Pricing and output decisions are crucial in the running of a firm. Pricing decisions involve the determination of the amount the firm is going to charge for its products or services. Typically, firms set prices aiming at profit maximization, which is the primary objective of almost all companies. Output decisions involve the determination of the amount of goods and services the firm is going to produce, and are made based on the concepts of marginal revenue and marginal cost.
Pricing and output decisions are affected by a number of factors; key among them being the market structure. Market structure refers to the manner in which the market is organised, as well as the characteristics of the market. Examples of market structures include perfect competition, monopoly, monopolistic competition, and oligopoly. The effects of each of the above market structures on pricing and output decisions are discussed in the following part.
In perfect competition, there are many firms dealing in similar products. As such, consumers choose from among the many businesses mainly based on the prices they charge for their products (Besanko, Dranove and Shanley, 2000, p.30). There are no market entry or exit barriers (Allen et al., 2015).The firms must, therefore, charge similar prices to remain competitive in the market. Prices are thus not within the control of the individual firm.
A monopoly market structure is characterised by the presence of just a single producer who of unique goods that have no close substitutes (www.econ.yale.edu, 2015). Such firms hardly exist in developed countries such as the US as there are legal barriers preventing their existence. Since monopolies are the sole producers in the industries in which they operate, their pricing and output decisions are dependent on the elasticity of the demand for their products. Their demand curves are downward sloping. They sell more output at lower prices, and less at higher prices (www.econ.yale.edu, 2015). The fact that monopolies have no competitors is their primary competitive advantage at the marketplace.
Monopolistic competition has many small firms in the same category or segment but with different products or slightly differentiated goods, for example, fast foods. Each of them is relatively small to the total market size that their individual pricing and output decisions have no effect on the market price (Users.humboldt.edu, 2015). The market structure is characterised by the presence of many real and apparently differentiated goods, as well as close but not perfect substitutes for the products (Allen et al., 2015, p.56). Pricing and output decisions in this kind of market structure fall into two; the short run and the long term. In the short term, pricing and production decisions are like that of a monopoly. The firm decides how much to produce and how much to charge for its products (Users.humboldt.edu, 2015). However, since there is free entry into the market, the long run, pricing and output decisions are dependent on the prices of other firms and the increased costs of advertisements. The presence of product differentiation in the market serves as a competitive advantage for the businesses since it allows them to serve as price makers, not price takers (Users.humboldt.edu, 2015).
Oligopolistic markets have few large firms that are responsible for most of the output of the industries in which they operate. The firms produce single or slightly differentiated goods. The price and output decisions of this type of market structure are intertwined. Companies make decisions based on the expected reactions from their few competitors (Users.humboldt.edu, 2015). A wide variety of price and non-price rivalry exists in an oligopolistic market structure, such as massive advertisements and differentiation of products. In oligopoly, higher rates are charged for products than in perfect competition. In addition, when the firms spend money on non-price competition, they increase the chance of shifting their demand curves to the right, which would increase the amount of output and price.