling cost makes the difference.

76. MONOPOLISTIC COMPETITORS IN THE
SHORT RUN
(a) Firm Makes a Profit
Price
MC
ATC
Price
Average
total cost
Profit Demand
MR
0 Profit-
Quantity
maximizing quantity

77. A MONOPOLISTIC COMPETITOR
IN THE LONG RUN...
Price
MC
ATC
P=ATC
Demand
MR
0
Profit-maximizing Quantity
quantity

78. MONOPOLISTIC VERSUS PERFECT
COMPETITION
• There are two noteworthy differences
between monopolistic and perfect
competition
– excess capacity and markup.

79. EXCESS CAPACITY
• There is no excess capacity in perfect
competition in the long run.
• Free entry results in competitive firms producing
at the point where average total cost is
minimized, which is the efficient scale of the firm.
• There is excess capacity in monopolistic
competition in the long run.
• In monopolistic competition, output is less than
the efficient scale of perfect competition.

80. EXCESS CAPACITY...
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Price Price
MC MC
ATC ATC
P
P = MC P = MR
Excess capacity (demand
curve)
Demand
Quantity Quantity
Quantity Efficient Quantity = Efficient
produced scale produced scale

81. MARKUP OVER MARGINAL COST
• For a competitive firm
– price equals marginal cost.
• For a monopolistically competitive firm
– price exceeds marginal cost.

82. MARKUP OVER MARGINAL COST
• Because price exceeds marginal cost
– an extra unit sold at the posted price means more
profit for the monopolistically competitive firm.

83. MARKUP OVER MARGINAL COST
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Price Price
Markup MC MC
ATC ATC
P = MC P = MR
(demand
Marginal curve)
cost
MR Demand
Quantity Quantity
Quantity Quantity
produced produced

84. MONOPOLISTIC VERSUS PERFECT
COMPETITION...
(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm
Price Price
MC MC
Markup ATC ATC
P = MC P = MR
Marginal (demand
cost curve)
MR Demand
Quantity Efficient Quantity Quantity produced = Quantity
produced scale Efficient scale
Excess capacity

85. ADVERTISING
• When firms sell differentiated products and
charge prices above marginal cost.
• Each firm has an incentive to advertise in
order to attract more buyers to its particular
product.

86. ADVERTISING
• Firms that sell highly differentiated consumer
goods typically spend between 10 and 20
percent of revenue on advertising.
• Overall, about 2 percent of total revenue, or
over 100 billion a year, is spent on advertising.

87. ADVERTISING
• Critics of advertising argue that firms
advertise in order to manipulate people’s
tastes.
• They also argue that it impedes competition
by implying that products are more different
than they truly are.

88. ADVERTISING
• Defenders argue that advertising provides
information to consumers
• They also argue that advertising increases
competition by offering a greater variety of
products and prices.
• The willingness of a firm to spend advertising
rupees can be a signal to consumers about the
quality of the product being offered.

89. BRAND NAMES
• Critics argue that brand names cause
consumers to perceive differences that do not
really exist.
• Economists have argued that brand names
may be a useful way for consumers to ensure
that the goods they are buying are of high
quality.
– providing information about quality.
– giving firms incentive to maintain high quality.

90. OLIGOPOLY

91. IMPERFECT COMPETITION
Imperfect competition includes
industries in which firms have
competitors but do not face so much
competition that they are price takers.

92. TYPES OF IMPERFECTLY COMPETITIVE
MARKETS
• Oligopoly
– Only a few sellers, each offering a similar or
identical product to the others.
• Monopolistic Competition
– Many firms selling products that are similar but
not identical. ………* ALREADY SEEN

93. CHARACTERISTICS OF AN OLIGOPOLY
MARKET
• Few sellers offering similar or identical
products
• Interdependent firms
• Best off cooperating and acting like a
monopolist by producing a small quantity of
output and charging a price above marginal
cost
• There is a tension between cooperation and
self-interest.

94. ….contd
• Few sellers.
• Large buyers.
• Product can be homogenous.
• Entry barriers due to product differentiation due
to few firms dominating the market.
• Prices are fixed high but always have the fear of
rivals.
• All factors of production, advertisement and
selling expenses primarily depend upon
competitors strategy.

