CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Chapter 2
2.1 Pricing of Products and Services in various Forms of
Markets
Pricing Strategies in various Forms of Market

Cost-plus pricing: Cost-plus pricing Limit pricing: A limit price is the price set by a
is the simplest pricing method. The monopolist to discourage economic entry into
firm calculates the cost of producing a market. The limit price is often lower than the
the product and adds on a percentage average cost of production of just low enough to
(profit) to that price to give the make entering not profitable
selling price.
Price discrimination: Setting a different price for
Penetration pricing: Setting the
the same product in different segments to the
price low in order to attract
market. For example, this can be for different
customers and gain market share.
classes, such as ages, or for different opening
The price will be raised later once
times.
this market share is gained.

Dynamic pricing: A flexible pricing mechanism

Psychological pricing: Pricing
made possible by advances in information
designed to have a positive
technology, and employed mostly by internet
psychological impact. For example,
based companies
selling a profit at ₹ 3.95 or ₹ 3.99,
rather than ₹ 4.000.
Target pricing: Pricing method where by the
selling price of a product is calculated to
Price leadership: An observation produce a particular rate of return on
made of oligopolistic business investment for a specific volume of production.
behaviour in which one company, The target pricing method is used most often
usually the dominant competitor by public utilities, like electric and gas
among several, leads the way in companies, and companies whose capital
determining prices, the others go investment is high, like automobile
on following. manufactures.

Absorption pricing: Method of High-low pricing: Method of pricing for an

pricing in which all costs are organization where the goods or services
recovered. The price of the product offered by the organization are regularly priced
includes the variable cost of each higher than competitors, but through
item plus a proportionate amount of promotions, advertisements, and coupons, lower
the fixed costs and is a form of prices are offered on key items.
cost-plus pricing.

Marginal cost pricing: In business, the practice

of setting the price of a product to equal the
extra cost of producing an extra unit of output.

1
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Meaning of market: Market is a means by which exchange of goods and services takes
place as a result of buyers and sellers being in contact with one another.
Classification of market
(a) On the basis of area or locality:
1. Local Market: Sometimes a particular commodity is exchanged in the locality
where it is produced. Then the commodity is said to have a local market.
Vegetables, flowers, fruits may be produced and marketed in the same area.
2. National Market: A commodity will have national market if it is demanded and
supplied by people. In different parts of the country. Commodities like wheat,
sugar, cotton have national market.
3. International Market: If a commodity is sold and purchased in different countries
it is said to have international market for example gold, silver, wheat, cotton
have international market.
(b) On the basis of time element:
1. Very Short Period Market: This is when the supply of the goods is fixed, and so it
cannot be changed instantaneously. Say for example the market for flowers,
vegetables. Fruits etc. The price of goods will depend on demand.
2. Short Period Market: The market is slightly longer than the previous one. Here
the supply can be slightly adjusted.
3. Long Period Market: Here the supply can be changed easily by scaling production.
So it can change according to the demand of the market. So the market will
determine its equilibrium price in time.
(c) On the basis of competition among the seller or producers of firms
1. Perfect competition market
2. Imperfect competition market
Perfect Competition
In a perfectly competitive market, there are numerous buyers and sellers selling
homogenous products and no one is able by his own actions to influence the market
price, since all have access to full and immediate knowledge of the price at which the
trading is currently taking place.
Features of Perfect Market:
The perfect competition market has the following features.
1. Large number of sellers and buyers: There will be a large number of sellers and buyers
for a good in this market. It means the output of a buyer or a seller is a small part of
the total output. A single producer or seller cannot change the price by his actions. None

2
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

of them is large enough to influence the price. Therefore a seller takes the price decided
by the market. The producer is a price taker.
2. Homogeneous commodities: Products in this market are similar in every aspect. A
consumer gets the same good whenever he purchases. As a result there will be one price
all over the market.
3. Free entry and exit: Any firm can enter into the production as per its desire. Finally
it can leave the production at any time. This helps new firms to enter into business
when conditions are favorable. As long as a firm earns super normal profits, it usually
stays in competition. But when the firm ends up with losses, it would leave the market.
4. Mobility of factors of production: Factors of production will move from one production
to another easily. This is also useful for free entry and exit of firms factors (land, labour,
capital) move to the production activities where they get higher incomes.
5. Absence of transport cost: Under perfect market transport costs should not be added
in the price. If transport costs are added the goods are available at the fewer prices at
the near markets and they are available at the higher prices at distant markets. Existing
of two prices for the same thing in different parts is against for perfect market. So
transport cost should not be added.
6. Perfect knowledge of market: Buyers and sellers in this market will have a clear
knowledge about market conditions. So that there will be one price throughout the
market. Because of perfect knowledge, sales and purchases of commodities take place as
one price.
Equilibrium of the firm under perfect Market
The firm reached the equilibrium position when it gets maximum output. To
determine the maximum output two conditions must be satisfied. They are:
1. Marginal Cost is equal to Marginal Revenue (MC = MR)
2. MC curve cuts the MR curve from below.
The equilibrium of the firm can be shown by the following diagram.

