Business Economics 09 Market Structures & Pricing StrategyPresentation Transcript
Learn about market formation
How decisions of price and output are taken in the markets
Price and output determination in various market structures – perfect competition, monopoly, monopolistic competition, oligopoly
Pricing strategies for firm with market power- price discrimination
A comparison of market structures for efficient production and equitable distribution
Four basic components of market
1. Consumers 2. Sellers
3. Commodity 4. Price
By the area
By the nature of transaction
By the volume of business
By the nature of competition
Competition in the market
Number and size distribution of sellers
Number and size distribution of buyers
Conditions of entry and exit
Structure Conduct Performance
A classification of market forms Form of Market Structure Number of Firms Nature of Product Price elasticity of demand for Degree of control 1 2 3 4 5 a) Perfect competition A large no. of firms Homogeneous Product Infinite None b) Imperfect competition A large no. of firms Differentiated products (but) they are close substitutes of each other Large Some i) Monopolistic competition A large no. of firms Product differentiation by each firm Large Some ii) Pure oligopoly Few firms Homogeneous Product Small Some iii) Differentiated oligopoly Few firms Differentiated products Small Some c) Monopoly One Unique product without close substitutes Very Small Considerable
Infinite buyers and sellers
Perfect knowledge and information
No barriers on entry or exit
Maximum profits or minimum losses
No transportation cost
All are price takers
Types of firms
Efficient (least cost) and profit making firms
Efficient but breaking even firms
Inefficient but operating firms
Inefficient and closing down firms
Perfect competition and the public interest
P = MC
Competition as spur to efficiency
Development of new technology
Economical use of national resources
Least cost Q in long run (LR)
Barriers on entry
Through elasticity of demand
Learner (Abba) index = P – MC/P or
MR = P(1+1/E)
Learner index = -1/E
Cross price elasticity of demand
Acquiring market power
Economies of scale
Product differentiation and brand loyalty
Ownership of, or control over, key factor and/or wholesale or retail outlets
Consumer lock in- high search, switching and initiation cost
Network externalities – product’s value rises as more consumers use it.
Mergers and takeovers
Monopoly and the public interest
Disadvantages – Higher price and lower output, possibility of higher cost due to lack of competition, unequal distribution of income
Advantages – Economies of scale, lower cost, competition for corporate control, innovation and new products
Deadweight loss – a measure of the aggregate loss in well-being of the participants in a market resulting from an inefficient output level.
(e.g. steel, aluminum, cement, fertilizes, petrol and cars).
Oligopoly in different forms
Kinked demand curve
Joint profit maximizing cartel
Market sharing cartel
Kinked demand curve model
Factors favoring collusion
Few firms well known to each other
They are not secretive
Similar production methods and AC and want to change price at the same time
Significant barriers to entry
No government measure to curb collusion
Joint profit maximizing cartel
Market sharing cartel
Case - OPEC: the rise and fall of a cartel
OPEC set up in 1960 by Saudi Arabia, Iran, Iraq, Kuwait and Venezuela.
The co-ordination and unification of the petroleum policies of member countries
The organization to ensure the stabilization of prices, elimination of harmful and unnecessary fluctuation in the price and quantity
OPEC is a joint profit maximizing cartel
Saudi Arabia is a dominant producer and price leader within the cartel
Initially OPEC was increasingly in conflict with international oil companies - as under ‘Concessionary Agreement’ they were given right to extract oil in return for royalties.
1973 – thirteen members – transfer of powers, OPEC makes decisions on oil production and thereby determining oil revenues.
1970s – setting market price for Saudi Arabian crude and OPEC members to set their prices in line – dominant firm price leadership
As long as demand is price inelastic – this policy allowed large P TR
1973-74 – Arab-Israeli war, OPEC raised price $3 per barrel to over $12 until 1979 and sales did not fall.
After 1979 – price $15 to $40 per barrel demand did fall
1982 – OPEC agreed to limit output and allocate production quotas to keep the price up. A production ceiling of 16 million barrel per day in 1984
Cartel was beginning to break down due to
- world recession
- growing output from non-OPEC members
- ‘cheating’ by some OPEC members who exceeded their quota limit
The trend of lower oil prices was reversed in the late 1980s due to boom
1990 – Iraq invaded Kuwait Gulf war supply of oil fell P
End of war and recession of 1990s the price fell again - $ 16
During mid-1970s International Bauxite Association (IBA) quadrupled bauxite prices
A secretive international uranium cartel pushed up uranium prices
From 1928-1970s Mercurio Europe kept the prices of mercury close to monopoly levels
A cartel monopolized the iodine market from 1878-1939
Tin, coffee, tea and cocoa cartels failed
Pricing Strategies for Firm With Market Power
How do we set prices relative to costs?
How do we change them?
To what extent should we try to protect our market?
Strategy to lead to the highest profit rate.
Lowering prices in response to potential competition.
Strategies that yield even greater profits
Extracting Surplus from consumers
Two part pricing
Changing different prices for the same product
Charging same price for different products when costs differ.
Possibility of differences in
age of the customer
time of purchase
First degree price discrimination (unit wise)
Charging each consumer one maximum price, he or she is willing to pay for each unit. Extracting all consumer surplus and earning maximum profit.