95. REASONS FOR OLIGOPOLY
• Strategic material supplies and patented
production techniques.
• Product differentiation
• Customer loyalty to established brands.
• Economies of scale.
• Restriction on the entry of new firms exercised by
the existing firms.
• Restriction on the entry of new firms exercised by
Government.

96. CLASSIFICATION OF OLIGOPOLY
• Perfect oligopoly / Homogenous oligopoly
– homogenous product.
• Imperfect oligopoly / Heterogeneous oligopoly
– Product differentiation.
• Open oligopoly
– Free entry of new firms
• Closed oligopoly
– Entry barriers.
• Partial oligopoly
– Price leader
• Full oligopoly
– No price leader.
• Agreement between firms / Cartels / Collision.

97. OLIGOPOLY PRICES, OUTPUT AND
PROFITS
• Normally in oligopoly the firm’s pricing policy will
be based on their rival firms.
• Rivals are likely to follow suit.
• Oligopoly firms hesitate to reduce price except
to meet a price cut by one of the group.
• So, initiation of price cuts is infrequent except
under serious market pressure on profits at
existing prices.
• If one firm increases price, there is a good
chance that others will follow suit.

98. KINKED DEMAND CURVE.
• When there is a sudden change in the slope of the
demand curve then it is called as kinked demand
curve. ( Sharp Corner in the demand curve).
• Price Reduction :
– Actually the demand of the firm should increase. But it will
increase for a very short period and then there will not be
any significant increase in sales. Because the rival firms
will follow suit.
• Increase in price:
– If the rival firms doesn’t follow suit, then the price increase
will cause a substantial decline in his sales.
• So neither a price increase nor a price reduction will
be an attractive proposition for the oligopolist.
Existence of price rigidity.

99. PERFECT COLLUSION / CARTELS.
• A cartel is an explicit agreement among
independent firms on subjects like prices,
output, market sharing etc.
– Centralised cartels.
– Market Sharing cartels.

100. IMPERFECT COLLUSION / PRICE
LEADERSHIP.
• A traditional firm or the firm which has
largest market share or the firm which
always initiate a price change are called as
leaders.
• If these company changes the price and all
other companies tend to follow the suit is
called as price leadership.
• Market share of a firm = Sales of firm / Total
Market sales.

101. NON PRICE COMPETITION
• Usually a cut in a price by a firm will follow suit by
its rival firms.
• This will lead to Price war.
• Price competition is always dangerous.
• Because it will squeeze profits.
• So it will be a better strategy to compete with the
rival firms in various parameters other than price.
• These various parameters will take gestation
period to imitate by the competitors.

102. VARIOUS PARAMETERS IN NON PRICE
COMPETITION
• Know-how barriers
• Advertisement.
• Personal selling.
• Product improvements or better products.
• Product research and development.
• Better quality packing and appearance.
• Easier credit terms.
• Home delivery.
• After sales services.
• Longer period of guarantee.
• New promotional strategies.
• Companies image.

103. A DUOPOLY EXAMPLE
A duopoly is an oligopoly with only
two members. It is the simplest type
of oligopoly.

104. COMPETITION, MONOPOLIES, AND
CARTELS
• The duopolists may agree on a monopoly
outcome.
– Collusion
• The two firms may agree on the quantity to produce
and the price to charge.
– Cartel
• The two firms may join together and act in unison.

105. SUMMARY OF EQUILIBRIUM FOR AN
OLIGOPOLY
• Possible outcome if oligopoly firms pursue
their own self-interests:
– Joint output is greater than the monopoly
quantity but less than the competitive industry
quantity.
– Market prices are lower than monopoly price but
greater than competitive price.
– Total profits are less than the monopoly profit.

106. HOW THE SIZE OF AN OLIGOPOLY
AFFECTS THE MARKET OUTCOME
• How increasing the number of sellers affects
the price and quantity:
– The output effect: Because price is above
marginal cost, selling more at the going price
raises profits.
– The price effect: Raising production lowers the
price and the profit per unit on all units sold.

107. HOW THE SIZE OF AN OLIGOPOLY
AFFECTS THE MARKET OUTCOME
• As the number of sellers in an oligopoly
grows larger, an oligopolistic market looks
more and more like a competitive market.
• The price approaches marginal cost, and the
quantity produced approaches the socially
efficient level.

