Transcript 6 Market structure and pricing

6 Market structure
and pricing
© John Tribe
© John Tribe
Learning outcomes
• By studying this section students will be
able to:
– understand how and why firms come to be
price takers, price makers or price shapers
– analyse the pricing strategies that result from
different market situations
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Pricing in the private sector
• Private sector organizations which seek to
maximize profits will attempt to minimize
their costs and maximize their revenue.
• Revenue is composed of price multiplied
by quantity sold
• The price that an organization can charge
for its product depends largely on the type
of market within which it is operating.
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Price takers: Perfect competition
• Market conditions
–
–
–
–
many buyers, many sellers
identical products
freedom of entry and exit in the market
perfect knowledge about prices and products in the
market.
• Firms which operate in this type of market have
to accept the market price.
– This is because any attempt to increase their own
price over and above market price will lead to
consumers purchasing identical goods or services
from competitor firms.
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Perfect competition: Which is a
typical firm’s demand curve?
P
a
• Answer = c
b
– (perfectly elastic: if the firm
increases its price customers
will buy from competitors)
c
• Not b
– (Supply curve)
• Not a
– (perfectly inelastic)
e
• Not e
– (Some customers remain
even after price rise)
D
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A Paradox
• In the UK a major
supermarket (Tesco) sells
top 50 CDs for £9.99.
Regular retailers (e.g. HMV)
charge £13.99 for an
identical product. These
stores are opposite each
other but HMV still manages
healthy sales of its more
expensive CDs. Why?
– consumer ignorance (i.e. lack
of perfect knowledge)?
– Non-identical shopping
experience?
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Price takers: Perfect competition
• Whilst free market prices and normal profits are
good for consumers, profit-maximizing
producers will aim to increase profits.
• Thus there are few examples in the real world of
price takers. If firms are not in the fortunate
position of being price makers they will generally
take steps to become price shapers.
• How could they do this?
– by introducing imperfections into the market
• What is the effect of the Internet on competition?
– increases knowledge and introduces more sellers
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Price makers: Monopoly
• literally defined as one seller
• monopoly power is maintained by ensuring
that barriers to entry into the industry are
maintained.
• the firm’s demand curve is the same as
the industry demand curve. Why?
– the firm is the industry
• because of this, the monopolist is in a
position to be a price maker.
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Monopoly: Which is a firm’s
demand curve?
P
a
• Answer = e
b
– A trade off between price
and demand
• not = c
c
– (perfectly elastic)
• Not b
– (supply curve)
e
• Not a
– (perfectly inelastic)
D
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Price makers: Monopoly
• a monopoly producer faces a trade-off
– it can raise prices but as it does so demand
falls (but does not disappear as would be the
case under perfect competition).
• so what is the best price to charge?
– that price that will maximise total revenue
• where demand is inelastic will it pay to
increase or decrease price?
– increase
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Which of the following is a
monopoly?
• BA – Airline, or
• BA – London Eye
– Ans = London Eye
• Why?
– No close substitute
• What does this mean
for pricing strategy?
– Where demand is
inelastic it pays to
raise prices
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Price discriminating
monopolist/yield management
• The conditions for price discrimination to take
place are:
– The product cannot be resold. If this were not the
case, customers buying at the low price would sell to
customers at the high price and the system would
break down. Services therefore provide good
conditions for price discrimination.
– There must be market imperfections (otherwise firms
would all compete to the lowest price).
– The seller must be able to identify different market
segments with different demand elasticities (for
example, age groups, different times of use).
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Price
discriminating
monopolist
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Is this price discrimination?
• British Airways return fares from London
to New York (summer 1999) are:
– £5446 (first class),
– £3213 (club class),
– £828 (standard economy),
– £417 (APEX),
– £82.80 (staff 10 per cent standby) and
– £0 (staff yearly free standby/holders of
airmiles or frequent flyer miles).
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Not strictly because
• In fact BA is not a monopolist …
• but most fares are subject to International Air Transport
Association (IATA) regulation and thus many firms are
able to act as monopolists.
• The fare differential for club and first-class passengers is
not strictly price discrimination since these represent
different services with different costs.
