Determining the Price of a Product to Maximize Profits - Assignment Example

Maximizing Profits in Market Structures Table of Contents Answer to Question 3 Answer to Question 2 5 Answer to Question 3 8 Answer to Question 4 9Answer to Question 5 10 References 11 Pindyck, R. S. & Rubinfeld, D. L. (2004) Microeconomics (5th Edition). New Jersey, USA: Prentice-Hall. 11 Webster, T. J. (2003) Managerial economics: theory and practice. USA: Emerald Group Publishing. 11 Bibliography 11 Mankiw, N. G. (2008). Principles of Economics (5th Edition). USA: Cengage Learning. 11 Answer to Question 1 Primarily four types of market structure could prevail in an economy, namely, competitive market, monopoly, oligopoly and monopolistic competition. The innate structures of each market type have been illustrated as follows. Competitive market There are a large number of buyers and sellers operating in a competitive market. The quality of products on sale in a competitive market is homogenous in nature. There are no barriers to entry or exit in a competitive market. Monopoly A monopoly market structure is characterised by a single seller and many buyers. The core element giving a monopoly market structure its name are the strong barriers to entry, created either due to government regulations or since a single firm in the market owns the resources necessary for production. Thirdly, the products sold by monopoly sellers are devoid of any close substitutes which give them a leeway to maintain their business. Oligopoly An oligopolistic market structure is featured by a few sellers but a large number of buyers, so that each of them enjoys a certain amount of market power. The products being sold in the market are almost homogeneous in nature, though in most of the cases, brand names of the respective companies distinguish them from the others and operate behind consumer choices. Thus, the sellers can actually advertise for their respective products. The business strategy to be posed by any one firm is dependent upon those of its rivals in the market, since all of them enjoy a significant amount of market control. There is a scope of forming cartels between the market players with an objective to maximise joint profits. Barriers to entry are quite active in an oligopolistic market structure. Monopolistic competition Monopolistic competition is almost identical to a monopoly form of market structure, with the only difference being the coexistence of a few sellers. The products sold by each seller have a subtle difference between them, either quality-wise or difference in brand names. Barriers to entry or exit are quite feeble (Pindyck & Rubinfeld, 2004). Answer to Question 2 The methodology to determine product price, with an objective of profit maximisation, in each market structure varies due to a difference in their integral features. The profit function applicable in each case is, π = Revenue – Cost = P.Q – C (Q); where, P = Market Price, Q = Quantity to be sold and C = Cost Hence, for differentiating π w.r.t. to Q for profit maximisation, and equating with 0 yields, δπ/ δQ = P – C’(Q) = 0 P = C’(Q) MR = MC Competitive market The marginal cost curve symbolises the market supply curve, since producers decide the quantity to be supplied based upon the additional cost that is incurred in producing each unit. The profit maximising price level in a any market is the point where the MC equates with the marginal revenue curve. In a competitive market, the MR is a horizontal straight line since there is practically no distinction between the market strategies of the players. Monopoly The marginal curve in this case is downward sloping in nature since a single player faces the entire market demand. The marginal revenue in this case thus keeps on falling since the price per unit of quantity being demanded keeps on falling, as the supply rises. Oligopoly Price determination in an oligopolistic market structure is dependent upon the market prices being determined by the rival firms operating in the market. In this case, the equilibrium quantity to be supplied depends upon the quantities being supplied by the rivals. Since quantity to be supplied depends upon the price being charged, so, prices vary between firms. Hence, the price is determined in the same way as being described above, with the only difference being that they have to be decided individually. Monopolistic competition The determination of price is quite identical to that of a monopoly market structure, though the marginal revenue curve applicable in each individual case is flatter than that for the monopoly market. Answer to Question 3 The equilibrium output in any market structure is determined at the point where the marginal cost curve is rising. The logic behind this is that the firms aim at profit maximisation; hence, if the profit maximising output falls at a point where the MC is found to be diminishing over time, it indicates a gradually rising marginal profit margin. The point where the producers decide to supply their output is where the marginal cost and marginal revenue curves equate with one another in addition to the fact that the former is upward rising. This could also be established mathematically, as a continuation of the above relationship. It had been established that δπ/ δQ = P – C’(Q) = 0 For maximisation of profit, δ2π/ δQ2 < 0 => - C” (Q) < 0 => C” (Q) > 0 Clearly, the above inequation indicates that the MC must be rising if a firm aims at profit maximisation. In fact, the above diagrams to display the MC to be rising at the point where the profit is maximised or rather where the equilibrium output is being produced (Webster, 2003). Answer to Question 4 The barriers to entry in a market are basically being implemented in those market structures where the scope of profit making is quite high, unlike in perfectly competitive ones, where every player earns normal profit. Such barriers could arise either due to government regulations or due to competitive advantages enjoyed by any particular market player. The government might impose some restrictions about the free entry and exit of market players to protect the resources being used as raw materials; the prime weapons they might use in this regard are provisions of licenses to a selected few. On the other hand, in many cases, any individual seller might also create an edge for themselves due to some special skills or resources which they own or have innovated. In such cases, they claim for patent rights thus adjudging themselves as the sole legal producer of a particular commodity or provider of a service. Answer to Question 5 There are a few aspects of each and every market structure which might influence an economy. When a buyer wants to purchase goods from a competitive market, they could be assured of being charged a price close to the cost of production. In case of monopoly however, though the market is far less chaotic than that of a competitive one, it often deprives the consumers of a market determined price level, thus leaving a huge scope for earning profits by the seller. In an oligopolistic market structure too, the buyers enjoy a competitive price as the market players vie over one another to capture a larger share of the total market. However, in cases where they form a cartel between themselves, the situation becomes similar to that of a competitive market. Lastly, in case of monopolistic competition, the market players do not enjoy a complete monopoly power over the market so that the buyers could be assured of a market determined price. In addition, the buyers are also assured of a range of products in this case, which adds to their utility. References Pindyck, R. S. & Rubinfeld, D. L. (2004) Microeconomics (5th Edition). New Jersey, USA: Prentice-Hall. Webster, T. J. (2003) Managerial economics: theory and practice. USA: Emerald Group Publishing. Bibliography Mankiw, N. G. (2008). Principles of Economics (5th Edition). USA: Cengage Learning. Read More