COLLEGE NAME: MET INSTITUTE OF

MANAGEMENT
COURSE NAME: MFM FIRST YEAR
NAME OF SUBJECT: MANAGERIAL
ECONOMIC
PROJECT NAME: MARKET STRUCTURE AND
PRICING THEORY
PROJECT PARTNERS:
DHERAJ KANCHAN
NIRAJ TRIVEDI

77

103

RAHUL SRIVASYAV

99

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Market Structure &

Pricing Theory

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Managerial Economics
Managerial Economics Overview
A close interrelationship between management and economics had led to
the development of managerial economics. Economic analysis is required
for various concepts such as demand, profit, cost, and competition. In this
way, managerial economics is considered as economics applied to
problems of choice or alternatives and allocation of scarce resources by
the firms.
Managerial economics is a discipline that combines economic theory with
managerial practice. It helps in covering the gap between the problems of
logic and the problems of policy. The subject offers powerful tools and
techniques for managerial policy making.

Managerial Economics Definition

To quote Mansfield, Managerial economics is concerned with the
application of economic concepts and economic analysis to the problems
of formulating rational managerial decisions.
Spencer and Siegelman have defined the subject as the integration of
economic theory with business practice for the purpose of facilitating
decision making and forward planning by management.

Micro, Macro, and Managerial Economics Relationship

Microeconomics studies the actions of individual consumers and firms;
managerial economics is an applied specialty of this branch.
Macroeconomics deals with the performance, structure, and behavior of
an economy as a whole. Managerial economics applies microeconomic
theories and techniques to management decisions. It is more limited in
scope as compared to microeconomics. Macroeconomists study aggregate
indicators such as GDP, unemployment rates to understand the functions
of the whole economy.
Microeconomics and managerial economics both encourage the use of
quantitative methods to analyze economic data. Businesses have finite
human and financial resources; managerial economic principles can aid
management decisions in allocating these resources efficiently.
Macroeconomics models and their estimates are used by the government
to assist in the development of economic policy.

Nature and Scope of Managerial Economics

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The most important function in managerial economics is decision-making.

It involves the complete course of selecting the most suitable action from
two or more alternatives. The primary function is to make the most
profitable use of resources which are limited such as labor, capital, land
etc. A manager is very careful while taking decisions as the future is
uncertain; he ensures that the best possible plans are made in the most
effective manner to achieve the desired objective which is profit
maximization.
1) Economic theory and economic analysis are used to solve the
problems of managerial economics.
2)

Economics basically comprises of two main divisions namely Micro

economics and Macro economics.

3)Managerial economics covers both macroeconomics as well as

microeconomics, as both are equally important for decision making and
business analysis.

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4) Macroeconomics deals with the study of entire economy. It considers

all the factors such as government policies, business cycles, national
income, etc.
5) Microeconomics includes the analysis of small individual units of
economy such as individual firms, individual industry, or a single
individual consumer.
All the economic theories, tools, and concepts are covered under the
scope of managerial economics to analyze the business environment. The
scope of managerial economics is a continual process, as it is a
developing science. Demand analysis and forecasting, profit management,
and capital management are also considered under the scope of
managerial economics.

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Demand Analysis and Forecasting

Demand analysis and forecasting involves huge amount of decisionmaking! Demand estimation is an integral part of decision making, an
assessment of future sales helps in strengthening the market position and
maximising profit. In managerial economics, demand analysis and
forecasting holds a very important place.

Profit Management
Success of a firm depends on its primary measure and that is profit. Firms
are operated to earn long term profit which is generally the reward for
risk taking. Appropriate planning and measuring profit is the most
important and challenging area of managerial economics.

Capital Management
Capital management involves planning and controlling of expenses. There
are many problems related to capital investments which involve
considerable amount of time and labor. Cost of capital and rate of return
are important factors of capital management.

Demand for Managerial Economics

The demand for this subject has increased post liberalization and
globalization period primarily because of increasing use of economic logic,
concepts, tools and theories in the decision making process of large
multinationals.
Also, this can be attributed to increasing demand for professionally
trained management personnel, who can leverage limited resources
available to them and maximize returns with efficiency and effectiveness.

Role in Managerial Decision Making

Managerial economics leverages economic concepts and decision science
techniques to solve managerial problems. It provides optimal solutions to
managerial decision making issues.

