Objectives of Pricing

Before fixing the price of a product it is essential for every firm to know the objectives of pricing.

(a) Ensuring a target Return on Investment (ROI)

Businessmen invest capital in a business with the expectation of getting a reasonable return on
investment. The price of a commodity is fixed so as to realise a predetermined rate of return on
investment.

(b) Market Share

If the primary objective of a business firm is to maintain current market share or to increase the
market share it will adopt a pricing policy to make maximum sale not profit.

(c) Preventing competition

This is the most important objective of pricing in the case of those who consider the prices of rival
firms before finalising a price policy. In such cases, a low price should be fixed in order to attract the
customers .

(d) Stability in price

Another objective of pricing is to maintain stability in prices. The price once fixed will remain more
or less stable over a long period of time irrespective of the changes in price level in the economy.

(e) Profit
Profit maximization is one of the major objectives of every firm.
(f) based on customer’s ability

In this case the main criterion of pricing is the ability of customers to pay for a product or
service. Generally this type of price policy is adopted by doctors and lawyers.

(g) Resource mobilization

Resource mobilization is another objective of pricing. If this is the objective then the prices
of products are fixed in such a way as to generate sufficient resources for further expansion
of business.

Perfect Competition

“Perfect Competition is the name given to an industry or to a market characterised by a

large number of buyers and sellers all engaged in the purchase and sale of homogenous
commodity, with perfect knowledge of market prices and quantities, no discrimination and
perfect mobility of resources.”

Features of perfect competition

Existence of large number of buyers and sellers

The most distinguishing feature of perfect competition is the existence of a large number of
buyers and sellers. In this market situation, no individual seller or buyer can influence the
price of a product, because the position of an individual seller or buyer is just like a drop in
an ocean.

Identical Products

The products dealt with in a perfectly competitive market are homogenous or identical. The
products are identical both in terms of quantity and price and therefore a buyer can buy the
product from any seller.
Free entry or exit of firms

Free entry and exit of firms means that a new firm can enter the industry at any time it
wants and an existing firm can leave the industry whenever it feels so.
Buyers and sellers have perfect knowledge

In a perfectly competitive market both the buyers and sellers have perfect knowledge about
the market conditions. It means that each firm in the industry is fully aware about the price
at which buyers are prepared to buy their products and the extent of business opportunities
open to each of them.
Perfect mobility of factors of production

Mobility of factors of production like raw-materials, labour etc. Is essential for every firm to
adjust their production (supply) in tune with the demand.
Assumption of no transport costs
To Have uniformity in prices , it is assumed that there are no transport costs. Even if there
are transport costs, it should be negligible. If there are transport costs. There cannot be
uniformity in prices because prices would vary depending on the amount of transport costs.

Concept of Equilibrium Price

Equilibrium price is the price at which the quantity demanded equals the quantity supplied.
The price of a commodity is determined by the forces of demand and supply. The law of
demand states that more of a commodity will be demanded at a lower price and less at a
higher price. On the other hand, law of supply states that more of a commodity will be
supplied at a higher price and less at a lower price. Thus there is a conflict between the law
of demand and the law of supply. It is the equilibrium price which balances the interest of
both the buyers and sellers by equating the quantity demanded and quantity supplied.
At a price above or below the equilibrium price there is a mismatch between quantity
demanded and quantity supplied. When the price is more than the equilibrium price, sellers
will be willing to sell more than what is demanded by the buyers. When the supply is more
than the demand naturally the prices would fall. Similarly when the price is less than the
equilibrium price, buyers will be willing to buy more than what the sellers are ready to sell.
When the demand is more than the supply naturally there will be a tendency for the prices
to rise. Thus it is only at the equilibrium price that there is stability in prices.

Price Determination Under Perfect Competition

In a perfectly competitive market, price is determined by the industry. Individual firms have
to accept the price determined by the equilibrium between industry, demand and supply.
This is because firms are not price makers' but they are 'price takers' as the output produced
by a single firm cannot influence the total supply in the industry.

