Competitive Markets

Firms compete in the market to increase their customer base, sales and market share and profits.

Price competition involves competing to offer consumers the lowest or best possible prices of a product. Non-price competition is competing on all other features of the product (quality, promotional campaigns, attractive displays, after-sales care, warranty etc) other than price.

Informative advertising involves providing information about the product to consumers. Examples include advertising of phones, computers, home appliances etc.
Persuasive advertising is designed to create a consumer want and persuade them to buy the product to boost sales. Examples include advertisements of perfumes,clothes, chocolates etc.

Pricing Strategies

What can influence the price that producers fix on a product?

  • Level and strength of consumer demand
  • The amount of competition from rival producers in the market
  • The cost of production and the level of profit required

Price skimming: When a new and unique enters the market, it’s producers charge a very high price for it initially as consumers will be willing to pay for the new product. As more competitors launch similar products, producers may lower prices.
Penetration pricing: when producers set a low price which encourages consumers to try the product and expand sales and increase loyalty. This way, the product is able to penetrate a market, especially useful when there are a lot of existing rival products.
Destruction pricing (predatory pricing): where prices are kept very low (lower than the cost of production per unit) in order to ‘destroy’ the sales of existing products, as consumers will turn to the lowest priced products. Once the product is successful, it can raise prices and cover costs.
Price wars happen when competing firms continually trying to undercut each other’s prices.
Cost-plus-pricing: this involves calculating the average cost of producing each unit of output and then adding a mark-up for profit (extra value).
Price = (Total Cost/Total Output) + Mark-up
This is used to cover the cost of production of the products and to generate a profit.

 

Perfect Competition

In a perfectly competitive market, there will be many sellers and many buyers– a lot of different firms compete to supply an identical product to an equally large customer base.
As there is fierce competitions, producers nor consumers cannot influence market price- they are all price takers. If any firm did try to sell at a high price, it would lose customers to competitors. If the price were too low, they may incur a loss. There will also be a huge amount of output in the market.

Advantages: 

  • High consumer sovereignty: consumers will have a wide variety of goods and services to choose from, as many producers will sell similar products. They are also likely to be of high quality, in order to attract consumers.
  • Low prices: as competition is fierce, producers will try and keep prices low to attract customers and increase sales.
  • Efficiency: to keep profits high and lower costs, firms will be very efficient. If they aren’t efficient, they would become less profitable. This will cause them to raise prices which would discourage consumers to buy their product. Inefficiency could also lead to poor quality products.

Disadvantages:

  • Wasteful competition: In order to keep up with other firms, producers will duplicate items. Similar products are sold by many firms; this is considered a waste of resources.
  • Mislead customers: To gain more customers and sales, firms might give false and exaggerated claims about their product, which would disadvantage both customers and competitors.

 

Monopoly

Dominant firms who have market power to restrict competition in the market are called monopolies. In a pure monopoly, there is only a single seller who supplies a good or service. Example: Indian Railways. Since, customers have no other firms to buy from, monopolies can raise prices- that is they are able to influence prices as it will not affect their profitability. These high prices result in monopolies generating excessive or abnormal profits.

Disadvantages:

  • There is less consumer sovereignty: as there are no (or very litte) other firms selling the product, output is low and thus there is little consumer choice.
  • Monopolies may not respond quickly to customer demands.
  • Higher prices
  • Lower quality: as there is little or no competition, monopolies have no incentive to raise quality, as consumers will have to buy it anyway. (But since they make a lot of profit, they may invest a lot in research and development and increase quality)
  • Inefficiency: With high prices, they may create high enough revenue that, costs due to inefficiency won’t create a significant problem in profitability.

Why monopolies are not always bad?

  •  As only a single producer exists, it will produce more output than what individual  firms in a competition do, and thus benefit form economies of scale.
  • They can still face competition from overseas firms.
  • They could sell products at  lower price and high quality if they fear new firms may enter the market in the future.

 

 

 

Notes submitted by Lintha

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7 thoughts on “3.8 – Market Structure

    1. Yes, the Indian government has made plans to allow private players to enter the railways in 2020. But currently, the rail system is entirely under the ambit of GoI

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  1. The content is really nice and well summarized. I usually use the textbook and znotes but from now on I’m gonna use this site only, at least for business studies and economics

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