Optimal Pricing in Various Market Structures
In Economics, “optimal price” of a product is defined as the price at which the producer, by selling that product, is earning the maximum possible return. It is basically the profit maximizing price. In order to maximize profits, a firm should produce if and only if price or average revenue is greater than or equal to average variable cost. Further, the firm should produce at the point where marginal revenue is equal to marginal cost, marginal cost is less than marginal revenue at slightly lower output and marginal cost exceeds marginal revenue at slightly higher output.
Market structure refers to the types of markets in which the producers or firms operate. It indicates how the market is organized. There are various factors that determine market structure, such as the number of buyers and sellers, nature of the product, freedom of entry or exit if firms, degree of price influence and the buyers’ and sellers’ knowledge about the market. Based on these features, the most important types of market structures include monopoly, perfect competition, monopolistic competition and oligopoly.
Optimal pricing strategy varies significantly across different market structures, owing to the different characteristics of each of these markets. Monopoly: Monopoly is a market structure
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A monopolist would face a negatively sloping demand or average revenue curve because increase in price would result in a decrease in demand and revenue. However, it would not be a perfectly elastic demand curve for the reason that consumers have no other alternatives and would be willing to pay a higher price, to a certain degree, in order to attain that product. Thus, the optimal price for a company in a monopoly form of market would be the price at which the average revenue earned from a product is greater than or equal to the average cost of producing that product.
Perfect Competition: Under perfect competition, there are a large number of producers producing a homogenous product so that no individual producer can influence the price of the commodity. Here the producer or seller is the price taker rather than a price maker. Thus, the price is determined solely by the mechanism of demand and supply. The companies will have to value the product at the price where demand is equal to supply. The company, however, must make sure that the marginal revenue is equal to marginal cost.