Very Short Question Answer

What do you mean by perfect competition?

Perfect competition is the market structure where there are too many buyers and too many sellers, each of whose output is so small in relation to total industry output that they can not affect the market price of the product.

Point out features of perfect competition.

The major features of perfect competition are as follows:

  1. Large number of buyers and sellers
  2. Homogenous products
  3. Freedom of entry and exit
  4. Perfect knowledge of market condition to both buyers and sellers
  5. No government intervention
What are the conditions of equilibrium of a firm according to marginal cost and margin revenue approach?

According to marginal cost and marginal revenue approach, following conditions must be fulfilled to attain equilibrium by a firm:

  1. MR = MC
  2. MC must intersect MR from below
What is monopoly?

Monopoly is defined as the market structure where there is a single firm or seller of a product having no substitute products.

What is the condition required to attain equilibrium by a firm according to TR and TC approach?

According to TR and TC approach, a firm attains equilibrium when the difference between total revenue (TR) and total cost (TC) should be maximum.

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Short Question Answer

What is price discrimination? Explain the conditions necessary for price discrimination.

Price discrimination is defined as the charging different prices to the different buyers for the same product. Price discrimination is possible only in the monopoly. Therefore, it is also called discriminating monopoly. According to Koutsoyinnis, “Price discrimination exists when the same product is sold at different prices for the same product.” Price discrimination is usually found in service industries. The main objective of price discrimination is profit maximization.

Conditions of Price Discrimination

Effective price discrimination needs the following conditions to be fulfilled:

  1. Monopoly power: Discrimination is possible only if monopoly exists and there is no competitor in the market. The firm must not be a price-taker; it must have the monopoly power.
  2. Market segmentation: The seller must be able to segment the total market by segregating buyers into groups or submarkets according to elasticity. For example, if the buyers can be divided into rich and poor, nationals and foreigners, they can be charged different prices.
  3. Market sealing: The firm must be able to prevent resale of the product. It should not be possible for the buyers of the dearer market to go to the cheaper market to buy the product. The markets should be divided into different sub markets in such a way that there should not be any chance of reselling. For example, the services of doctors, lawyers cannot be resold.
  4. Different elasticity of demand: The buyers in the various markets must have different price elasticity of demand due to difference in income, location, available alternatives, tastes and other factors. In general, high price is charged in the market having inelastic demand and low price is charged in the market having elastic demand. If elasticity of demand in different market segmentation is different, price discrimination is not profitable.
Define the oligopoly. What are its features or characteristic? Explain.

Oligopoly is the market structure in which few sellers capture large share of the market In other words, this is a situation in which there are only few sellers whose products are either homogenous or close substitute. It is competition among the few. If products are homogenous, it is called perfect oligopoly. On the other hand, if products are differentiated, it is called imperfect oligopoly.

The main features of oligopoly are as follows:

  1. A few sellers: In oligopoly, there will a few sellers. They may produce homogeneous products or differentiate their products. The share of each firm is quite large in market supply. Hence, the output and price policy of an individual firm can affect market conditions.
  2. Interdependence: Since the individual firms have a bearing on the market conditions, each firm depends on the price and output decisions of other firms while determining its own policy. Moreover, interdependence is also due to substitutability of products.
  3. Advertisements: The policy and fortune of one firm depends on that of the other firms. Hence, advertisement costs are incurred. Advertisement becomes an unavoidable necessity under oligopoly.
  4. Competition: There is close competition among the few firms because their products are close substitutes to one another.
  5. Lack of uniformity: There is no uniformity in the size of the oligopoly firms. Some firms may be small and others may be large. Uniformity of size is very rare.
  6. Indeterminate demand: Interdependence is responsible for this feature. No single firm can forecast its demand. An estimation of increase of sales cannot be made by reducing the price. Thus, it is difficult to construct a demand curve. The price-output changes of one firm will have backward and forward effects on that of the other firms. At best, the demand curve estimation is only a guesswork.
  7. Price rigidity: The prices are not easily changed due to fear of retaliation by the other firms. Thus, prices remain rigid and sticky. If one firm cuts its price, it leads to a price-war which finally benefits none of the firms.
Discuss skim pricing practice.

The skim pricing, is a product pricing strategy by which a firm charges the highest initial price for a product or service that customers will pay. As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price-sensitive segment or layer of the consumers. The objective of a price skimming strategy is to capture the consumer surplus and earn maximum revenue or profit in the shortest time possible rather than maximum sales. This model encourages the entry of competitors. When other firms see the high margin available in the industry, they will quickly enter. Price skimming can be considered as a form of price discrimination. Price skimming is effective and useful in the following context:

  • When the firm is facing an inelastic demand curve or when close substitutes of a new product are not available in the market or when the cross elasticity of demand of the product is very low.
  • When a new product enters the market
  • If enough potential customers are willing to buy the product at a high price. If the goal of the firm is to gather as much revenue as possible while consumer demand is high.
  • If the high price does not attract competitors into the market.
  • If the lowered price would have only a minor effect on increasing sales volume and reducing unit costs.
  • When the high price is interpreted as a sign of high quality.

