Revenue Analysis

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Revenue Analysis

TR= P* Q AR= TR/Q= P Demand curve of the consumer is the AR curve from the seller’s point of view since price paid by the consumer is the revenue of the seller.

MR= TR n - TR n-1 Shape of TR, AR and MR curves change according to market situation 2

Revenue Analysis

TR= P* Q AR= TR/Q= P Demand curve of the consumer is the AR curve from the seller’s point of view since price paid by the consumer is the revenue of the seller.

MR= TR n - TR n-1 Shape of TR, AR and MR curves change according to market situation 3

Revenue Structure under Perfect competition

Quantity 1 Price (Rs) 100 TR 100 AR 100 MR 100 2 3 4 5 100 100 100 100 200 300 400 500 100 100 100 100 100 100 100 4 100

Revenue Structure under Perfect competition

• Large no of buyers and sellers buying and selling homogeneous products • Uniform prices • Producer can sell any quantity of output at the market price.

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Revenue Structure under Perfect competition

Y TR P=AR=MR X O Quantity 6

Revenue Structure under Perfect competition

• Demand curve is perfectly elastic • Price does not fall if one more unit is sold • Therefore P(AR) remains the same when one more unit is sold and so AR=MR- so MR and AR curves coincide • Horizontal line parallel to X axis indicates that P or AR is constant irrespective of quantity sold 7

Revenue Structure under Imperfect competition

• Under imperfect competition, producer faces a downward sloping demand curve He needs to lower the price to attain higher sales 8

Revenue under Imperfect competition

Quantity 1 2 3 4 5 6 7 8 9

10

TR 16 30 42 52 60 66 70

72

72

70

AR 16 15 14 13 12 11 10 9 8

7

MR 16 14 12 10 8 6 4

2

0

-2

9

Revenue Structure under Imperfect competition

• MR is positive as long as TR is increasing • MR becomes negative when TR declines • When quantity sold is increased from 9 to 10 units, TR declines from Rs. 72 to Rs. 70 and MR turns negative • AR declines as additional units of product are sold 10

Revenue Structure under imperfect competition

Y TR O MR AR X 11

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Perfect Competition

• Large no of undifferentiated buyers and sellers each one is so small as to be insignificant to influence the market--price takers • Homogeneous products- each competitor offers or seeks exactly a similar thing as others • The seller is a price-taker • No barriers to entry and exit- survival of the fittest: Firm will shut down where AVC=AR. At any price lower than the AVC, firm will have to shut down 13

Perfect Competition

• Markets must be well organised and continuous and everyone has information (knowledge) on market condition, product and price • Market prices must be flexible to keep responding to changing conditions of supply and demand • No transport cost • Perfect mobility of factors of production (raw materials, labour and capital)-this results in factor price equalisation.

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Perfect Competition

• No Government interference: No rationing, administered prices, subsidies etc.- Underlying presumption that free market operates in social interest “invisible hand” and self-regulatory mechanism- it provides an effective check on the power of the sellers, safeguards consumer against exploitation and makes it unnecessary for the State to intervene by regulating prices and production in order to protect the consumer 15

Perfect Competition

Key lessons of perfect competition for managers

• Important to enter the market as far ahead of the competitors as possible-when supply is low and price is high- this requires entrepreneurial skill • A firm earning an economic profit (as distinguished from normal profits) cant afford to be complacent because economic profit will attract new entrants • Only way for a firm to survive is to keep costs as low as possible 16

Perfect Competition

• With growing globalisation, new competitive cost pressures are being felt by firms around the world- Indian companies have the advantage of low – cost labour but disadvantage of technology lag 17

Monopoly

• Only one seller of a particular good or service • Rivalry from producers of substitutes is so remote as to be insignificant: cross elasticity of demand is zero • Monopolist is a price setter- strength of a monopolist’s power depends on how much he can raise the price without losing all his customers- this depends on elasticity of demand, which in turn depends on availability of substitutes • 2 conditions are necessary to make a monopolist strong: 1) Gap in the chain of substitutes and 2) possibility of securing control over all the substitutes 18