Requirement - full information regarding consumers
Application - service related business - mechanics, doctors, lawyers, professionals etc.
Second degree price discrimination (Lot wise)
A practice of posting a discrete schedule of declining prices for different ranges of quantities. Extracting part of the surplus, lower profit.
Third degree discrimination (Market wise)
Charging different groups of consumers different prices for the same product.
Different elasticity of demand - students’ discount, senior citizen discount
Information regarding elasticity of demand
Different elasticity of demands
Profit-maximizing output under third-degree price discrimination a) Market X b) Market Y c) Total (market X+Y) Q 0 1000 MR X D X 0 2000 MR X D X 0 3000 MR T 5 9 7 5 Q Q MC 5
Two part pricing
Initially a fixed fee for the right to purchase its goods, plus a per unit charge for each unit purchased.
Examples - athletic clubs, golf courses, health clubs
Initiation (fixed) fee plus monthly or per visit charges.
All or none decision
Block pricing provides a means by which the firm can get one consumer to pay the full value of the blocked units.
Consumer’s decision - buying all units (blocked) or buying nothing .
( hiring a bus, a pack of three soaps )
Bundling two or more different products and selling them at a single ‘bundle price’.
Example - travel companies package deal, computer, monitor, software deal
Pricing strategies for special cost and demand structures
Peak load pricing
Peak load pricing
Markets having high demand and low demand periods.
Example - road, train, air, electricity, telephone. No problem of resale. Commodity must be consumed as it is purchased.
Objective- to reduce costs and increase profits if
the same facilities are used to provide a product or service at different periods of time.
the product or service is not storable.
demand characteristics vary from period to period.
The theory of peak-load pricing suggests that peak-period users should pay most capacity costs while off-peak user may be required to pay only variable costs.
Case - Central Electricity Generating Board, UK (CEGB)
High demand - morning & evening
Moderate - throughout rest of the day
Very little - night
Extra power stations for peak load - capacity cost. Stations idle rest of the day and therefore high MC.
Charge different prices.
Group, capacity limitation, price discrimination
Peak load pricing(cont)
CEGB combining peak load pricing and two part tariff
CEGB uses less efficient power stations during peak load hours MC
Capacity Charges to directly recoup costs of building plants and electricity charges on the basis of KWh used. In addition energy charges to cover short run MC of extra plants
1986-87 - Complex structure of energy charges
1.4 pence/KWh at night during weekends
3.8 pence/KWh at breakfast time on week days
Further surcharge of 2.5 pence/KWh (hourly) during heaviest demand.
Case - Computer time and peak load pricing
Usually a computer has only a single CPU but is in constant use. Same facility to provide the service at different periods of time.
CPU time not used is lost forever i.e. service is not storable.
Center may provide same service at different times, late -night service is not desirable.
Prices at university computer facility
Peak load pricing of Computer time
6 AM Noon 6 PM Midnight Midnight CPU Usage After pricing Before pricing Time of Day
A strategy which uses profits made with one product to subsidize sales of another product
Relevant in situations where a firm has cost complementarities and demand for a product independence
Economies of scope - saving in producing jointly or using excess capacity to produce another products
Example - computer & software
It permits the firm to sell multiple products.
If the two products have independent demands, the firm can induce consumers to buy more of each product than they would otherwise.
Pricing strategies in markets with intense price competition
Pricing joint products
Inducing brand loyalty
Reduce price to discourage the entry of new firms- initially enjoy profit and face competition.
Increasing returns to scale provides cost advantages for large firms .
To influence expectations of entrants
To protect margins
Entrants have limited information of market.
Present V/s future prices.
Convince new firms of low cost and charge less.
Give misleading information
Pricing Joint Products
When goods are produced jointly and in fixed proportion, they should be thought of as a ‘product packages’
Price matching A strategy in which a firm advertises a price and promises to ‘match’ any lower price offered by a competitor. Advertisement “ Our price is P. If you find a better price in the market, we will match that price. We will not be undersold.”
Inducing Brand Loyalty
Brand loyal customers will continue to buy a firm’s product even if another firm offers a slightly better price.
To induce brand Loyalty
engage in advertising compaign
A firm varies its prices frequently - hour to hour or day to day
Case - Randomized pricing in the airline industry
There are over 215,396 changes in the airfares each day. This translates into 150 changes per minute. Domestic airlines spend considerable sums of money in an attempt to monitor the prices of another firms. As noted by Marius Schwartz:“Delta airlines assigns 147 employees to track rivals’ prices and select quick responses - on a typical day, comparing over 5,000 industry pricing changes against Delta’s more than 70,000 fares. New fares filed the prior day with Air Traffic Publishing Co. are tracks by Delta computer.
“ Secret” price changes that are deliberately withheld from the Air Traffic Publishing System for several days are tracked through local newspapers or call to other airlines’ reservation offices. Once Delta learns of a competitors pricing more, it can put a matching fare into its reservation system within two hours.
Why do airlines take such drastic measures to learn the prices set by their rivals?
Why do airfares change so frequently?
Source - Marius Schwartz, “the nature and scope of contestable theory” Oxford Economic Papers, 1986, pp. 46-49.