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Market Structure
Price determination is one of the most crucial aspects in economics.
Business managers are expected to make perfect decisions based on their
knowledge and judgment. Since every economic activity in the market is
measured as per price, it is important to know the concepts and theories
related to pricing. Pricing discusses the rationale and assumptions behind
pricing decisions. It analyzes unique market needs and discusses how
business managers reach upon final pricing decisions.
It explains the equilibrium of a firm and is the interaction of the demand
faced by the firm and its supply curve. The equilibrium condition differs
under perfect competition, monopoly, monopolistic competition, and
oligopoly. Time element is of great relevance in the theory of pricing since
one of the two determinants of price, namely supply depends on the time
allowed to it for adjustment.

Market Structure
A market is the area where buyers and sellers contact each other and
exchange goods and services. Market structure is said to be the
characteristics of the market. Market structures are basically the number
of firms in the market that produce identical goods and services. Market
structure influences the behavior of firms to a great extent. The market
structure affects the supply of different commodities in the market.
When the competition is high there is a high supply of commodity as
different companies try to dominate the markets and it also creates
barriers to entry for the companies that intend to join that market.

Perfect Competition
Perfect competition is a situation prevailing in a market in which buyers
and sellers are so numerous and well informed that all elements of
monopoly are absent and the market price of a commodity is beyond the
control of individual buyers and sellers
With many firms and a homogeneous product under perfect competition
no individual firm is in a position to influence the price of the product that
means price elasticity of demand for a single firm will be infinite.

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Pricing Decisions
Determinants of Price Under Perfect Competition
Market price is determined by the equilibrium between demand and
supply in a market period or very short run. The market period is a period
in which the maximum that can be supplied is limited by the existing
stock. The market period is so short that more cannot be produced in
response to increased demand. The firms can sell only what they have
already produced. This market period may be an hour, a day or a few
days or even a few weeks depending upon the nature of the product.

Market Price of a Perishable Commodity

In the case of perishable commodity like fish, the supply is limited by the
available quantity on that day. It cannot be stored for the next market
period and therefore the whole of it must be sold away on the same day
whatever the price may be.

Market Price of Non-Perishable and Reproducible Goods

In case of non-perishable but reproducible goods, some of the goods can
be preserved or kept back from the market and carried over to the next
market period. There will then be two critical price levels.
The first, if price is very high the seller will be prepared to sell the whole
stock. The second level is set by a low price at which the seller would not
sell any amount in the present market period, but will hold back the whole
stock for some better time. The price below which the seller will refuse to
sell is called the Reserve Price.

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Monopolistic Competition
Monopolistic competition is a form of market structure in which a large
number of independent firms are supplying products that are slightly
differentiated from the point of view of buyers. Thus, the products of the
competing firms are close but not perfect substitutes because buyers do
not regard them as identical. This situation arises when the same
commodity is being sold under different brand names, each brand being
slightly different from the others.
For example Lux, Liril, Dove, etc.
Each firm is therefore the sole producer of a particular brand or product.
It is monopolist as far as a particular brand is concerned. However, since
the various brands are close substitutes, a large number of monopoly
producers of these brands are involved in a keen competition with one
another. This type of market structure, where there is competition among
a large number of monopolists is called monopolistic competition.
In addition to product differentiation, the other three basic characteristics
of monopolistic competition are
There are large number of independent sellers and buyers in the market.
The relative market shares of all sellers are insignificant and more or less
equal. That is, seller-concentration in the market is almost non-existent.
There are neither any legal nor any economic barriers against the entry of
new firms into the market. New firms are free to enter the market and
existing firms are free to leave the market.
In other words, product differentiation is the only characteristic that
distinguishes monopolistic competition from perfect competition.

Monopoly

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Monopoly is said to exist when one firm is the sole producer or seller of a
product which has no close substitutes. According to this definition, there
must be a single producer or seller of a product. If there are many
producers producing a product, either perfect competition or monopolistic
competition will prevail depending upon whether the product is
homogeneous or differentiated.
On the other hand, when there are few producers, oligopoly is said to
exist. A second condition which is essential for a firm to be called
monopolist is that no close substitutes for the product of that firm should
be available.
From above it follows that for the monopoly to exist, following things are
essential
One and only one firm produces and sells a particular commodity or a
service.
There are no rivals or direct competitors of the firm.
No other seller can enter the market for whatever reasons legal,
technical, or economic.
Monopolist is a price maker. He tries to take the best of whatever demand
and cost conditions exist without the fear of new firms entering to
compete away his profits.
The concept of market power applies to an individual enterprise or to a
group of enterprises acting collectively. For the individual firm, it
expresses the extent to which the firm has discretion over the price that it
charges. The baseline of zero market power is set by the individual firm
that produces and sells a homogeneous product alongside many other
similar firms that all sell the same product.
Since all of the firms sell the identical product, the individual sellers are
not distinctive. Buyers care solely about finding the seller with the lowest
price.
In this context of perfect competition, all firms sell at an identical price
that is equal to their marginal costs and no individual firm possess any
market power. If any firm were to raise its price slightly above the
market-determined price, it would lose all of its customers and if a firm
were to reduce its price slightly below the market price, it would be
swamped with customers who switch from the other firms.

