MAIN MARKET FORMS AND REVENUE THEORY

Introduction

 The theory of demand - behavior of consumers

 Theory of a firm - behavior of producers

☺ These theories enable us to ascertain the behavior

of prices and outputs of various products and their
determination.

☺ The nature of demand curve and the price-output

business decisions depend upon the type of the
market in which the commodity is produced and sold.
 Market
☺A market is a group of people and firms which are
in contact with one another for the purpose of buying
and selling some product.

☺ Itis not necessary that every member of the market

be in contact with each other.
 Market Structure

☺A simple definition of this concept can be found in

Pappas and Hirschey (1985). According to them
“Market structure refers to the number and size
distribution of buyers and sellers in the market for a
good or service.

☺ The market structure for a product not only includes

firms and individuals currently engaged in buying
and selling but also the potential entrants.
 Elements of Market Structure

 Number of firms/sellers

 Number of buyers

 Product Differentiation

 Conditions of entry and exits

 Number of firms/sellers

☺ If there are large number of firms, the markets

structure will be perfect competitive

☺ ifthere is only one seller, it will be the monopoly

market

☺ In the same way it may be monopolistic competition,

oligopoly and duopoly
 Number of buyers

☺ Large number of buyers make market competitive

☺ Lesser number of buyers make market centralized

☺ The number of buyers and the place of their

residence make the market local, national and
international
 Product Differentiation

☺ Homogeneous product makes the market perfect

competition

☺ Identical with differentiation makes the market

monopolistic competitive
 Conditions of Entry and Exits

☺ In case of free entry and exist of firms the market

will be perfectly competitive.

☺ If there is restriction, it will be monopoly market.

 Market Classification on the Basis of Competition

Haggling and bargaining between buyers and sellers

is called competition.
•

• Perfect competition or pure competition

• Monopoly or zero competition

• Imperfect competition

– Monopolistic Competition

– Oligopoly

– Duopoly
Perfect competition and monopoly are two extremes;
and the situations between them are those of
imperfect competition.
Perfect competition and monopoly are two extremes;
and the situations between them are those of imperfect
competition.
Perfect competition and monopoly are two extremes;
and the situations between them are those of
imperfect competition.
 'Perfect Competition'
A market structure in which the following
five criteria are met
• All firms sell an identical product

• All firms are price takers - they cannot

control the market price of their product

• All firms have a relatively small market

share
 'Perfect Competition'

• Buyers have complete information about

the product being sold and the prices
charged by each firm

• The industry is characterized by freedom

of entry and exit.

• Perfect competition is sometimes referred to

as "pure competition".
 Imperfect Competition
An imperfect competitive market is a type of market
where the conditions of the perfect competitive markets
are not satisfied.

Conditions that help cause imperfect competition

include

• restricted flow of information on costs and prices

• near monopoly power of some suppliers
• collusion among sellers to keep prices high
• discrimination by sellers among buyers on the
basis of their buying power.
 The types of imperfect competition

 Monopoly (single seller)

 Monopolistic competition (many sellers manufacturing
highly differentiated goods)
 Oligopoly (few sellers)
 Duopoly
 Monopsony (single buyer)
 Oligopsony (few buyers)
 'Monopolistic Competition'

A type of competition within an industry where:

 All firms produce similar yet not perfectly substitutable

products.

 All firms are able to enter the industry if the profits are
attractive.

 All firms are profit maximizers.

 All firms have some market power, which means none

are price takers.
• Monopolistic competition is a form of imperfect
competition where many competing producers sell
products that are differentiated from one another (that
is, the products are substitutes, but, with differences such
as branding, are not exactly alike)

• In monopolistic competition firms can behave like

monopolies in the short-run, including using market power
to generate profit.

• In the long-run, other firms enter the market and the

benefits of differentiation decrease with competition; the
market becomes more like perfect competition where
firms cannot gain economic profit.
 'Oligopoly'

 A situation in which a particular market is controlled

by a small group of firms.

 An oligopoly is much like a monopoly, in which only

one company exerts control over most of a market.

 In an oligopoly, there are at least two firms

controlling the market.
 'Oligopoly'
 In oligopolistic markets, independent suppliers (few in
numbers) can effectively control the supply, and thus the
price, thereby creating a seller's market.

 They offer largely similar products, differentiated mainly

by heavy advertising and promotional expenditure.

 Can anticipate the effect of one another's marketing

strategies.

 Examples include airline, automotive, banking, and

petroleum markets.
 'Duopoly'
 A situation in which two companies own all or nearly
all of the market for a given product or service.
 A duopoly is the most basic form of oligopoly, a
market dominated by a small number of companies. A
duopoly can have the same impact on the market as
a monopoly if the two players collude on prices or
output.
 Collusion results in consumers paying higher prices
than they would in a truly competitive market

Amazon and Apple have been called a duopoly for

their dominance in the e-book marketplace.
 'Monopsony'

 A term used to describe a market where a very large

buyer typically dominates the price action.

 In a monopsony, the large buyer is typically able to

force prices to decline and this type of market
contrasts with a monopoly

The defense 'industry' is by far perhaps the BEST

example. The federal gov't is primarily the only one
that buys all those rockets, bombs, planes, etc.
 Oligopsony (few buyers)

 Similar to an oligopoly (few sellers), this is a market in which

there are only a few large buyers for a product or service.

 This allows the buyers to exert a great deal of control over the
sellers and can effectively drive down prices.

 A good example of an oligopsony would be the U.S. fast

food industry, in which a small number of large buyers (i.e.
McDonald's, Burger King, Wendy's) controls the U.S. meat
market.