Equilibrium of a Firm under Perfect Competition

(Output Determination)

An individual firm under perfect competition has no role in determining the price but it has
to determine the quantity of output that brings maximum profit to the firm. The output
which gives maximum profit to the firm is called equilibrium output.
Conditions for equilibrium.
A. MC=MR
B. The MC curve cuts the MR curve from below.

Monopoly

The word monopoly is derived from the Greek words “mono’ which means ‘single’
and ‘poly’ which means “seller”. Thus monopoly means single seller.

Features of monopoly

There is only a single producer or seller for a product. B) Since there is only a single
seller, the distinction between firm and industry under monopoly becomes
irrelevant.

The product produced by the monopolist will not have no close competing
substitutes. D) The cross elasticity of demand for the product of a monopolist is
either Zero or even negative.

As there are no other competing firms, the monopolist will have full
 Control over the price and supply of the product. F) Entry into a monopoly industry
is protected by barriers, legal or Otherwise.
G) Competition is absent in a monopoly market.

Source of Monopoly

Monopoly situation occurs due to the following reasons.

1. Economies of large scale production

Economies of large scale production occur when a firm can reduce its cost per unit
by increasing production. A new entrant will find it difficult to produce the product
at the same cost per unit of an established firm.

2. Economies of scope

“Economies of scope exist when it is cheaper to produce products A and B in the

same firm than in two separate firms.”
3. Exclusive ownership of raw-materials

If the raw materials required for the production of a particular commodity is owned
by a single person or a firm then natural monopolies emerge out of such ownership.
This is because raw materials are not available to rival firms.

4. Patent laws

Patent laws allow an inventor exclusive right to control a product for a specified
period. During this period a patent holder is protected from competition.

Kinds of Monopoly

1. Perfect or Absolute Monopoly - Perfect monopoly is a situation in which there is only a

single seller of a product having no close substitute and there is absolutely zero level of
competition.

2. Imperfect Monopoly - Imperfect monopoly is a situation of a single seller market having

close substitutes.

3.

Private Monopoly - Private monopoly is a situation where production is owned, controlled

and managed by an individual.

4. Public Monopoly - Public monopoly is a situation where production. is owned, controlled

and managed by the government.

5. Simple Monopoly - Simple monopoly is a situation where the monopoly firm charges a
uniform price or single price to all the customers.
6. Discriminating Monopoly Discriminating monopoly is a situation where the monopoly firm
charges different prices to different customers for the same product.

7. Legal Monopoly - Legal monopoly is a situation which emerges on account of trademarks,

patents, copyrights, statutory regulation of the government etc.

8. Natural Monopoly - Natural Monopoly is a situation which emerges as a result of natural

advantages such as good location, abundant mineral resources etc.

9. Technological Monopoly Technological monopoly is a situation which emerges as a result

of economies of large scale production, use of capital goods, new production methods etc.

10. Joint Monopoly-Joint monopoly emerges when a number of businesses. firms acquire
monopoly positions through amalgamation, cartels, syndicates etc.

Price and Output Determination under Monopoly

The main objective of a monopoly firm is to maximize profit. Unlike a perfectly competitive
firm, a monopolist is a price maker because a monopoly firm has the power to set his own
price. The demand curve of a monopoly firm is downward sloping throughout its length. It
means that if he increases the price of his product, the quantity demanded will fall and vice
versa.

A monopoly firm can either sell less at a higher price or more at a lower price. He has to find
out a price - output combination which maximises his profit. To maximise profit a
monopolist has to follow the MR=MC rule. It means that the profit of a monopolist will be at
the highest at the level of output where marginal revenue from an extra unit of output is
equal to marginal cost of the extra unit. A monopoly firm can continue to produce more and
more units of output as long as MR is more than MC.

