Managerial Economics Pricing with Market Power

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Managerial Economics
Pricing with Market Power
The main achievement that a manager seeks for their organization is the maximization of the firm’s profits. Profit is the difference between revenues and costs. Businesses have to choose between the price they set for their goods or services and the quantity the firm produces for sale. Generally, most businesses set the price of their goods. However, it is much easier to look into the behavioral aspects of a business by assessing the quantity it chooses to produce.
A business maximizes its profits when the extra revenue gained from the sales of an extra output unit (marginal revenue) is the same as the additional cost incurred to produce the extra unit (marginal cost). The main rule guiding the business decision is to choose a mark on the demand graph to match the marginal revenue and the marginal cost. This situation can be rearranged to get a business’s pricing guideline. Figure 1.1 highlights this pricing decision. Markup pricing relies on demand price elasticity. In situations when the market’s demand is inelastic, businesses gain a lot of market power, and to gain as much as they can from this, businesses set a high markup (Cooper and John). This formula does not, however, work in every scenario because the markup price and the marginal cost are subject to the price that a business decides on.


Fig 1.1 Markup Pricing
The main concepts governing pricing with market power include when the firm incurs a higher marginal cost, it also sets a higher price for its products. When the business has more market power due to the inelasticity of the demand, the markup increases and thus, the business sets a higher price. In cases where the demand is elastic, the markup price is set to one. The business then adjusts its price to match the marginal cost. This is what happens in a competitive market. Any form of pricing is comprised of two elements, the markup price, and the marginal cost. When a price change occurs, either or both of these prices must have shifted (Cooper and John).
Google’s Market Power
The difference between the maximum price that one would pay for a product and the actual price paid is known as the consumer surplus. Monopolies decrease the consumer surplus due to the power they hold over the markets, which dictates how big the variation between the set cost and the maximum cost payable will be. This grip that monopolies have over the market is not necessarily due to few businesses being in the industry. It could be as a result of the nature of demand. An inelastic demand gives the firm the ability to reduce the consumer surplus.
Google is an example of a monopolistic firm with immense market power. The New York Times article, There’s no Limit to Google’s Power,’ presents an analysis of the immense strength of the market power google posses. Vollrath states, “But Google's market power is more pervasive because, in contrast to the gas station and the coffee shop, there is no natural limit to...