Causes and Forms of Monopoly

• Barriers to entry • Legal: Emerges as a result of statutory regulation by government: Copy right, trade marks, government regulation, licence, tariffs and non-tariff barriers against import of goods • Technical; Arises when the technical know-how is available with only one person • Natural: If a single firm acquires control over supply of raw materials or natural resources such as minerals Oil well in a particular area • High costs of capital investment or economies of scale 19

Causes and Forms of Monopoly

• Joint Monopoly: Through voluntary agreement, business companies jointly acquire monopoly power. e.g., Trusts, syndicates, cartels, • Public Monopoly: Created for the welfare of the public- e.g., public utilities like water supply, electricity, railways, telephones • Private Monopoly: Owned an operated by private individuals or organisations- objective is profit maximisation 20

Causes and Forms of Monopoly

• Simple Monopoly: Charges uniform or single price for a product to all the consumers- no discrimination between buyers or uses.

• Discriminating Monopoly : Act of selling the same commodity produced under single control, at different prices to different buyers or different uses.

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Discriminating Monopoly/ Price Discrimination

• 3 forms: • 1 st Degree: Different rate for every unit of output. Monopolist forces every consumer to part with his entire consumer surplus- discrimination between buyers is more common than discrimination between units of a homogeneous good 22

2nd degree Discrimination • 2

nd

Degree

: Buyers are divided into different groups and then different rates charged for different blocks or groups: here, consumers enjoy a part of the consumer surplus and monopolist is also able to get a part of the surplus; e,g., electricity charges • Taxi fare a certain amount or the 1st km, then different for further units 23

3

rd

degree Discrimination

• 3 rd degree: Most common type-Seller divides his buyers into sub-markets and charges a different price for each market- Dumping is an example: High price in domestic market and low in international market. • Reasons: To dispose off surplus; to remove rivals; to take advantage of increasing returns to scale; to create new demand abroad; because demand elastic in international market, he has to reduce price 24

Conditions of Price Discrimination

Conditions of Price Discrimination ( When is Price discrimination possible?)

1. Consumers are unaware of the difference in prices charged 2.

Price difference so small that consumers don’t bother 3. Price illusion/ irrationality 4. Markets are situated far from one another and so it is expensive to transfer goods from one market to another 25

Conditions of Price Discrimination

5) When elasticities of demand in the two markets are different: higher price for low elasticity market and lower price for high elasticity market. Why?

6) Direct personal services such as those of doctors and lawyers where resale is not possible 7) Legal sanction provided by government: e.g., lower prices in army canteen 26

Forms of Price discrimination

• • •

Personal Discrimination

: Occurs when different prices are charged to different consumers – doctors and lawyers may charge different fees for the rich and the poor

Local Discrimination

: Lower prices in one locality and higher in another. e.g., dumping by charging higher prices in domestic market and lower prices in foreign markets

Trade Discrimination:

Charging different rates, based on use e.g., electricity charges for domestic/ industrial/agricultural uses 27

Forms of Price Discrimination

• •

Quality Discrimination

: Hard cover editions being sold at higher prices than paper back editions of books; business class travel vs economy class in air travel

Time Discrimination

: Different charges for the same commodity at different points of time- off-season air tickets; happy hours in restaurants 28

• What is the cross elasticity of demand for a monopolist’s product?

• There is only one hospital in Mumbai with an advanced equipment for diagnosis of a certain disease. This is an example of ______________ monopoly.

• BEST and Indian Railways are examples of _________monopoly.

• Downloading music on internet is an example of violation of -------------------------- monopoly.

• 4 powerful traders get together and control supply of vegetables in Mumbai. This is ----------------------------- monopoly.

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Monopolistic Competition

‘Most economic situations are composites of both competition and monopoly’ Chamberlin. In reality, monopoly and competition are not mutually exclusive, but markets have both elements in differing degrees 30

Characteristics of Monopolistic Competition

Large no of firms/ sellers

individual has any significant control over the market -Consequently no

Absence of interdependence

market.

