Price is important Pricing in idealized economic markets and then shifts to the gragmatics of pricing in real markets Prices in idealized economic markets Prices in perfect competition The price of a product in perfect competition depends on supply demand attributes and timing associated with the product o Spot transactions and homogenous products are in perfect competition this reduces to price dependent only on supply and demand o Every seller should ask the same price and every buyer would be expected to accept that price equilibrium price Who determines equilibrium price Buyers and sellers jointly determine the equilibrium price by their choice of actions In perfect competition shopping on price is equivalent to shopping on value or on status Prices on oligopoly In oligopolies sellers have some control over prices o Homogeneous products in oligopolies although we allowed for the existence of brands typically sellers prices are similar not identical o 2 reasons Sellers with stronger brands may get higher prices than those sellers with weaker brands Often prices are relative to the market share of the seller with the largest supplier setting a slightly higher price than the second largest and so on through to the smallest player Brand and share may be related in the sense that it may give the largest player in an oligopoly some serious competitive advantages o The same seller in an oligopoly can often price differently in different market segments price discrimination Different prices for regular customers and for senior citizens o Prices in oligopoly are collusive Explicit collusion in oligopoly it makes sense for sellers to share info and or strike agreements among themselves to fix prices at artificially high levels Illegal under US and EU law Implicit collusion agreement to collude sellers can often exchange info by signaling even in the absence of overt exchange of info or No price changes in a market until the largest sellers increases price followed quickly by price increases among all of the smaller players adjust their prices upward Clearly the price move by the larger player is a trigger for the other moves Legal or not Just because small players increase price after larger players price became public not enough info to establish any explicit collusion Prices in oligopolies tend to be higher than in perfect competition resulting in opportunity to earn profit greater than zero Sellers prefer it to perfect competition In a monopoly the single seller has considerable control over prices o o In theory Monopolist can set any price they wish In practice there are constraints For most goods as price increases demand generally decreases Beyond some point the drop in demand may produce a reduction in revenue and in an extreme case this effect is so great that total revenue may be insufficient to cover the cost of the sellers High prices provide incentives for new entrants Federal and state laws also limit the monopolist s pricing policy o Price in monopoly is generally higher than in oligopoly but there are constraints on how high price will go A single supplier has considerable control over price Prices in monopolistic competition Individual sellers in perfect competition may attempt to gain some control over price by differentiating their products These differentiated products target different market segments o Toothpaste package size type paste gel cavity fighting or whitening agents Each target different market segments o Price also varies All things equal first movers have considerable control over pricing moderated by the same forces as may affect monopolist For our purposes there are 2 differences between monopolistic competition and normal monopoly o Total size of market segment vs entire market o Presence of differentiated rather than homogeneous product Prices in oligopoly monopolistic competition and monopoly tend to be increasingly higher than in expected in perfect competition Higher prices tend to produce higher profit Excess rents to refer to these higher profits that tend to emerge when actual price exceeds equilibrium price Monopolistic rent and oligopolistic rent From a pure price perspective buyers prefer perfect competition while sellers prefer oligopoly monopoly or monopolistic competition Why o Buyers favor the lower equilibrium price o Sellers favor opportunities to earn excess rents Firms are both buyers and sellers Firms prefer perfect competition in their input markets and oligopoly monopoly or monopolistic competition in their output markets Price and non price competition Price vs pricing Price is the amount of money that a seller is willing to accept in exchange for a product of specific attributes at a given time and under given circumstances Pricing is a decision making process by which one party to the transaction usually but not always the seller decides what price to ask for a product given attributes at a given time and under given circumstances Demand increases if price goes down and demand decreases if price increases For some products price change has little or no effect on demand and in some instances we observe price and demand move in the same direction Price competition A firm may decide to compete on price by setting prices lower than that of the competition o Why would they do this To steal customers from competitors To induce non buyers to enter the market It may be an attempt to drive others out of business Possible increases in revenue or profit What effect does lowering the price have on revenue o If could increase decrease or have no effect on revenue depending on the relative decrease in price vs the increased quantity Revenue equals price per unit p volume of units sold q Current revenue is p q R Assume I cut my price by 10 new price 9p In order for this decision to produce no change in revenue the new q has to increase by 1 9 or slightly more than 11 If q increases by more than 1 9 firms revenue will increase If q increases by less than 1 9 firms revenue will decrease o o o If the new lowered price has no effect on revenue revenue neutral If new lowered price increases revenue revenue enhancing If new lowered price decreases revenue revenue detracting What effect will dropping price have on profit Increasing revenue is fine but more important is the effect on profit o o The key issue is the relative increase in revenue vs the relative increase in costs Each product made incurs some cost Total cost of production usually