3
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Type of Equilibrium:
The equilibrium of the firm can be divided into two types. They are:
1. Short period equilibrium and
2. Long period equilibrium.
In the short period equilibrium, the firm can get either abnormal profits or losses. But
in the long period equilibrium it gets only normal profits
(a) Abnormal profits: When the firm is in the short period equilibrium sometimes it
can get abnormal profits. This can be shown by the following diagram.

(b) Losses: When the firm is in the short equilibrium sometimes it may get losses. This
can be shown by the following Diagram

Long period equilibrium – Normal Profits: When the firm is in the long period
equilibrium it gets only normal profits. This can be shown by the following diagram

4
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Imperfect Competition
Imperfect Competition Market:
The imperfect market appears in various forms. They are
1. Monopoly
2. Duopoly
3. Oligopoly
4. Monopolistic competition
Monopoly Market
The word Monopoly is derived from two words ‘Mono’ and ‘Poly’. Mono means Single
and Poly means seller. In the market where there is only one seller or one producer or
one firm it is said to be monopoly market. The single seller supply the commodity to
the entire market. They are many restrictions for other producers to enter into the
market as a result monopoly has no competition in the market.
Features of Monopoly:
The monopoly market has the following features:
1. Single firm: A single firm produces the commodity in the market there is only one
seller or one producer or one firm.
2. No close substitute: The produce supplied by the monopolist will not have close
substitutes in the market. A consumer will not find a substitutes commodity for the
monopoly products.
3. Strong barriers to entry: New firms cannot enter in the production due to the certain
restrictions in market i.e. huge investment, lack of technology; patents etc. prevent the
new firms to enter the market.
4. Firm and Industry are same: As there is one firm in monopoly market there is no
difference between firm and industry.
5. Price maker: In this market the producer can determine the price of the commodity
so the producer in the market is said to be price maker.
6. Nature of AR & MR curves: The average Revenue Curve (AR) and Marginal Revenue
Curve (MR) both are slopes downwards from left to right because when a seller wants
to sell the more of output he must reduce the price when the price is decreased both
AR & MR are declining.
7. Price discrimination: The monopolist can charge the different prices from the different
customers for the same goods or services. The price is not uniform as in the perfect
market competition.
8. Maximum profits: The main aim of monopoly is to earn to get the maximum profits.

5
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Price and output determination

In monopoly market as there is a single producer, he can control either the price of the
commodity or supply of the commodity. But he can’t control both at the same time. He
can increase the price by decreasing the output or he can sell more output by decreasing
the price. Maximization of profits is the sole objective of the monopolist.

Duopoly Market
Where there are two sellers or two producers or two firms it is said to be duopoly
market. It is also one of the forms of oligopoly markets.
Oligopoly Market
The word oligopoly is derived from two Greek words oligo and pollien, oligo means “A
few”, Pollien means seller. Where there are a few firms or few producers or few sellers,
it is said to be oligopoly market. For example: automobile industry, gas industry etc.
A market with a small number of producers is called oligopoly. The product may be
homogeneous or there may be differences. Since producers are a few each firm produces
a large portion of the output. It is a market with competition among the few. This
market exists in automobiles, electrical and cigarettes etc.
1. Less number of firms: The numbers of producers are a few in this market. Each one
produces a large part of the total output. He can control the output in the market. A
firm can change the price by supplying either more or less.
2. Interdependence: In the oligopoly market the decisions of every producer affect other
producers. This is due to less number of producers in the market. A change in the
decisions of a producer (output or price) makes the other producers to change their
decisions.
3. Selling costs: Sometimes commodities are produced with small differences. Then each
firm makes a huge expenditure on advertisements. It is in the oligopoly that we can see
the highest expenditure on selling costs.