108. GAME THEORY AND THE ECONOMICS
OF COOPERATION
• Game theory is the study of how people
behave in strategic situations.
• Strategic decisions are those in which each
person, in deciding what actions to take, must
consider how others might respond to that
action.

109. GAME THEORY AND THE ECONOMICS
OF COOPERATION
• Because the number of firms in an
oligopolistic market is small, each firm must
act strategically.
• Each firm knows that its profit depends not
only on how much it produced but also on
how much the other firms produce.

110. THE EQUILIBRIUM FOR AN
OLIGOPOLY
• A Nash equilibrium is a situation in which
economic factors interacting with one
another each choose their best strategy given
the strategies that all the others have chosen
(I.e. Dominant Strategy)

111. PRICING

112. FACTORS GOVERNING PRICE
• External Factors:
– Elasticity of supply and demand.
– Extent of competition in the market.
– Trend of the market.
– Purchasing power of buyers.
– Government policies towards prices.
• Internal Factors:
– The costs.
– The management policy towards gross margin & sales
turnover.
– The basic characteristics of the product
– The stage of the product on the product life cycle. Extent
of distinctiveness of the product.
– Extent of product differentiation practiced.

113. • Consideration while pricing:
– General Objectives of Business.
• Survival
• Continued existence.
• Rate of growth
• Market share
• Maintenance of control or leadership
• Profit.

114. – Competitive situation.
– Product & Promotional strategies.
– Nature of price sensitivity.
– Conflicting interests of manufacturers and
middlemen.
– Active entry of non-business groups into the
determination of prices.

115. OBJECTIVES OF PRICING POLICY
• Maximization of profits for entire product line.
• Discouraging the entry of competitors.
• Adaptation of prices to fit the diverse competitive
situations faced by different products.
• Flexibility to vary prices to meet changes in
economic conditions affecting the various
consumer industries.
• Stabilization of prices and margin
• Market penetration.
• Early cash recovery.
• For achieving satisfactory rate of return.

116. ROLE OF COSTS IN PRICING
• Cost in Selling & Marketing.
• Cost is related with volume of production.
– Price decisions cannot be based merely on cost.
• In the long run prices should cover costs.
• Relevant cost: all direct costs are relevant.
Problem arises in a multi product firm.
• Demand factor in pricing
– Cost reduction
– Elasticity of demand.

117. REASONS FOR INCREASING PRICES.
• Costs of Raw material increase
• Increase in demand than supply.
• Advertising.
• Change in the position of the product.
• Increase in the Per capita income.

118. PRICE DISCRIMINATION
• Charging different Prices on some systematic
basis .
• Time Price Differentials:
– Clock time differentials. Eg. Telephone service
charges
– Calendar-time differentials. Eg. Off season rates in
Hospitality industry.
• User Price Differentials. Eg. Electricity.
• Quality Price Differentials.
• Quantity Price Differentials. Eg. Slab system,
Functional discounts.

119. …contd
• Geographic price Differentials:
– Free on Board pricing (F.O.B)
– Delivered pricing.
– Zone pricing.
– Basing point pricing.
• Personal price Differentials.
• National Areas Price Differentials / Export price
Differentials.
• Cash Discounts.

120. PRICING STRATEGIES.
• Stay-out Pricing.
• Price lining.
• Psychological pricing.
• Limit Pricing.
• Skimming price
• Penetration price
• Sliding down the demand curve.
• Premium pricing.
• Fraction below competition.
• Price Discrimination.
• Bench mark Pricing.

121. PROCESS OF PRICING FOR GOODS &
SERVICES.
• Individuals affected by pricing decision:
– Sales promotional personnel.
– Rival firms & potential rival firms.
– Consumers and potential consumers.
– Middlemen / Suppliers.
– The Government.
• Multi-stage process:
– Determining target group.
– Decision about the firm’s image.
– Selection of sales strategy.
– Choice of pricing policy & pricing strategy.
– Setting specific prices.

122. CONSIDERATIONS IN PRICING
• Impact of price and output on revenue & cost.
• Elasticity of demand.
• Incremental contribution of output to
overheads and profit.
• Output level that can contribute maximum
towards overheads and profit.
• Possibilities of price adjustments to changes in
cost and demand conditions.

