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Economies and Markets T6 Price and Non-price competition


Economies Markets and Decision Making in International Contexts
Professor David Pickernell
Topic 6 : Price and Non-price Competition

? University of South Wales

The Price Mechanism and Individual Firm’s Output Decisions : Cost and Revenue Curves Combined
? For any output level, we assume the firm attempts to minimize costs (simplification) ? Assume the firm aims to maximize profits ? Profits depend on both COSTS and REVENUE ? each of which varies with the level of output ? Marginal cost (MC) is the rise in total cost if output increases by 1 unit. ? Marginal revenue (MR) is the rise in total revenue if output increases by 1 unit

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2 1.2

choosing output COSTS
Technology & costs of hiring factors of production

REVENUES
Demand curve

TC curves (short & long run)

AC (short & long run) CHECK: produce in SR? close down in LR?

AR

MC
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Choose output level
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MR
3 1.3

maximizing profits : 1 find the output
If MR > MC, an increase in output will increase profits. If MR < MC, a decrease in output will increase profits. So profits are maximized when MR = MC at q* (so long as the firm covers variable costs)
Output
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MC, MR

MC

E MR

0
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q*

profit maximization 2 : compare revenue and cost (AR and AC)
? Profits are maximized where MC = MR at Q1P1. In this position, AR is greater than AC AC so the firm makes profits above the opportunity cost of capital
shown by the shaded area

MC

P1
AC1

MC=MR

MR

D = AR Output
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Q1
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5 1.5

Firm’s Shut down point : Short and Long Run
?

? Between P1 and P3, (A and C), the firm makes short-run losses, but remains in the market

SMC
SATC

? Below P1 (the SHUT-DOWN PRICE), the firm fails to cover SAVC, and exits ? In long run firm must cover ALL costs P must equal long run AC

P3 P1

C A

SAVC

Q1 Q3 Output
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Qualifications : costs and the economist
? Accounting cost
? actual payments made by a firm in a period

? Opportunity cost
? amount lost by not using a resource in its best alternative use

? Supernormal profit
? profit over and above the return earned at the market rate of interest

? Economists include opportunity cost in a firm’s total costs

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Real World Selling
? In the real world firms don’t sell only on the basis of price, but also quality, technology, service, etc. ? So advertising and branding are also issues ? How important these are, and firms’ strategies also depends on Market Structure

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8 1.8

market structure
? An industry is the set of all firms making the same product ? The market structure is a description of the behaviour of buyers and sellers in that market. ? Issues of importance include :? Numbers of firms ? Ability to affect price ? Entry barriers

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9 1.9

market structure
Number Ability to Entry Example of firms affect barriers price Perfect competition Imperfect competition: Monopolistic competition Oligopoly Monopoly Many Few One Small Medium Large None Some Huge Corner shop Cars Post Office Many Nil None Fruit stall

3.10

perfect competition
Characteristics of a perfect competition market
? many buyers and sellers
? so no individual believes that their own action can affect market price

? firms take price as given
? so face a horizontal demand curve

? the product is homogeneous ? perfect customer information ? free entry and exit of firms

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11 1.11

the marginal firm in long-run equilibrium
Firm ? SMC ? SAC P* D=MR=AR D q* INDUSTRY

SRSS
LRSS

P*

Output

Q

Output

The market settles in long-run equilibrium when the marginal firm just makes normal profit by setting LMC=MR at the minimum point of LAC. Long-run industry supply is relatively flat.
3.12

monopoly
? A monopolist:
? is the sole supplier of an industry’s product
? and the only potential supplier

? is protected by some form of barrier to entry ? faces the market demand curve directly ? Unlike under perfect competition, MR is always below AR.

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13 1.13

profit maximization by a monopolist
Profits are maximized where MC = MR at Q1P1. MC In this position, AR is greater than AC so the firm makes profits above the opportunity cost of capital

?

AC P1 AC1

MC=MR

MR
Q1

D = AR Output

shown by the shaded area
Entry barriers prevent new firms joining the industry.
3.14

comparing monopoly with perfect competition
? Monopoly compared with perfect competition implies: ? higher price ? lower output

? Does the consumer always lose from monopoly? ? Among other things, this depends on whether the monopolist faces the same cost structure ? there may be the possibility of economies of scale.

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15 1.15

most markets fall between the two extremes of monopoly and perfect competition
? An imperfectly competitive firm
? would like to sell more at the going price ? faces a downward-sloping demand curve ? recognises its output price depends on the quantity of goods produced and sold

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16 1.16

imperfect competition
? Monopolistic competition
? there are many sellers producing products that are close substitutes for one another ? no barriers to entry ? product differentiation ? so the firm faces a downward-sloping demand curve ? The absence of entry barriers means that profits are competed away... ? an industry with a few producers ? each recognizing that its own price depends both on its own actions and those of its rivals.
17 1.17

? An oligopoly

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Oligopoly in more detail
? A market with a few sellers ? The essence of an oligopolistic industry is the need for each firm to consider how its own actions affect the decisions of its relatively few competitors. ? Oligopoly may be characterized by collusion or by non-co-operation

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18 1.18

collusion and cartels
? COLLUSION
? an explicit or implicit agreement between existing firms to avoid or limit competition with one another

? CARTEL
? is a situation in which formal agreements between firms are legally permitted
?e.g. OPEC

3.19

the kinked demand curve
Consider how a firm may perceive its demand curve under oligopoly.

?

P0

It can observe the current price and output,

but must try to anticipate rival reactions to any price change.

Q0

Quantity
3.20

the kinked demand curve (continued)
? The firm may expect rivals to respond if it reduces its price, as this will be seen as an aggressive move

P0
… so demand in response to a price reduction is likely to be relatively inelastic

D Q0

The demand curve will be steep below P0.

Quantity
3.21

the kinked demand curve (continued)
? …but for a price increase rivals are less likely to react,

P0

so demand may be relatively elastic above P0 so the firm perceives that it faces a kinked demand curve.

D Q0

Quantity
3.22

the kinked demand curve (continued)
? Given this perception, the firm sees that revenue will fall whether price is increased or decreased, so the best strategy is to keep price at P0. Price will tend to be stable, even in the face of an increase in marginal cost.

P0

D Q0

Quantity
3.23

Oligopoly: The importance of Non price competition
? Because of the difficulties in using price to compete, non price competition is very important in oligopoly
? ? ? ? ? ? Quality Service Technology Design Brand (including brand extension) Diversification (by product and market)

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24 1.24

Activity 1

Group Activity : Explore examples of the four types of market structure

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25

Topic 7 : Tasks
Examine price and non-price competition in the following markets ? Transport, ? Electronics, ? Telecommunications, ? Insurance, ? Supermarkets. Use specific company examples

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26


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