6
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

4. Uncertainty: It will be difficult to guess what kind of demand curve will be there for
a firm. Every time when a producer changes his decision, other producers will also
change their decision. Therefore, it is not possible to expect price, output conditions to
be the same in this market.
5. Rigid price: Usually in this market firms will not change the price, they follow a rigid
price. A firm cannot increase price because other firms will not raise their prices. The
firm that increases the price will be put to loss. If one firm reduces its price others will
also do the same. Therefore, all the firms will follow a price without making any changes
in it. Hence it is called rigid prices.
Price and output determination under Oligopoly Market
1. Cournot’s Duopoly Model: According to Cournot each duopolist believes that regardless
of his actions and the effect upon the market of the product the other firm will go on
producing the same commodity. Cournot output is two- third of the competitive output
and the price is two – third of most profitable i.e., monopoly price.
2. Stackleberg Duopoly Model: The producer under duopoly structure incorporates the
decision level of his rival. It then incorporates in its own profit function and thereby
maximizes profit. Non-collusion is practiced at large. Leader-follower relation emerges.
3. Bertrand Duopoly Model: In the Bertrand model, the assumptions/conjectures of the
model are similar to the Cournot model but the former is based upon price as the
strategy variable. According to this model each producer can always lower the price
until price is equal to cost of production.
4. Edgeworth Model: Each duopolist believes that his rival will continue to charge the
same price as he is just doing irrespective of what price he himself sets in. No determinate
equilibrium can exist under duopoly.
5. Collusive Oligopoly: According to this model a cartel is formed when firms jointly fix
the price and output with a view to maximize joint profit. For example: OPEC countries
form a cartel.
Monopolistic Competition Market
The concepts of monopolistic competition was introduced by Prof. Chamberlin. It is a
market with many sellers for a product but the products are different in certain
respects. The features of monopoly and competition are combined in this market. Hence,
it is called monopolistic competition. Example: Cosmetics, Soaps etc.
Characteristics of Monopolistic Competition:
The main features are:

7
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

1. A considerable number of producers: A commodity is produced by a considerable

number of producers. Since there are more number of producers no one controls the
output in the market. Competition will be high among the producers.
2. Product differentiation: The commodity of each producer will be different from that
of other producers. The difference may be due to material used, colour design, smell,
packaging, trademark etc. Because of this each product will have specific identification
in the market.
3. Entry and exit: Firms are allowed to enter into production and leave the market.
When profits are high new firms will join. In case of losses inefficient firms will leave.
4. Selling costs: An important feature of this market is every firm makes expenditure
to sell more output. Advertisement through newspapers, journals, electronic media, sales
representatives, exhibitions, free sampling help to promote the sales. Lot of expenditure
is made on these items under this market.
5. Imperfect knowledge: Buyers will have an imperfect knowledge about commodities.
Sometimes products may be the same but consumers think that a particular good is
superior than another. Due to the advertisements and other devices consumers purchase
the commodities.
6. Price decision: Each firm produces a commodity with small differences. It is due to
this reason that a firm will decide the price for its product. The demand curve for a
firm will be downwards sloping and more elastic.
Price and output determination under monopolistic competition market
Demand curves:
There are two types of the demand curves under monopolistic completion markets
1. Perceived demand curve.
2. Proportional demand curve
1. Perceived demand curve: This demand curve shows the different combinations
between quantity demand and price such that neither of the firms has any further
initiative to deviate from their decisions.
2. Proportional demand curve: This demand curve captures the impact of the all firms
simultaneously changing the same price and hence it takes into accounts the affects of
the actions of the rivals.

8
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

When the perceived demand curve (dd) and proportional demand curve (DD) intersect,
then the price is determined in monopolistic competition market.
Equilibrium condition under monopolistic competition
Like the perfect competition market the firm in this market also satisfies the two
conditions to reach the equilibrium position. They are
Marginal cost = marginal revenue (MC = MR)
MC curve cuts the MR curve from below

Long-run equilibrium under monopolistic competition

Excess profits earned by each firm during the short-run would attract new firms into
this market. As there is no barrier on the entry into the market, new firms can easily
enter into the market in the long-run. As a result, the actual market-share of each
firm will be less than before. So, the actual market-share demand curve shifts in the
leftward direction. At that situation, each firm may think that, with a fall in their
product price, more quantity can be sold following its perceived demand curve. Thus, in
an attempt to increase the profit, a firm wants to lower the price. It expects to sell
more along its perceived demand curve. A situation of price competition would arise
when each firm tries to do the same thing independently.