123. …contd
• Consideration of goodwill.
• Impact of price change in a product on the
product line.
• Finding out long run / short run implications
of any price change.
• Consideration of rivals price strategies &
reactions.
• Coordination of pricing policy with overall
corporate goals.

124. PRICING OVER THE LIFE CYCLE OF A
PRODUCT
• Introduction
• Growth stage.
• Maturity.
• Stage of decline.

125. FACTOR MARKETS

126. FACTOR OF PRODUCTION
• Used to produce some output.
– It also called an input or a productive resource.
• Examples: labor, machinery, raw materials,
land

127. FACTOR MARKET
• A market for a factor of production.
– Example: The market for construction workers
brings together the buyers and sellers of
construction workers’ services.

128. DERIVED DEMAND
• The demand for an input is derived from the
demand for the output that the input helps
produce.

129. IMPORTANT NOTE
• A firm might be a perfect competitor in the
product market and might not be a perfect
competitor in the factor market, or vice
versa.

130. FOUR POSSIBILITIES FOR A FIRM
• Perfect competitor in the product market, and
perfect competitor in the factor market.
• Perfect competitor in the product market, but
not a perfect competitor in the factor market.
• Not a perfect competitor in the product market,
but a perfect competitor in the factor market.
• Not a perfect competitor in the product market,
and not a perfect competitor in the factor
market.

131. Example: The local water company is the only
water company in the area. It is one of many
employers who hire accountants.
This firm is not a perfect competitor
in the product market (water market).
It may be a perfect competitor in
the factor market (market for
accountants).

132. PRICE-TAKING IN THE FACTOR
MARKET
• Just as a firm in a perfectly competitive
product market takes the price of the product
as given
• A firm in a perfectly competitive factor
market takes the price of the factor as given.
• The firm can hire as much of the input as it
wants at the going input price.
– So, the supply curve of the input to the firm is a
horizontal line at the input price.

133. PRICE OF LABOR
price of labor
PL
S
labor

134. FACTOR MARKET TERMS

135. MARGINAL RESOURCE COST (MRC)
• The change in total cost that results from the
employment of an additional unit of an input.
MRC = ∆TC / ∆ L

136. MARGINAL PHYSICAL PRODUCT
(MPP) OR MARGINAL PRODUCT (MP)
• The change in the quantity of output that
results from the employment of an additional
unit of an input.
MPP = ∆Q / ∆ L

137. MARGINAL REVENUE PRODUCT
(MRP)
• The change in total revenue that results from
the employment of an additional unit of an
input.
MRP = ∆TR / ∆ L

138. WHAT IS THE DIFFERENCE
BETWEEN THE MPP AND MRP?
• Suppose your company produces chairs.
– The MPP tells how many more chairs you can
make if you hire another worker.
– The MRP tells how much more revenue you can
make from the additional chairs produced by the
additional worker

139. ALTERNATIVE FORMULA FOR MRP
MRP = TR = TR Q
L L Q
= TR Q
Q L
= MR . MPP
So, MRP = MR . MPP

140. Example: A firm sells its shirts in a perfectly competitive product
market for Rs 10 each.
L Q
0 0
10 70
20 130
30 180
40 220
50 250
60 270
70 280

141. Example: A firm sells its shirts in a perfectly competitive product
market for Rs 10 each.
L Q MPP=Q/L
0 0 ---
10 70 7
20 130 6
30 180 5
40 220 4
50 250 3
60 270 2
70 280 1

142. Example: A firm sells its shirts in a perfectly competitive product
market for Rs 10 each.
L Q MPP=Q/L TR=PQ
0 0 --- 0
10 70 7 700
20 130 6 1300
30 180 5 1800
40 220 4 2200
50 250 3 2500
60 270 2 2700
70 280 1 2800

143. Example: A firm sells its shirts in a perfectly competitive product
market for Rs 10 each.
L Q MPP=Q/L TR=PQ MR =TR/Q
0 0 --- 0 ---
10 70 7 700 10
20 130 6 1300 10
30 180 5 1800 10
40 220 4 2200 10
50 250 3 2500 10
60 270 2 2700 10
70 280 1 2800 10