A monopoly firm attains equilibrium at one level of output in the short run and at a higher
level of output in the long run. This is because in the long run a monopolist will make
adjustments in the size of his plant. He will choose that plant size which is most appropriate
for a particular demand. On the other hand, in the short run he will adjust his output with
the given existing plant. However the principle of profit maximization (MR=MC rule) remains
the same in both the short run and long run. The only difference is that in the short run the
monopolist compares MR with short run marginal cost and in the long run MR with long run
marginal cost.

Price discrimination
Price discrimination is the practice of charging different prices for the same product from
different buyers. “Price discrimination exists when the same product or service is sold at
different prices to different buyers.”

Objectives of price discrimination

Price discrimination may be practiced by a monopoly firm to achieve one or more of the
following objectives.

● To maximise profit by taking advantage of different classes of customers or different

business opportunities available at different places.

● To sell off accumulated inventories especially due to wrong demand Forecasting.

● To penetrate into a new market segment. A low price may be charged in the new
market segment than the existing market segment.
● Price discrimination may be practiced to take advantage of the economies of large
scale production.

● . Price discrimination may also be practiced in order to enter into or retain export
markets.

Conditions of price discrimination

Price discrimination is possible only under the following situation

● Works under monopoly only

Price discrimination works only under monopoly. If there are more than one seller the effort
of one firm to practice price discrimination gets defeated by the pricing policy of another
firm,
 ● Division of market into sub market

To practice price discrimination it should be possible to divide the market into sub-markets
for the purpose of charging different prices in each sub market.

● Transfer of goods

It should not be possible to transfer from one market to another any unit of the commodity
for which price discrimination is resorted to by a monopolist.

● Elasticity of demand should be different for different product

The elasticity of demand of the product should be different in different markets. A high price
may be charged for the product in those markets where there is inelastic demand and a low
price in the markets where there is elastic demand.

● Consumer prejudices(misunderstanding)

Consumers belonging to upper class have certain prejudices that higher the price the better
will be the quality and vice versa. To take advantage of these prejudices a monopolist can
sell the same product at a higher price under different brands and labels in order to induce
the rich and snobbish buyers to separate themselves from the poor class of buyers.

● Government regulations

Sometimes government regulations give rise to a situation of price discrimination. As part of

social commitment and poverty eradication programmes, the government may insist on
selling certain products at a cheaper rate to a particular class of customers.

● Duty and tariff barriers

Due to duty and tariff barriers a monopolist can resort to price discrimination at different
places or countries. A high price can be charged at a place or country where there is high
rate of duty and tariff charges. A low price can be charged elsewhere where there is no duty
and tariff charge.

Price determination under price discrimination

A simple monopolist charges a single price for the whole output while a discriminating
monopolist charges different prices in different markets. Therefore it is essential that the
total market should be divided into different sub markets on the basis of price elasticity of
demand in each market. The same principle of MC=MR as used by a simple monopolist is
used by a discriminating monopolist to determine the equilibrium price and output.To
explain the process of price determination under price discrimination, let us assume that the
total market is divided into two sub markets A and B. Price elasticity of demand in market A
is less than that of market B. In other words, elasticity of demand in market B is greater.
Therefore a high price can be charged in market A than market B.

In short, a discriminating monopolist will be in equilibrium if the following two conditions

are fulfilled.

● Marginal cost of total output should be equal to aggregate marginal Revenue.

Marginal revenue in market A= to Marginal revenue in market B = Marginal cost of total

market.

Monopolistic competition

“Monopolistic competition refers to a market situation in which there are many

producers producing goods which are close substitutes of one another or where output
is differentiated.”
Characteristics of monopolistic competition

The important distinguishing characteristics of monopolistic competition are as follows.

1) Presence of large number of sellers

“Monopolistic competition refers to that market situation in which a relatively large

number of small producers or sellers offer similar but not identical products.

2) Product Differentiation

“Product differentiation means that the products are different in some ways, but not
altogether so.” In other words product differentiation is an act of distinguishing one
firm’s product with another firm, who produces a close substitute, in one or more
aspects like product quality, colour, design, brand name, packaging etc.
3) Independent price policy

The firms in a monopolistically competitive market have an independent price policy.

