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CHAPTER 8PRICING AND OUTPUT DECISIONS

UNDER

MONOPOLISTIC COMPETITION

&

OLIGOPOLY

Dr. Vasudev P. Iyer

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OBJECTIVES

1. Understand the conceptual issues

2. Understand how price related decisions are taken under monopolistic competition and oligopoly

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The Agenda

• The Imperfect Competition

• Meaning and features of monopolistic competition

• Meaning and features of oligopoly

• The Kinked Demand model of oligopoly

• CASELET (17): STRATEGY- The fundamental challenge for firms in imperfect competition

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Imperfect Competition

• Imperfect Competition: Less Competition, but not the absence of the same

• Features

– Some market power but not absolute market power.

– Have the ability to set prices within certain constraints

– Mutual Interdependence

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Perfect MonopolisticCompetition Monopoly Competition Oligopoly

Market Power? No Yes, subject to Yes Yes government regulation

Mutual interdependence No No No Yes among competing firms?

Non-price competition? No Optional Yes Yes

Easy market entry or exit ? Yes No Yes No, relatively relatively

easy difficult

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MONOPOLISTIC COMPETITION

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DEFINITION

• Monopolistic competition refers to a market structure in which a large number of sellers sell differentiated products, which are close substitutes of one another.

• Element of competition and monopoly.

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Examples

• Examples of this very common market structure include:– Toothpaste– Soap– Cold remedies

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PRODUCT DIFFERENTIATION

• By product differentiation we mean the modification of a product usually in minor ways, to make it more attractive to the target market and to differentiate it from competitors' products.

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WHAT THE GURU HAS TO SAY ON DIFFERENTIATION ?

• PHYSICAL DIFFERENTIATION

• BRAND DIFFERENTIATION

• RELATIONSHIP DIFFERENTIATION

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THUS SPOKE THE GURU

• PHYSICAL DIFFERENTIATION

• BRAND DIFFERENTIATION

• RELATIONSHIP DIFFERENTIATION

• Sizes, shapes, colours, tastes etc.

• Different brand names

• Customer satisfaction

Source: Marketing insights from A to Z by P. Kotler, John Wiley & Sons

“” BE DISTINCT OR EXTINCT”

TOM PETERS

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FEATURES

• Product differentiation

• Large number of sellers

• Free entry and free exit

• Selling costs

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OLIGOPOLY

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MEANING

• An oligopoly is a market dominated by a few large suppliers.

• The degree of market concentration is very high (i.e. a large per centage of the market is taken up by the leading firms)

• In case of only two firms: Duopoly

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FEATURES

• A few firms selling similar product 

• Each firm produces branded products 

• High barriers to entry.

• Interdependence of decision making

• Importance of non-price competition

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Pricing under rivalry

• Developed by Prof. Paul Sweezy

• The demand curve has a bend.

• When a firm increases the price above the market price, other firms maintain status-quo.

• When a firm decreases the price below the market price, others do the same.

THE KINKED DEMAND CURVE

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• One firm in the industry (typically the largest firm) is the price leader and, as such, takes the lead in changing prices.

• The price leader assumes that firms will follow a price increase. It assumes that firms may follow a reduction in price, but will not go lower in order not to trigger a price war.

OligopolyPrice Leadership Model

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Oligopoly: Non-price Competition

• Definition– Any effort made by firms other than a

change in the price of the product in question in order to change the demand for their product.

– Efforts intended to affect the non-price determinants of demand

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Non-price Determinants of Demand

• Any factor that causes the demand curve to shift

• Tastes and preferences

• Income

• Prices of substitutes and complements

• Number of buyers

• Future expectations of buyers about the product price

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Non-price variables

• Any factor that managers can control, influence, or explicitly consider in making decisions affecting the demand for their goods and services

• Advertising• Promotion• Location and distribution channels• Market segmentation• Loyalty programs• Product extensions and new product

development• Special customer services product “lock-in” or

“tie-in”• Pre-emptive new product announcements

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CASELET (17):

STRATEGYThe fundamental challenge for firms in

imperfect competition

MANAGERIAL ECONOMICSKEAT AND YOUNG

PG. 477

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Introduction to strategy

• Strategy is important when firms are price makers and are faced with price and non-price competition as well as threats from new entrants into the market.

• More important for firms in imperfectly competitive markets than those in perfectly competitive markets or monopoly markets.

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Meaning

• Strategy is defined as “the means by which an organization uses its scarce resources to relate to the competitive environment in a manner that is expected to achieve superior business performance over the long run.”

• Managerial Economics is “the use of economic analysis to make business decisions involving the best use of an organization’s scarce resources.” (see Chapter 1)

• Important linkages between managerial economics and strategy.

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Division of Linkages

•Linkages are divided into two sections:–Industrial Organization

–Ideas of Michael Porter

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StrategyIndustrial Organization

• Industrial organization studies the way that firms and markets are organized and how this organization affects the economy from the viewpoint of social welfare.

• How does industry concentration affect the behaviour of firms competing in the industry?

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StrategyIndustrial Organization

• Structure-Conduct-Performance (S-C-P) Paradigm– Structure affects conduct which affects

performance– Structure

• Demand and supply conditions in the industry.

– Conduct• Pricing and non-price strategies

– Performance• Welfare and efficiency results

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StrategyIdeas of Michael Porter

• Economics professor from the Harvard Business School.

• “Five Forces” model illustrates the factors that affect the profitability of a firm.

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StrategyIdeas of Michael Porter