• But since all economy-class passengers receive an
identical service, why should BA charge different prices
and why do passengers accept different prices?
– The answer is that by price discrimination companies can
increase their profits by charging different prices according to
how much different market segments are prepared to pay.
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Yield management
• Computer technology is able to identify
patterns of demand for a particular product
and compare it with its supply.
• A request for a hotel reservation or an
airline ticket will result in the system
suggesting a price that will maximize the
yield for a particular flight or day’s
reservations
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Price shapers
• Firms operating in markets between these
two extremes can exert some influence on
price. Such firms are called price shapers
• The two main market types which will be
examined are:
– oligopoly
– monopolistic competition
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Oligopoly
• An oligopoly is a market dominated by a
few large firms.
• An example of this is the cross-channel
(UK to France) travel market.
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Oligopoly
• Oligopoly makes pricing policy more difficult to
analyse since firms are interdependent, but not
to the extent as in the perfectly competitive
model.
• The actions of firm A may cause reaction by
firms B and C, leading firm A to reassess its
pricing policy and thus perpetuating a chain of
action and reaction.
• For these reasons firms operating in oligopolistic
markets often face a kinked demand curve.
© John Tribe
Kinked Demand Curve
a price rise will cause consumers to
purchase from competitors: demand
elastic
P
l
k
demand curve kinked at this
point
m
a price fall will be
matched by competitors:
demand inelastic
a
bc
D
© John Tribe
Kinked demand curve
• With a kinked demand curve it is clearly not in the
interests of individual firms to cut prices, and these
markets tend to be characterized by price rigidities.
• Marketing and competition under oligopoly conditions
are often based around:
–
–
–
–
advertising
free gifts and offers
quality of service or value added
follow-the-leader pricing – pricing is based on the decisions of
the largest firm
– informal price agreements
– price wars occasionally break out if one firm thinks it can
effectively undercut the opposition
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Monopolistic competition
• This is a common type of
market structure,
exhibiting some features
of perfect competition and
some features of
monopoly.
– The competitive features
are freedom of entry and
exit and the existence of a
large number of firms.
– However products are not
identical
– E.g. hotels
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Monopolistic competition
• The more inelastic a firm is able to make
its demand curve, the more influence it will
have on price, and thus firms will attempt
to minimize competition by:
– product differentiation
– acquisitions and mergers
– cost and price leadership
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Market types
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Pricing in the public sector
• Prices of public sector goods and services
will depend upon the market situation
which prevails in a particular industry as
well as the objectives set for a particular
organization. These might be:
– profit maximization
– break-even pricing
– social cost/benefit pricing
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Pricing and the macroeconomy
• The condition of the economy at large also has
an influence on firms’ pricing policy.
– If the demand in the economy is growing quickly,
there may be temporary shortages of supply in the
economy and firms will take advantage of boom
conditions to increase prices and profits.
– Similarly, during a recession there may well be overcapacity in the economy and demand may be static or
falling. These conditions will force firms to have much
more competitive pricing policies to attract
consumers.
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What is the market type for each of
these?
• Coca-cola stall in the
desert!
– Monopoly
• Qantas
– Monopolistic
competition
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… and these?
• Arsenal Football Club
– Monopoly
– One seller
– Demand elasticity?
• Inelastic
– Possibility for high profits
• Fast Food in China
– Perfect competition
– Many buyers and sellers
– Demand elasticity?
• elastic
– Normal profits
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Review of key terms
• Price taker =
– a firm in a perfectly competitive market which cannot
directly influence price.
• Price maker =
– a firm in a monopoly market which sets its desired
price.
• Price shaper =
– a firm in an oligopoly or imperfectly competitive
market which may seek to influence price.
• Perfect competition =
– many buyers and sellers, homogeneous products,
freedom of entry and exit to market.
© John Tribe
Review of key terms
• Monopoly =
– one seller, barriers to entry.
• Oligopoly =
– a small number of powerful sellers.
• Monopolistic competition =
– many buyers and sellers, freedom of entry and exit, products
differentiated.
• Product differentiation =
– real or notional differences between products of competing firms.
• Price discrimination =
– selling the same product at different prices to different market
segments.
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6 Market structure
and pricing:
The End
© John Tribe