Market Structure and Pricing

1. Market Structure and Pricing

3. 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

4. Market Structures • Type of market structure influences how a firm behaves: • Pricing • Supply • Barriers to Entry • Efficiency • Competition

5. Market Structures • Degree of competition in the industry • High levels of competition – Perfect competition • Limited competition – Monopoly • Degrees of competition in between

6. Market Structure • Determinants of market structure • Freedom of entry and exit • Nature of the product – homogenous (identical), differentiated? • Control over supply/output • Control over price • Barriers to entry (by laws or cost of entry)

7. 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.

8. 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.

9. Price takers: Perfect competition • 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.

10. 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.

11. 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

12. 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

13. 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

14. Oligopoly • An oligopoly is a market dominated by a few large firms. • Ex. AIS; DTAC; True

15. 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.

16. 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 b c D

17. 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.

18. Kinked demand curve • 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

19. 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

20. 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

21. Market types

22. 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

23. 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 over-capacity 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.

24. The End