144. Example: A firm sells its shirts in a perfectly competitive product
market for Rs 10 each.
MRP =TR/L
L Q MPP=Q/L TR=PQ MR =TR/Q MRP= MR•MPP
0 0 --- 0 --- ---
10 70 7 700 10 70
20 130 6 1300 10 60
30 180 5 1800 10 50
40 220 4 2200 10 40
50 250 3 2500 10 30
60 270 2 2700 10 20
70 280 1 2800 10 10

145. Focusing on the first and last columns of the previous table, we have
the MRP schedule.
L MRP
0 ---
10 70
20 60
30 50
40 40
50 30
60 20
70 10

146. PLOTTING POINTS WE HAVE A GRAPH
OF THE MRP CURVE.
MRP
70
60
50
40 MRP
30
20
10
labor
0 10 20 30 40 50 60 70

147. WHEN SHOULD YOU EMPLOY MORE
OF AN INPUT?
MRP > MRC employ more input
MRP < MRC cut back employment
MRP = MRC profit-maximizing
employment level

148. PROFIT-MAXIMIZING CONDITION
FOR INPUT USAGE:
MRP = MRC

149. MRC in a Perfectly Competitive Labor Market
• Each time a firm hires another unit of labor,
its cost increases by the price of the labor
(PL).
– So for a firm in a perfectly competitive labor
market, MRC = PL .
( firm is not in a perfectly competitive labor
market, is possible…………….)

150. • Suppose the firm in the example we
considered earlier is also perfectly competitive
in the labor market.
– So the MRC is the same as the price of labor or
the market wage.
• Let’s see what the demand curve for labor is
for this firm.
– What we need to know is how many workers
will be hired at various wage levels.

151. Remember: You hire workers as long as they add at
least as much to revenues as to cost.
L MRP Suppose the market wage is Rs 70. How
0 --- many workers will you hire?
10 70 10
20 60 Suppose the market wage is Rs 60. How
many workers will you hire?
30 50 20
40 40 Suppose the market wage is Rs 50. How
50 30 many workers will you hire?
60 20 30
70 10 Suppose the market wage is Rs 40. How
many workers will you hire?
40

152. A FIRM’S DEMAND CURVE FOR LABOR
Rs
70
60
50
40 demand curve for labor
30
20
10
labor
0 10 20 30 40 50 60 70

153. THE SUPPLY OF LABOUR
• The LABOUR FORCE:
– all individuals in work or seeking employment
• Labor supply
– for an individual, the decision on how many hours to offer
to work depends on the real wage
– an individual’s attitude towards leisure and income
determines if more or less hours of work are supplied at a
higher real wage rate.

154. THE INDIVIDUAL’S SUPPLY CURVE OF LABOUR
SS2 For the labor supply
SS1
curve SS1, an increase
in the real wage induces
higher labor supply.
Whereas for SS2,
there comes a point
where a higher wage
induces less hours of
work to be supplied:
labor supply is
Hours of work supplied backward-bending.

155. THE LABOR DEMAND CURVE SHIFTS
BECAUSE
1)An increase or decrease in the price of output.
An increase in the price of widgets, increases the
MP of each worker, and increases the demand for
labor in widget factories.
2) Change in technology.
Improvements in widget technology increases the
MP of labor, which increases the demand for
labor in widget factories.
3) A change in the supply of linked factors of
production.
A fall in the supply of iron to make widgets will
decrease the MP of widget workers and decrease
the demand for widget workers.

156. THE LABOR SUPPLY CURVE SHIFTS
BECAUSE:
1) A change in attitudes regarding work.
Prior to World War II, few women worked outside
the home. A changing attitude regarding working
has increase the supply of labor for females.
2) Change in opportunity
Changing opportunities may cause a worker in
one field to seek work in a higher paying position
elsewhere.
3) Immigration policies.
An increase in the immigration will increase the
supply of labor.

157. The Supply of and Demand for Labor in a
Competitive Labor Market.
Wage P
S1
rate (Rs)
S2
S = MRC
W1
w2
D=MRP D=mrp
L 1 L2 Q Q Q
Q of labor for total Q of labor for an
labor market individual firm
When the supply of labor increases from S1 to S2, the
wage rate falls from W1 to W2 and firms begin to hire
more labor increasing quantity from L1 to L2.