 Such control allows these fast food mega-chains to dictate

the price they pay to farmers for meat and to influence
animal welfare conditions and labor standards.
Market Classification and Cross Elasticity of Demand
The concept of cross elasticity of demand has been used by Robert Thriffin to measure the
amount and kind of competition among firms and for classifying the market competition.

Market form Cross elasticity of demand

Perfect competition Cross elasticity is infinite (ec =∞)

Monopolistic competition Cross elasticity is very high
Monopoly Cross elasticity is very low or zero
 Total Revenue

Total revenue ( TR ) is the total amount of money

that a firm receives from the sale of its goods.

TR = P x Q = Total Expenditure of the Consumer

 Average Revenue

• Average revenue ( AR ) is the total amount of

money that a firm receives from the sale divided
by the number of units of goods sold.

• AR = TR/Q, since TR=P x Q, then AR = P for

single pricing practice
 Marginal Revenue

• Marginal revenue ( MR ) is the change in total

revenue resulting from selling an extra unit of
goods.

• MR = TR/Q, where TR = change in TR

due to change in Q, Q = change in Q
 To find T R from the M R curve
The slope of the TR curve is MR
Rs.
Slope at point E = MR

E TR

0
Quantity
 Total Values Total Revenue is
Cost/Revenue price x quantity
The slope of the TR
sold. (TR = P x Q)
curve varies at each
point.
A firmThis is because
facing a
the amount added
downward sloping to
TR from each sale is
demand curve must
slightly less than before.
lower price to sell
A positive slope
successive
suggests TR isunits of a
rising,
its product.
negative slopeTRthat TR
therefore
is falling. rises at
first but the rate at
which it rises begins
to slow down and
will eventually fall.

TR
Output/Sales
For a certain known quantity transacted, the area under the MR and above the horizontal
axis is the T R . (i.e. the sum of the Marginal Revenues of all units of goods, i.e. area 0ACQ)

Also, TR = AR x Q, i.e. area 0PBQ

Price

B
P

AR
MR

0 Q
Quantity
 Profit TR –(TC)
Total =Cost TC is
At thisthe sum
point theof slope
fixed
Maximum profit will
Cost/Revenue of thecosts
TR and(FC)TCand
TC be made where the
curvesvariable costs
are equal. At
distance between
(VC).
this point MC = MR
TR and TC are at
since MC and MR are
their
TC =greatest.
FC + VC
the slopes of the TR
and TC It cuts the vertical
curves.
axis at
(Students of a point
calculus
should indicating
recognisethe level
this!) of fixed costs.
Hence profit
maximisation occurs
where MC = MR.

FC

TR
Output/Sales
 Revenue Curves Under Perfect Competition
• Under perfect competition any amount of the
commodity can be bought or sold at the ruling price.

• No single seller or buyer can influence the price

prevailing in the market.

• As the price remains constant, the total revenue will

increase proportionately with the sales. Therefore,
price would be equal to average revenue and also
marginal revenue.

Price = Average Revenue = Marginal Revenue

 The Demand Curve for a Perfectly Competitive
Firm is Horizontal

• When the
equilibrium
price has been
established, a
single perfectly
competitive
faces a
horizontal
demand curve
at the
equilibrium
price.
Revenue Curves Under Perfect Competition
PRICE ELASTICITY OF
DEMAND – INFINITE :
REVENUE THEORY

When the price

elasticity of demand
is perfectly elastic,
the price, average
revenue, marginal
revenue and
demand are all the
same. In this case,
they are all $5.

Total revenue
increases at a
constant rate as
output increases.
 Revenue Curves under Monopoly

• The average revenue curve is the downward sloping

industry demand curve and its corresponding
marginal revenue curve lies below it.

• The reason for the downward sloping AR and MR curve

is that, the monopolist can increase his sales by
lowering the price.

• Marginal revenue also falls but the rate of fall in

marginal revenue is greater than that in average
revenue.
 Total Revenue in Graphical Analysis
• For a normal, downward-sloping demand curve,
TR rises at first but will eventually start to fall as
output increases.

• This is because the extra revenue gained from

dropping the price and selling more units is
outweighed by the loss in revenue from the units
that were being sold at a higher price and now
have to be sold at the lower price.
REVENUE THEORY

Average revenue (AR) has

obvious correlation with price
and so it falls as output
increases, since the price has to
be lowered in order to sell more
products. This is shown where
demand curve is now labelled
D=AR.

Marginal Revenue (MR) also falls

as output increases, but at a
greater rate than AR. As shown
in the graph the MR curve is
twice as steeply sloping as the AR
Curve and also goes below the x-
axis. This is a relationship that
holds for all downward sloping
AR curves and the MR curves
that relate to them.
 Relationship between the value of
PED for a Demand Curve & TR

• The knowledge of the relationship between the

value of PED for a demand curve and TR is very
useful for firms.

• The firms can assess the impact that a change in

price of their product have upon the total
revenue they receive.
Inelastic Demand & Total Revenue
• If the firm raises prices and the demand is
inelastic then the firm will find that total
revenue will increase, because the increase in
price will see a relatively smaller fall in the
quantity demanded.
Elastic Demand and Total Revenue
• If the firm raises price and demand is elastic
then the firm will find that total revenue will
decrease, because the increase in price will
cause a relatively larger fall in the quantity
demanded.

• If a firm knows whether their demand is elastic

or inelastic they know what pricing policy to
adopt to increase their revenue.
 ELASTICITY AND REVENUE POLICY
1. When PED is elastic any firm wishing to
increase revenue should lower its price.
2. When PED is inelastic any firm wishing to
increase revenue should increase its
price.
3. When PED is unity then any firm wishing
to increase revenue should leave the
price unchanged, since revenue is
already maximised.
CHAPTER 15 MONOPOLY 48