: Since the number is large and size of each firm is small, no firm can influence or is influenced by others in the Example of FMCG product market

Freedom of entry

: No barriers to entry- this leads to occurrence of only

normal profits in the long run

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Characteristics of Monopolistic Competition

•

Product Differentiation

:

Core of monopolistic competition-

Different firms produce similar, but not homogeneous products. It is because of product differentiation that firms enjoy some monopoly power i.e., power to control the price in a narrow circle, but in the wider circle the firm faces competition from rival producers. Firms in effect are competing monopolies 32

Characteristics of Monopolistic Competition

•

Selling Costs

consumers -

samples etc.-

: Expenditure incurred on changing the demand and preference of the

Expenditure on advertising, promotion, displays, salaries of salesmen, free

No need or role for selling costs in monopoly of perfect competition . Under monopolistic competition, firms compete with each other mainly not on the basis of price but on the basis of non price elements. Product differentiation and selling costs are known as non-price competition 33

Monopolistic Competition

Wastes of Monopolistic Competition Excess capacity- resources are not fully utilised, leading to higher costs Competitive advertising ( as opposed to constructive advertising) worse if consumers regard different products as substitutes and thus resources are wasted 34

Oligopoly: Definition and Features

• • • Few sellers producing homogeneous or differentiated products • Automobiles, steel, consumer electronics

Few sellers

: Naturally each seller has a sizeable share of market-

Close interdependence-

decision of a single firm to expand or contract output affects entire market- moves and counter moves- need to predict and analyse every possible reaction of rivals before a firm takes decisions 35

Oligopoly: Definition and Features

• •

Indeterminate demand curve

: because of extreme interdependence

Price Rigidity-

Price remains stuck at a certain level-No desire for a departure from prevailing price in either direction price cutting will be followed by rival but price hike may not be and hence “sticky” prices 36

Oligopolistic Pricing

• Oligopolistic pricing can take 3 different forms: 1. Independent Pricing 2. Collusion Model • • 3. Price Leadership

Independent Pricing

: Method of pricing its differentiated product – result of the fact that each firm has a certain monopoly power, but there is fear of retaliation by rivals Various possibilities occur: Price wars and price rigidity 37

Collusive Oligopoly

•

Collusion Model:

• When there are only a small no of firms in a market, they have a choice between cooperative and non cooperative behaviour.

• A Cartel agreement represents the most complete form of collusion among oligopolists-here firms are in a cooperative mode and minimise competition among themselves- due to explicit agreement between firms – Joint output and price decisions- has a board of control which determines the market share of each member • Example: OPEC- decides on output rather than price 38

• Sometimes tacit collusion occurs between firms without explicit agreement here they quote identical prices: Indian cement and steel market • Barriers to collusive oligopoly: -Considered illegal as it converts oligopoly into monopoly - Firms may cheat by giving secret price concessions and thereby increasing the market share - Some cartel members may be political rivals such as Iraq, Kuwait and Iran in OPEC 39

Price Leadership

•

Price Leadership

: It is an informal position in most oligopolistic markets. It may emerge spontaneously due to technical reasons such as size, efficiency, economies of scale or the firm’s ability to forecast market conditions accurately • Typically, leadership role is played by a dominant firm (largest in the industry) and smaller ones follow 40

• Sometimes price leadership is barometric-Here one of the firms (not necessarily the dominant one) takes lead in announcing a price change, especially when a change is due but is not effected due to uncertainty in the market –The barometric firm is supposed to have a better knowledge of the changing environment of the market than others • Price leadership often serves as a means to price discipline and price stabilisation 41

Comparison of different Market

Feature Perfect

Structures

competition Monopolisti c competition No of sellers Many One Large Nature of goods Homogene ous Homogene ous Differentiat ed Entry Free Degree of monopoly power Zero Barriers Absolute Unrestricte d Limited 42

