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'Although corporate pricing decisions are influenced by many different factors, fundamentally prices will reflect cost and market conditions.Explain and discuss.

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Introduction

For my essay I have chosen the second option available to me, which is: 'Although corporate pricing decisions are influenced by many different factors, fundamentally prices will reflect cost and market conditions. Explain and discuss. Firms have to know not only about costs, but also about revenues when they make pricing and output decisions. In order to understand the relationship between output, revenues and price, a firm has to know the structure of the market or industry in which it is selling its product. There are various market structures, all dependant upon the extend to which buyers and sellers can assume that their own buying and selling decisions do not affect market price. At one extreme, when buyers and sellers correctly assume that they cannot affect market price, the market structure is one of perfect competition. Whenever buyers and sellers must take into account how their individual actions affect market price, we are not in a market structure of perfect competition and have entered an imperfectly competitive market. Such a market is examined later in the essay relating to the extreme on the other side of the line -monopoly. The characteristics of perfect competition The following section will cover how a firm acting within a perfectly competitive market structure makes decision about how much to produce. Before I go ahead with this analysis, I want to give the characteristics of the market structure called perfect competition. These characteristics are as follows: 1. The product that is sold by the firms in the industry is homogeneous. This means that the product sold by each firm in the industry is a perfect substitute for the product sold by every other firm. In other words, buyers are able to choose from a large number of sellers of a product that the buyers believe to be the same. The product is thus not in any sense differentiated as a result of whoever is the source of supply. ...read more.

Middle

Lack of availability of inputs Preventing a newcomer from entering an industry is often difficult. Indeed, there are some economists who contend that no monopoly acting without the government support has been able to prevent entry into the industry and unless that monopoly has had the control of some 'essential' natural resource. Considering the possibility of one firm owning the entire supply of a raw material input that is essential to the production of a particular commodity. The exclusive ownership of such a vital resource serves as a barrier to entry until an alternative source of the raw material is found or an alternative technology not requiring the raw material in question is developed. A good example of control over vital input is the Aluminium Company of America (Alcoa), a firm that prior to the Second World War controlled the world's bauxite, the essential raw material in the production of aluminium. (Such a situation is rare, though) * Government regulations and exclusivity agreements In many industries it is illegal to enter without a license provided by the government. For example, in the United Kingdom you could not operate an unlicensed postal service or radio service. Similarly, it is necessary to obtain a license from the Independent Broadcasting Authority before you can manage a regional independent television service. Successful applicants will receive monopoly rights to the sale of TV advertising space in their areas for eight years. Since these licenses are not granted very often, long-run monopoly profits can be earned by those firms already in the industry. Historically, TV franchises have been very profitable to own. One franchise-holder described it as a "license to print money"! An equivalent type of situation was found (in 1989) to exist in the supply of beer. Many brews, especially the largest, were involved in brewing, wholesaling and retailing. In fact, it was estimated that 75% of public houses were owned by brewers. ...read more.

Conclusion

Such is not the case for the individual monopolistic competitor. The demand curve has some slope to it. This firm has some control over price; it has some market power. Price elasticity of demand is not infinite. The two situations can be seen in the figures below. Both show average total costs just touching the respective demand curves at the particular price at which the firm is selling the product. Notice, however, that the perfect competitor's average total costs are at a minimum. This is not the case with the monopolistic competitor. The equilibrium rate of output is to the left of the minimum point on the average total cost curve where price is greater than marginal cost (the monopolistic competitor cannot expand output to the point of minimum cost without lowering price; and then marginal cost would exceed marginal revenue.) It has been argued, therefore, that monopolistic competition involves waste because minimum average total costs are not achieved and price exceeds marginal cost. There are too many firms producing too little output. This situation is described as one of "excess capacity". According to critics of monopolistic competition, society's resources are being wasted. Figure 1.3 (a) Figure 1.3 (b) In (a) the perfectly competitive firm has zero economic profits in the long run. Its long-run average total cost curve is tangent to the demand curve dd just at the point of intersection with the marginal cost curve. The price is set equal to the marginal cost, and the price is P1. There are zero economic profits. Also its demand curve is just tangent to the minimum point on its average total cost curve, which means that the firm is operating at its best possible rate of production. With the monopolistically competitive firm in (b), there are also zero economic profits in the long run, because the average total cost curve is tangent to the individual monopolistic competitor's demand curve, d'd', at the output where production occurs. The price, however, is grater than marginal cost; the monopolistically competitive firm does not find itself at the minimum point on its average total cost curve. ...read more.

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