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Accordingly, the standard definition for market power is to define it as the

divergence between price and marginal cost, expressed relative to price.
In Mathematical terms we may define it as
L = (P MC)
P

Oligopoly
In an oligopolistic market there are small number of firms so that sellers
are conscious of their interdependence. The competition is not perfect, yet
the rivalry among firms is high. Given that there are large number of
possible reactions of competitors, the behavior of firms may assume
various forms. Thus there are various models of oligopolistic behavior,
each based on different reactions patterns of rivals.
Oligopoly is a situation in which only a few firms are competing in the
market for a particular commodity. The distinguishing characteristics of
oligopoly are such that neither the theory of monopolistic competition nor
the theory of monopoly can explain the behavior of an oligopolistic firm.
Two of the main characteristics of Oligopoly are briefly explained below
Under oligopoly the number of competing firms being small, each firm
controls an important proportion of the total supply. Consequently, the
effect of a change in the price or output of one firm upon the sales of its
rival firms is noticeable and not insignificant. When any firm takes an
action its rivals will in all probability react to it. The behavior of
oligopolistic firms is interdependent and not independent or atomistic as is
the case under perfect or monopolistic competition.
Under oligopoly new entry is difficult. It is neither free nor barred. Hence
the condition of entry becomes an important factor determining the price
or output decisions of oligopolistic firms and preventing or limiting entry
of an important objective.
For Example Aircraft manufacturing, in some countries: wireless
communication, media, and banking.

Pricing Strategies
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Pricing is the process of determining what a company will receive in

exchange for its product or service. A business can use a variety of pricing
strategies when selling a product or service. The price can be set to
maximize profitability for each unit sold or from the market overall. It can
be used to defend an existing market from new entrants, to increase
market share within a market or to enter a new market.
There is a need to follow certain guidelines in pricing of the new product.
Following are the common pricing strategies

Pricing a New Product

Most companies do not consider pricing strategies in a major way, on a
day-today basis. The marketing of a new product poses a problem
because new products have no past information.
Fixing the first price of the product is a major decision. The future of the
company depends on the soundness of the initial pricing decision of the
product. In large multidivisional companies, top management needs to
establish specific criteria for acceptance of new product ideas.
The price fixed for the new product must have completed the advanced
research and development, satisfy public criteria such as consumer safety
and earn good profits. In pricing a new product, below mentioned two
types of pricing can be selected

Skimming Price
Skimming price is known as short period device for pricing. Here,
companies tend to charge higher price in initial stages. Initial high helps
to Skim the Cream of the market as the demand for new product is
likely to be less price elastic in the early stages.

Penetration Price
Penetration price is also referred as stay out price policy since it prevents
competition to a great extent. In penetration pricing lowest price for the
new product is charged. This helps in prompt sales and keeping the
competitors away from the market. It is a long term pricing strategy and
should be adopted with great caution.

Multiple Products
As the name indicates multiple products signifies production of more than
one product. The traditional theory of price determination assumes that a
firm produces a single homogenous product. But firms in reality usually
produce more than one product and then there exists interrelationships
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between those products. Such products are joint products or multi

products. In joint products the inputs are common in the production
process and in multi-products the inputs are independent but have
common overhead expenses. Following are the pricing methods followed

Full Cost Pricing Method

Full cost plus pricing is a price-setting method under which you add
together the direct material cost, direct labor cost, selling and
administrative cost, and overhead costs for a product and add to it a
markup percentage in order to derive the price of the product. The pricing
formula is
Pricing formula = Total production costs Selling and administration
costs Markup
Number of units expected to sell
This method is most commonly used in situations where products and
services are provided based on the specific requirements of the customer.
Thus, there is reduced competitive pressure and no standardized product
being provided. The method may also be used to set long-term prices that
are sufficiently high to ensure a profit after all costs have been incurred.