Advantages of Price Skimming:

 Price skimming strategy helps to make a high-quality image and perception of the product.

 The company can quickly recover its cost strategy. of development by using this

This strategy generates a high-profit margin for the company.

This strategy is helpful to utilize economies of scale

 It helps distributors of the company to earn a higher percentage of mark-up

Disadvantages of Price Skimming:

The product may not be sold in the market if the producer is unable to justify its high price.

If the firm is unable to sell a large amount of the product using price skimming, the firm may not be able to utilize economies of scale.

Price skimming may not be a long-term strategy because competitors may soon enter into the market with rival products and pricing pressure.

The firm having a history of price skimming, may not sell the product at the desired level and price because the consumers may wait for a time before purchasing the product with the expectation of a fall in price.

Explain the incremental cost pricing practice.

Incremental cost pricing is an alternative method of determining price and output of a product by a firm. Under the traditional theory, price and output are determined by the MR-MC approach. But in practice, it is very difficult to calculate MR and MC and match them. Therefore, incremental cost pricing is regarded as the popular and practical method of determining price. In this method, fixed costs are ignored and only variable and marginal costs are accounted.

In this incremental cost pricing, decision is taken on the basis of change in cost and revenue due to particular decision. Incremental cost is the change in total cost as a result of an expansion of firm’s volume of business or level of activity. It gives emphasis on the impact of changes in output on revenue and cost. It also provides guidelines for a firm to analyse the particular course of action. In other words, it gives an idea to analyse effect of firm’s decision regarding the benefits. If firm’s decision increases revenue more than the cost, it should be made. Likewise, if firm’s decision reduces cost of production, it should be made. But if decision increases cost more than revenue and decision decreases revenue more than it decrease cost, it should not be made.

Incremental cost pricing method is also known as the marginal cost method because under this method price is determined on the basis of marginal cost. But there is slightly difference between marginal cost and incremental cost. Marginal cost is the addition in total cost as a result of one unit increase in output where as incremental cost is the change in total cost when there is large amount change in output.

Advantages/ Merits of Incremental Cost Pricing

The advantages or merits of incremental cost pricing are as follows:

  1. The incremental cost pricing helps a businessman to pursue a far more aggressive pricing policy than full cost pricing or cost plus pricing policy. An aggressive pricing policy should lead to higher sales.
  2. Under the incremental cost pricing, prices never rendered uncompetitive because of higher fixed costs and orders are never rejected because the prevailing price is below the average cost.
  3. Incremental cost pricing is more useful for pricing over the life cycle of the product, which requires a short-run marginal cost and separable fixed cost data relevant to each, particular stage of the cycle, not long run full cost.
  4. Incremental cost pricing is more useful than full cost pricing because of the prevalence of multiproduct, multi process and multimarket firms which makes absorption of fixed cost into product cost difficult.
  5. Incremental cost pricing more accurately reflects those changes in costs which results from the decision, while total costs include fixed cost which are not incurred as a result of that decision.

Disadvantages/ Limitations of Incremental Cost Pricing The weakness or limitations of incremental cost pricing are as follows:

  1. Incremental cost pricing leads to frequent changes in prices, which are not liked by the consumers. In other words, it is harmful for both consumers and firms.
  2. Many business men and some accountants are not acquainted with the incremental cost techniques themselves. Therefore, they can not use incremental cost pricing technique in order to estimate future demand and cost accurately.
  3. This method involves high administrative cost of operating business because this method needs estimation of demand elasticity and sales forecasting.
  4. The incremental cost pricing may lead to losses because overhead costs are not covered by it.
  5. In a period of business recession, firms using incremental cost pricing technique may lower prices in order to maintain business and this may lead other firms to reduce their prices leading to a cut throat competition. Due to this reason, firms can not earn a fair return on capital used.
Define monopoly. How monopoly firm attains equilibrium according to TR and TC approach.

Monopoly is the market structure in which there is single seller, there no close substitute for the product it produces and there are barrier to entry of new firms in the industry. The objective of monopoly firm is to maximize profit. It is almost impossible to get pure monopoly. Examples of monopoly in Nepal are Nepal electricity Authority, Water Supply Corporation, Postal service etc. Those are different types of monopoly such as pure monopoly, imperfect monopoly, natural monopoly, bilateral monopoly etc.

TR-TC Approach of Determining Equilibrium under Monopoly:

According to TR and TC approach, the monopoly firm attains equilibrium when profit is maximized. Total profit becomes maximum when there is maximum difference between TR and TC. The equilibrium of the monopoly firm according TR and TC approach is explained by the help of following diagram.

In the diagram, X-axis represents output and Y-axis represents cost, revenue and profit. The curves TR and TC represents total revenue curve and total cost curve respectively. These two curves are intersecting each other at point A and B respectively. At these points, TC and TR are equal. Therefore, there is neither loss, nor profit. These points are also known as the break even points. Before point A i.e. when output is below OQ₁, TR <TC. Therefore, the firm will have to bear loss. Similarly, beyond point B or when output is above OQ3, TR<TC. Therefore, there is also loss. The firm earns profit only between output OQ; and OQ Between OQ₁ and OQ3, where there is maximum profit, is the equilibrium output of the firm. At output OQ3 there is maximum profit or the difference between TR and TC is maximum. The maximum profit is CD, which has been shown in the diagram. Hence, the monopoly firm is in equilibrium producing OQ; output.