Though there are competitions among firms, each firm’s price policy is not dependent
on other firm’s price policies.
 4) Non – price competition

Under monopolistic competition though the products are differentiated there is

competition among the firms on non- price factors such as product quality, advertising,
after sale service, packing and labelling etc.

5) Large number of buyers

In a monopolistically competitive market there exist a large number of buyers. Each
buyer has his own brand preferences.
6) Free entry and exit

As in perfect competition freedom of entry and exit prevails in monopolistic competition

7) Selling costs

Since the product of a monopolistic competitor is a close substitute of one another, a

considerable amount has to be incurred on selling the products.

8) Absence of perfect knowledge

The buyers do not have perfect knowledge about the competing products, their quality,
prices etc. And therefore they are influenced by advertisement and sales promotional
techniques.

9) The group concept

In monopolistic competition the firms produce differentiated products and therefore

these firms work together as groups instead of industry.

Short run equilibrium of monopolistic competition

Short run

In the short run a monopolistic competitive market can either supernormal profit or normal profit
sometimes it may incur a loss

Supernormal profit. Monopolistic competitive market can earn supernormal profit in the short run if
the price is above the short run average cost.

Loss. In the short run monopolistic firm may have a loss if the price is below the short run average
cost.

Long run equilibrium.

In the long run, a firm under monopolistic competition can earn only normal profits. If the existing
firms make supernormal profits it will attract new entrants and the super normal profit of the
existing frame will be completely taken away by the new entrants. On the other hand, if the existing
firms make losses, some of the existing loss making firms will exit from the industry leaving an
opportunity for the remaining firms to earn normal profit.
Oligopoly

The word Oligo means few. It is a market with few big sellers Producing either homogeneous
product or differentiated product.

Characteristics or features of oligopoly

Important characteristics of an oligopolistic situation are as follows

Few sellers

There are only a few sellers in oligopoly. Even if the sellers are few, every seller can influence the
market because each one enjoys a significant portion of the total market.

Mutual Interdependence

Mutual interdependence among the firms is the most important feature of the oligopolistic
situation. Because of the few firms in the market any decisions taken by a seller will affect the other
firm also.

Homogeneous or differentiated products

The products in an oligopoly market are either homogeneous or differentiated.

Indeterminate demand curve

. Because of the interdependence of firms under oligopoly, a firm cannot be certain about what it
can sell at different prices. Because of that the demand curve cannot be determined.

Advertising and selling cost

To protect the existing market and also to gain more market share, oligopoly firms have to indulge in
aggressive and defensive marketing strategies.
Price stability

The situation of price stability is often found in oligopoly. This is because of the fact that firms under
oligopoly normally would not venture either to increase price or to decrease price. Even if demand
increases no firm will increase the price because of fear that other firms will not increase their price
and it may lose its customers. On the other hand, no firm will reduce its price because of fear that
other firms will also reduce their price which will ultimately leave no advantage to the firm.

Kinked demand curve theory

The concept of the kinked demand curve was introduced by an American economist Paul M Sweezy.
Kinked demand curve explains the situation of price rigidity under oligopoly. The demand curve of an
oligopolist firm has a ‘kink’ at the prevailing market price. The kink divides the demand curve into
two portions. The upper portion of the demand curve is more elastic and the lower portion is less
elastic.

The upper portion of the demand curve is more elastic because if the firm raises its price beyond the
prevailing market price other competing firms may not increase their price and therefore it will lose
its sales.

The lower portion of the demand curve is less elastic because if the firm reduces its price below the
prevailing market price, other competing firms may also reduce their price and therefore it cannot
increase its sales much. This happens because of the mutual interdependence of firms in oligopoly.
Therefore there will be a tendency among the firms to remain at the prevailing market price. This
gives rise to a situation of price rigidity.