Marginal Cost Pricing Method

The practice of setting the price of a product to equal the extra cost of
producing an extra unit of output is called marginal pricing in economics.
By this policy, a producer charges for each product unit sold, only the
addition to total cost resulting from materials and direct labor. Businesses
often set prices close to marginal cost during periods of poor sales.
For example, an item has a marginal cost of $2.00 and a normal selling
price is $3.00, the firm selling the item might wish to lower the price to
$2.10 if demand has waned. The business would choose this approach
because the incremental profit of 10 cents from the transaction is better
than no sale at all.

Transfer Pricing
Transfer Pricing relates to international transactions performed between
related parties and covers all sorts of transactions.
The most common being distributorship, R&D, marketing, manufacturing,
loans, management fees, and IP licensing.

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All inter-company transactions must be regulated in accordance with

applicable law and comply with the "arm's length" principle which requires
holding an updated transfer pricing study and an inter-company
agreement based upon the study.
Some corporations perform their inter-company transactions based upon
previously issued studies or an ill advice they have received, to work at a
cost plus X%. This is not sufficient, such a decision has to be supported
in terms of methodology and the amount of overhead by a proper transfer
pricing study and it has to be updated each financial year.

Dual Pricing
In simple words, different prices offered for the same product in different
markets is dual pricing. Different prices for same product are basically
known as dual pricing. The objective of dual pricing is to enter different
markets or a new market with one product offering lower prices in foreign
county.
There are industry specific laws or norms which are needed to be followed
for dual pricing. Dual pricing strategy does not involve arbitrage. It is
quite commonly followed in developing countries where local citizens are
offered the same products at a lower price for which foreigners are paid
more.
Airline Industry could be considered as a prime example of Dual Pricing.
Companies offer lower prices if tickets are booked well in advance. The
demand of this category of customers is elastic and varies inversely with
price.
As the time passes the flight fares start increasing to get high prices from
the customers whose demands are inelastic. This is how companies
charge different fare for the same flight tickets. The differentiating factor
here is the time of booking and not nationality.

Price Effect
Price effect is the change in demand in accordance to the change in price,
other things remaining constant. Other things include Taste and
preference of the consumer, income of the consumer, price of other goods
which are assumed to be constant. Following is the formula for price
effect
Price Effect = Proportionate change in quantity demanded of X

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Proportionate change in price of X

Price effect is the summation of two effects, substitution effect and
income effect
Price effect = Substitution effect Income effect

Substitution Effect
In this effect the consumer is compelled to choose a product that is less
expensive so that his satisfaction is maximized, as the normal income of
the consumer is fixed. It can be explained with the below examples
Consumers will buy less expensive foods such as vegetables over meat.
Consumers could buy less amount of meat to keep expenses in control.

Income Effect
Change in demand of goods based on the change in consumers
discretionary income. Income effect comprises of two types of
commodities or products
Normal goods If there is a price fall, demand increases as real income
increases and vice versa.
Inferior goods In case of inferior goods, demand increases due to an
increase in the real income.

Elements and Concerns

The imperfectly competitive structure is quite identical to the realistic
market conditions where some monopolistic competitors, monopolists,
oligopolists, and duopolists exist and dominate the market conditions. The
elements of Market Structure include the number and size distribution of
firms, entry conditions, and the extent of differentiation.

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These somewhat abstract concerns tend to determine some but not all
details of a specific concrete market system where buyers and sellers
actually meet and commit to trade. In other words, competition can align
the sellers interests with the buyers interests and can cause the seller to
reveal his true costs and other private information. In the absence of
perfect competition, three basic approaches can be adopted to deal with
problems related to the control of market power and an asymmetry
between the government and the operator with respect to objectives and
information: (a) subjecting the operator to competitive pressures, (b)
gathering information on the operator and the market, and (c) applying
incentive regulation.[1]

Market Structure

Seller
Entry
Barriers

Seller
Number

Buyer
Entry
Barriers

Buyer
Number

Perfect
Competition

NO

MANY

NO

MANY

Monopolistic competition

NO

MANY

NO

MANY

Oligopsony

NO

MANY

YES

FEW

Monopoly

YES

ONE

NO

MANY

The main criteria by which one can distinguish between different market
structures are: the number and size of producers and consumers in the
market, the type of goods and services being traded, and the degree to
which information can flow freely.

Conclusion
We may thus conclude that if demand increases, price will immediately
rise but ultimately it will rise, fall or remain constant, according as the
industry is subject to the law of diminishing returns, increasing returns or

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constant returns, respectively. In case of decrease in demand, the effect

on normal price will be the opposite. This is how the laws of returns
influence price. We repeat that they cannot influence market price, i.e.,
price at any given moment. They can only affect normal price, i.e., price
in the long run.

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