econ theme 4

• Market structures


  Characteristics that differ between markets
• Characteristics that differ between markets

  • Number of producers
  • Concentration ratio
  • Barriers to entry
  • Product differentiation
  • Price taker or price maker
  • Knowledge

  
• Perfect competition


  • Firms are price takers
  • Consumers have perfect knowledge of all prices
  • No product differentiation

  
• In the short run, perfectly competitive firms can make large profits or losses


  But in the long run the market will always gravitate back to normal levels of profit
• Perfect competition is a model that is not seen in reality
• Monopolistic competition


  • Firms are to some degree 'price makers'
  • Downwards sloping demand curve
  • Relatively elastic price elasticity of demand
  • Firms can only make a loss or high levels of profits in the short run
• Oligopoly


  • A small number of businesses dominate the market
• Monopoly


  • Existence of just one producer in the whole industry
  • Barriers to entry are high
  • Firms are price-makers
  • Consumers have very inelastic price elasticity of demand
• Costs and benefits of monopolies

  • Monopolies can reinvest supernormal profits into risky business investments
  • Monopolies are generally large enough to compete with global companies
  • Supernormal profits can be reinvested into becoming more efficient and competitive
  • Monopolies can take advantage of economies of scale
  • Supernormal profits can make the incentive to improve efficiency redundant
  • Supernormal profits can be used to protect high market power and reduce competition
  • Monopolies generally charge higher prices and reduce supply
  • Monopolies may use price discrimination
  • Monopolies are inefficient as they do not produce where average costs are lowest and misallocate resources

  
• Competitive pricing


  One company is the price leader, setting the amount that all other businesses will charge
• Loss leader


  Pricing a product below its actual cost as a way to encourage customers to shop for other goods
• Price discrimination


  Charging different prices to different customers for the same product or service
• Businesses are more likely to use competitive pricing when the markets they sell to are highly competitive
• Highly competitive markets


  Customers have bargaining power and may react differently to different products/services depending on their prices
• Market Types


  • Perfect competition
  • Monopolistic competition
  • Oligopoly
  • Monopoly

  
• Perfect competition


  • Eggs and milk on the high street, companies can only differentiate through price as consumers do not see any difference between brands
  • Businesses may choose psychological pricing to convince customers of best value
  • Competitive pricing is prevalent, with one company as the price leader
  • Some firms may use loss leader pricing, selling below cost to encourage customers to buy other goods
• Monopolistic competition


  • Restaurants on a high street, vying for the same customers but selling different goods/services
  • Firms may use price discrimination, e.g. charging less for 'early bird specials'
  • Firms have a monopoly on the particular service they provide
• Oligopoly


  • Manufacturers of video game consoles, a small number of businesses control most of the market
  • Firms are interdependent and have to follow each other's pricing
  • Firms may collude to set prices together
  • Firms may use price-skimming, charging higher prices on new product releases
• Monopoly


  • One company has majority control of a market, e.g. Microsoft in 1980s/1990s
  • Firm may use predatory pricing to destroy competition
  • Firm may use cost-plus pricing, decreasing production costs and offering attractive prices
• Non-price competition


  Businesses employ strategies when faced with imperfect competition, competing by offering different products/services and demonstrating unique selling points
• Marketing methods


  • Public relations
  • Direct marketing
  • Personal selling
  • Advertising
  • Sponsorship
  • Digital communications
  • Sales promotions
  • Branding
  • Rebranding
• Distribution


  Businesses can compete on distribution terms, offering the safest, cheapest, most reliable and/or most convenient form of distribution
• Differentiation


  How different a product appears compared to competitors, allows firms to charge a premium without losing sales
• Types of unique selling points (USPs)

  • Design
  • After-sales service
  • Unique features
  • Distribution
  • Quality
  • Durability
• Barriers to entry


  • Product differentiation
  • Branding
  • Start-up costs
  • Intellectual property rights
  • Research and development (R&D) and technology change
• Impact of barriers to entry on market structure

  Low barriers = high competition, perfect/monopolistic competition

  High barriers = low competition, oligopoly/monopoly
• Contestable markets


  • Markets with low barriers to entry and exit, firms can 'come and go as they please'
  • Firms behave as if perfectly competitive to avoid profit fluctuations

  
• Economies of scale


  Opportunities that arise from growth, allowing firms to cut costs and reduce prices, presenting a barrier to entry for new firms
• Types of internal economies of scale

  • Technical
  • Marketing
  • Risk-bearing
• Concentration ratio


  The total market share of the top few firms in an industry, indicates the level of competition
• 1. firm concentration ratio


  The share of the market controlled by the top N firms in the market
• The three-firm concentration ratio for the UK supermarket industry in 2014 was 64%
• The four-firm concentration ratio for the UK supermarket industry in 2014 was 75%
• Oligopolistic market structure


  • Highly concentrated market
  • Firms are interdependent and cannot make decisions on price independently
  • Firms tend to cooperate, either openly or tacitly, to ensure they are able to charge a high price
  • Fierce non-price competition including product differentiation, offers and marketing

  
• Tacit (implicit) agreements


  When firms do not want to engage in competitive behaviour and so behave uncompetitively, without a formal agreement or mention
• Tacit collusion is hard to detect because it is hard to identify and prove firms are price fixing
• One firm cuts costs and cuts prices

  Other firms are likely to also cut prices to avoid a 'price war'
• Price discrimination


  Firms charge different prices to different consumers based on their willingness and ability to pay
• Conditions for price discrimination


  • Market power
  • Information to identify groups with differing willingness and elasticities
  • Limited ability for consumers to resell

  
• Costs and benefits of third degree price discrimination

  • Producers: Gain more revenue, may enable firms to remain in market or invest in R&D; Producer surplus can be increased; Costs of administration and enforcement
  • Consumers: Some benefit from lower prices, some face higher prices; Consumer surplus minimised and turned to producer surplus