9
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Selling costs and monopolistic competition

The recognition of product differentiation provides the rationale for the selling expenses
(particularly expenses for advertisement) incurred by any firm under monopolistic
competition. The firm desires to accentuate the differences between its own brand and
other brands of the product available, through its advertising and other selling activities.
Thus, selling expenses have a definite role in strengthening the preferences of the
consumers for the advertised product, and making the demand for the product
relatively inelastic.
Chamberlin argues that there are both economies and diseconomies of advertising with
changes in the level of output. At the initial stage, expansion in sale will not require an
equi-proportionate increase in selling expenses; and this causes a decline in spend more
per unit of output to attract buyers of other varieties, and the average selling costs will
rise. So, the average selling costs curve becomes U-shaped and the vertical summation
of the U-shaped Average Cost (AC) curve and the average selling cost curve, would result
in the true AC curve. It operates less than its full utilization level. This call for the
emergence of the excess capacity in the market.

10
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

2.2 Price Discrimination

In a perfect situation price is decided by the market. Market brings about a balance
between the commodities that come for sale and those demanded by consumers. It
means the forces of supply and demand determine the price of the good. Equilibrium
price is established at the point where the supply and demand are equal.

Price Discrimination under Monopoly

If the seller charges different prices from the different customers for the same goods
or services, it is said to be price discrimination. It is possible only in monopoly market.
Hence it is called discriminating monopoly.
Classification of price discrimination
Prof. Pigou has classified the price discrimination into three types:
1. Price discrimination of first degree.
2. Price discrimination of second degree.
3. Price discrimination of third degree.
Price discrimination of first degree
If the seller charges the different prices from the different customers on the basis of
paying capacity of the consumer, it is said to be price discrimination of first degree. It
is thus called perfect price discrimination.
Price discrimination of second degree
In this case the seller charges one price up to a limit of goods purchased, after that
limit he charges the another prices, it is called price discrimination of second degree. It
is also known as Block Pricing.
Price discrimination of third degree
Irrespective of the paying capacity of the consumer and quantity of the goods
purchased, if the seller charges the different prices it is said to be price discrimination

11
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

of third degree. The markets of the product are made different on the basis of
differences in elasticity of the demand of the different markets.
The price discrimination of third degree was commonly prevailed in the society.
Conditions for price discrimination
A monopoly firm can sell the same product at two different prices to two different
groups of buyers. This type of price discrimination becomes possible under the following
circumstances:
(a) Different price elasticities of demand:
The monopolist charges higher price for the product in a market where price elasticity
of demand is relatively inelastic. On the other hand, he charges relatively lower price in
a market where the price elasticity of demand is relatively elastic.
(b) Tariff barrier:
If two markets are separated by a tariff wall, the monopolist can follow this principle
of price discrimination. For example, the monopolist can sell its product at a lower price
in the foreign market, and at a higher price in the domestic market.
(c) Geographical distance between the markets:
Price discrimination is also possible when two markets are separated from one another
by geographical distance. In this case, the monopolist can sell its product at a lower
price in a distant market and at higher price in the local market.
(d) Impossibility of resale of a product (particular service items):
If it is not possible on the part of any buyer to resale the product sold by the monopolist,
then the monopolist can easily follow the policy of price discrimination. This happens
particularly in case of service items. For example, a renowned doctor can charge
different fees for rendering similar service to two different patients.
(e) Ignorance of the consumers:
If the consumers remain ignorant about the difference in prices of the same product in
two different markets, then also the monopolist can easily follow the policy of price
discrimination.
(f) Typical behavior of the consumers:
In some cases, a group of consumers consider higher price as an indicator of higher
quality (the so called Veblen effect). Such typical behavior of the consumers creates an
opportunity for the monopolist to follow the policy of price discrimination.

12
CMA FOUNDATION ECONOMICS & MANAGEMENT

CHAPTER 2: Forms of Market

Conditions when price discrimination is profitable

Price discrimination, though possible in many situations, need not always be profitable.
The objective of price discrimination is to maximise personal profit of the monopolist.
Assume that the firm produces at a single plant and supplies to two markets. We have
to determine the amount of sale and the price in each of the markets so that his total
profit is maximised.
Sales in market 1 = R1*Q1
Sales in market 2 = R1*Q1
So the relevant profit function is = R1 (Q1 ) + R2 (Q2 ) – Cost (Q1 + Q2 )
Thus, total profit depends on the quantities of sales in both the markets.
The necessary condition for profit maximisation is the equalizations of the marginal
revenues in the two markets with the single marginal cost. That is
MR1 = MC ………………(1) and MR2 = MC ……………(2)
Combining (1) and (2) we get MR1 = MR2 = MC. This is the first order condition of
profit maximisation under a common form of price discrimination.
The second order condition is MC Curve cuts MR Curve from below.

Note: Demand curve is AR Curve

13