158. When there is demand for . . . . and because Q went up,
the good or services in the there is a derived demand for
product market (causing P resources (labor) in the factor
and Q to go up). . . . market (causing W and Q to go
up).
P
W
S
S
P1
W1
P W
D
D
Q Q1 Q
QL QL1 Q of
Product Market Resource Market Labor

159. IMPORTANT: do NOT label
the supply curve for the labor . . . . .label it MFC
market as “S”. . . . (marginal factor cost)
P MFC
W
S
P1
W1
P W
D
D
Q Q1 Q
Q Q1 Q
Product Market Resource Market

160. IMPORTANT: do NOT label
the demand curve for the . . . . .label it MRP
labor market as “D”. . . (marginal revenue
product)
P MFC
W
S
P1
W1
P W
D1
MRP1
D
MRP
Q Q1 Q
Q Q1 Q
Product Market Resource Market

161. LABOUR SUPPLY IN AGGREGATE
• If we consider the economy as a whole, or an
industry
• A higher real wage rate also encourages a
higher participation rate
• so labour supply is likely to be upward-sloping

162. LABOUR MARKET EQUILIBRIUM FOR AN INDUSTRY
• The industry supply curve
SLSL slopes up
DL SL – higher wages are needed to
attract workers into the
industry
• For a given output
W0 demand curve, industry
demand for labour slopes
DL down
SL
• Equilibrium is W0, L0.
L0
Quantity
of labour

163. A SHIFT IN PRODUCT DEMAND
Beginning in equilibrium,
DL SL
a fall in demand for the
D'L product also shifts the
derived demand for labour
to D'L
W0
W1
The new equilibrium is
DL at W1, L1.
SL
D'L
L1 L0
Quantity
of labour

164. A CHANGE IN WAGES IN ANOTHER INDUSTRY
S'L Again starting in equilibrium,
DL SL
An increase in wages in
another industry attracts
labour,
W2
W0
so industry supply shifts
to the left –
S'L DL
SL
The new equilibrium is
at W2, L2.
L2 L0
Quantity
of labour

165. TRANSFER EARNINGS AND ECONOMIC RENT
• Transfer earnings
– the minimum payments required to induce a
factor of production to work in a particular job.
• Economic rent
– the extra payment a factor receives over and
above the transfer earnings needed to induce the
factor to supply its services in that use.

166. TRANSFER EARNINGS AND ECONOMIC RENT (2)
In labour market
equilibrium at W0, L0,
D
SS If workers were paid only
Wage
the transfer earnings, the
industry would need only
E pay AEL0 in wages.
W0
But if all workers must be
paid the highest wage
needed to attract the
D
marginal worker into the
industry (W0), then workers
A as a whole derive economic
rent of 0AEW0.
0 A L0
Quantity

167. INFRAMARGINAL RENT vs
PURE ECONOMIC RENT
in the Labor Market

168. There are two types of rent:
1) Inframarginal rent
2) Economic rent

169. INFRAMARGINAL RENT
Firms demand labor from households…..
Wage …..households supply labor
to the firms.
S
The number of workers hired is
Q…..
W
……and the wage rate is W.
D
Q Quantity

170. INFRAMARGINAL RENT
If you notice, many workers are willing to work below the equilibrium wage.
Even though they are willing
Wage to work for less, they are
paid the equilibrium wage
S
rate. This means workers are
receiving added profit above
what they are paid for…
W
D
Q Quantity
This added profit is called INFRAMARGINAL RENT.

171. PURE ECONOMIC RENT
First we label the derived demand and supply curves correctly.
In any industry, the firm will
Wage hire only so many workers.
So at some Q, the supply
MFC
curve becomes perfectly
inelastic.
W
MRP
Q Quantity

172. PURE ECONOMIC RENT
In the short run, if derived
Wage MFC demand for labor increases
without a change in the
supply of labor, MRP
increases.
W
MRP1
MRP
Q Quantity

173. PURE ECONOMIC RENT
Individuals who were willing
Wage MFC to work for W are now
earning W1 and are now
W1 earning PURE ECONOMIC
RENT.
W
MRP1
MRP
Q Quantity

174. COST MINIMIZATION
• An ISOQUANT
– shows the different
Labour
minimum quantities of
inputs required to
L0
produce a given level of
output
A • An ISOCOST curve
– shows the different input
I'' combinations with the
I' same total cost, given
I
relative factor prices.
KA
Capital