Long Question Answer

What do you mean by perfect competition? Point out features of perfect competition. What is price discrimination? Explain the conditions necessary for price discrimination.

Perfect competition is the market structure where there are too many buyers and too many sellers, each of whose output is so small in relation to total industry output that they can not affect the market price of the product.

The major features of perfect competition are as follows:

  1. Large number of buyers and sellers
  2. Homogenous products
  3. Freedom of entry and exit
  4. Perfect knowledge of market condition to both buyers and sellers
  5. No government intervention

Price discrimination is defined as the charging different prices to the different buyers for the same product. Price discrimination is possible only in the monopoly. Therefore, it is also called discriminating monopoly. According to Koutsoyinnis, “Price discrimination exists when the same product is sold at different prices for the same product.” Price discrimination is usually found in service industries. The main objective of price discrimination is profit maximization.

Conditions of Price Discrimination

Effective price discrimination needs the following conditions to be fulfilled:

  1. Monopoly power: Discrimination is possible only if monopoly exists and there is no competitor in the market. The firm must not be a price-taker; it must have the monopoly power.
  2. Market segmentation: The seller must be able to segment the total market by segregating buyers into groups or submarkets according to elasticity. For example, if the buyers can be divided into rich and poor, nationals and foreigners, they can be charged different prices.
  3. Market sealing: The firm must be able to prevent resale of the product. It should not be possible for the buyers of the dearer market to go to the cheaper market to buy the product. The markets should be divided into different sub markets in such a way that there should not be any chance of reselling. For example, the services of doctors, lawyers cannot be resold.
  4. Different elasticity of demand: The buyers in the various markets must have different price elasticity of demand due to difference in income, location, available alternatives, tastes and other factors. In general, high price is charged in the market having inelastic demand and low price is charged in the market having elastic demand. If elasticity of demand in different market segmentation is different, price discrimination is not profitable.
Define the oligopoly. What are its features or characteristic? Explain.
Explain the conditions necessary for price discrimination.

Oligopoly is the market structure in which few sellers capture large share of the market In other words, this is a situation in which there are only few sellers whose products are either homogenous or close substitute. It is competition among the few. If products are homogenous, it is called perfect oligopoly. On the other hand, if products are differentiated, it is called imperfect oligopoly.

Features of Oligopoly

The main features of oligopoly are as follows:

  1. A few sellers: In oligopoly, there will a few sellers. They may produce homogeneous products or differentiate their products. The share of each firm is quite large in market supply. Hence, the output and price policy of an individual firm can affect market conditions.
  2. Interdependence: Since the individual firms have a bearing on the market conditions, each firm depends on the price and output decisions of other firms while determining its own policy. Moreover, interdependence is also due to substitutability of products.
  3. Advertisements: The policy and fortune of one firm depends on that of the other firms. Hence, advertisement costs are incurred. Advertisement becomes an unavoidable necessity under oligopoly.
  4. Competition: There is close competition among the few firms because their products are close substitutes to one another.
  5. Lack of uniformity: There is no uniformity in the size of the oligopoly firms. Some firms may be small and others may be large. Uniformity of size is very rare.
  6. Indeterminate demand: Interdependence is responsible for this feature. No single firm can forecast its demand. An estimation of increase of sales cannot be made by reducing the price. Thus, it is difficult to construct a demand curve. The price-output changes of one firm will have backward and forward effects on that of the other firms. At best, the demand curve estimation is only a guesswork.
  7. Price rigidity: The prices are not easily changed due to fear of retaliation by the other firms. Thus, prices remain rigid and sticky. If one firm cuts its price, it leads to a price-war which finally benefits none of the firms.

Conditions of Price Discrimination

Effective price discrimination needs the following conditions to be fulfilled:

  1. Monopoly power: Discrimination is possible only if monopoly exists and there is no competitor in the market. The firm must not be a price-taker; it must have the monopoly power.
  2. Market segmentation: The seller must be able to segment the total market by segregating buyers into groups or submarkets according to elasticity. For example, if the buyers can be divided into rich and poor, nationals and foreigners, they can be charged different prices.
  3. Market sealing: The firm must be able to prevent resale of the product. It should not be possible for the buyers of the dearer market to go to the cheaper market to buy the product. The markets should be divided into different sub markets in such a way that there should not be any chance of reselling. For example, the services of doctors, lawyers cannot be resold.
  4. Different elasticity of demand: The buyers in the various markets must have different price elasticity of demand due to difference in income, location, available alternatives, tastes and other factors. In general, high price is charged in the market having inelastic demand and low price is charged in the market having elastic demand. If elasticity of demand in different market segmentation is different, price discrimination is not profitable.

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