Comparison of different Market Structures

Feature Cost Elements Perfect competition Monopoly Production cost Production cost Monopolisti c competition Production cost+ Selling cost Long run Profits Nature of Demand Normal Elastic Super normal Inelastic Normal Relatively 43 inelastic

Feature Pricing Perfect competition Monopoly Monopolisti c competition Price taking Price making: i) Uniform ii) Price discriminati on Price making: Uniform price 44

Review Questions

• Product differentiation is an important feature of __________________ competition (Perfect/monopolistic) • Duopoly is a market form with just -------------- sellers (two/ few) • If market price is more than the equilibrium price, it indicates that --------------- is more than --------- -(Supply/ demand) • Break-even point is a _________________ situation (No profit-no loss/ maximum profit) 45

Review Questions

• Price elasticity of demand under perfect competition is ________ • Under perfect competition, __________ is equal to AR=MR. (Price/ Total Revenue) • In the __________ period, both the fixed and variable factors of production change. (Short/ Long) • Mergers, acquisitions and take-overs are common under the _________________ market structure. (oligopolistic/ monopolistic) 46

• --------------- cost increases continuously with an increase in production. (Fixed/ variable) • There is a dichotomy of costs into fixed and variable in the _________ run. (short/ long) • --------------------Cost has to be incurred even if production is nil. (Fixed/ variable) • The ____________ run cost curve is also known as planning curve. (long/ short) • Rent is a _______________ cost (Fixed/ variable) • Self-owned resources used in business are called ___________________ costs. (imputed/ explicit) 47

• Private cost: Costs incurred by the private producer/ firm during the process of production. includes both implicit and explicit costs • Social cost: Costs incurred by society as a whole as a result of the production process undertaken of the private firm eg., water/ air/ noise pollution, congestion, traffic jam, development of slums 48

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Review Questions

• Define: • Normal profit • Market • Dumping • Barriers to entry • Product differentiation • Monopolistic competition • Oligopoly • Selling cost • Collusive oligopoly 51

Review Questions

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Review Questions

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Review Questions

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Answers to Review Questions

• Product differentiation is an important feature of __________________ competition (Perfect/monopolistic) • Duopoly is a market form with just -------------- sellers (two/ few) • If market price is more than the equilibrium price, it indicates that --------------- is more than --------- -(Supply/ demand) • Break-even point is a _________________ situation (No profit-no loss/ maximum profit) 55

Answers to Review Questions

• Price elasticity of demand under perfect competition is ________ • Under perfect competition, __________ is equal to AR=MR. (Price/ Total Revenue) • In the __________ period, both the fixed and variable factors of production change. (Short/ Long) • Mergers, acquisitions and take-overs are common under the _________________ market structure. (oligopolistic/ monopolistic) 56

Answers to Review Questions

• Define: • Normal profit: Remuneration received by entrepreneur for his service as a factor of production. This profit is just enough for him to exist in the industry.

• Market: A mechanism through which the buyer and seller interact to determine the price and quantity of a product. Buyers and sellers can be individuals, firms, agents or dealers. ( Market is not a geographical locality.) 57

• Barriers to entry: Hurdles created to prevent other potential firms from joining the industry- trade marks, patents, copyrights • Dumping: Selling in the international market at very low rates and in large quantities such that it affects the domestic producers 58

Answers to Review Questions

• Product differentiation: Changing designs, features, packaging or pricing of a product to give the consumer the perception that the product under consideration is unique or superior.

• Price Discrimination: Charging different prices for the same product to different consumers • Monopolistic competition: A market condition lying between perfect competition and monopoly, selling differentiated products 59

• Oligopoly: A market condition with few sellers, selling homogeneous or differentiated products and facing intense rivalry and competition and a high degree of interdependence.

• Selling cost: Cost incurred on advertising, sales promotion, after-sales service etc • Collusive oligopoly: A situation where firms in an oligopolistic market enter into an explicit agreement regarding output and price decisions; Example OPEC. In the case of tacit collusion, there is no open or formal agreement.

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Answers to Review Questions

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Answers to Review Questions

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