MICROECONOMICS TOPIC 5 Economics 2013/2014

TYPES OF MARKET

2 MAIN TYPES  Perfect markets: do not exist in the real world  Imperfect markets: do not have any of the characteristics of a perfect market. 4 types:  Monopoly  Oligopoly  Monopolistic competition  Monopsony

PERFECT COMPETITION (MARKET)  Characteristics:  Large number of firms – firms are price takers  Large number of buyers  Freedom of entry and exit  Perfect knowledge  Homogeneous products

MONOPOLY  Only one dominant firm.  The strength of any monopoly is determined by the barriers to entry and the availability of substitutes.  They can charge above the normal price but don’t have a free reign on what they can charge as there will be a limit to what consumers will pay.

 A monopoly that is too powerful may be investigated by the government.  A monopoly is any firm that holds more than 25% of a market.

OLIGOPOLY  The market here is dominated by a few large firms.  Markets that have this structure are soap powder, supermarkets and petrol.  A firm with two dominant firms are called a DUOPOLY.

 Each firm has a branded or differentiated product.  It has a lot of influence in the market and can affect its own and competitors’ market share.  To expand or maintain market share, firms will tend to use non-price methods.  This can include advertising or branding.

 Competing on price can lead to costly price wars which is not good for business.  Firms sometimes in this type of market will collude to fix prices, limit output or share out a market.  This is called a CARTEL.

MONOPOLISTIC COMPETITION  There are a large number of firms but each firm produces a branded or differentiated product.  Each firm has a bit of control over price and its market share.  There are weak barriers to entry.  Examples: restaurants, taxi businesses, hairdressers.

MONOPSONY  This is a market where there is only one buyer.  The buyer has a huge amount of power to dictate price, product, design and delivery.  Supermarkets have a degree of monopsony power over many of their suppliers.

PRODUCT DIFFERENTIATION  This is when suppliers try to create differences between their products and those of the competition.  Real differences include: design and quality  Imaginary differences include: advertising and brand image.

BARRIERS TO ENTRY

 These prevent any potential competitors from getting into an industry.  They can either be deliberate or natural.

DELIBERATE BARRIERS  Marketing Barriers  High spending on advertising can create a strong brand image and loyalty, which new firms will find hard to overcome.  eg washing powder, breakfast cereals

 Restrictive Trade Practices  A strategy that restricts competition Refusing to sell to a retailer who buys from a rival Refusing to sell unless they buy the whole range Using predatory pricing to drive out competition

NATURAL BARRIERS  Capital costs  Entry costs to some industries are very high. Eg car manufacturing.  Sunk costs  These are costs that can’t be recovered if they firm fails. Can include advertising costs or R&D.

 Economies of Scale  Large firms can gain huge economies of scale that new entrants will find hard to compete with as existing firms will have lower average cost.  Legal barriers  The law can prevent new entrants to a market. Examples include: patents and copyrights.

PRICING

PERFECT MARKETS  The price here is determined by the interaction of demand and supply.  Each firm has to accept the equilibrium price for their market.  Each firm is a PRICE TAKER.

IMPERFECT MARKETS  Firms in these markets can adopt a number of strategies.  The decision on what to price is determined by how much competition there is.  Fall into two groups:

COST-BASED PRICING  Cost-plus pricing  Price is set by working out the AC and adding a mark up for profit.  E.g. AC is £1 and mark up is 10% then the price would be £1.10.  Firms with little competition can use this method

 Advantages to Cost-Plus Pricing  It is a very quick and easy method  Ensures sales revenue will cover TC and make the firm profits  Disadvantages of Cost-Plus Pricing  Fixed mark-up could be a problem if new competition was to enter the market

 Contribution (marginal cost) Pricing  Price is set to cover VC.  As long as price more than covers VC a contribution will be made towards FC.  If enough orders are received so that contribution equals FC then the firm will break-even.  If contribution is greater than FC then profit is made

 Advantages of Contribution Pricing  More flexible than cost-plus  Pricing of products can take into account competitors prices and demand by customers  Can be used during poor trading, so long as VC are covered and a contribution is made to FC

CUSTOMER-ORIENTATED PRICING  Competition-based Pricing  When there is strong competition firms may base their price on what other firms in the market are charging.  There may a price leader, who sets their price and the rest of the market follows e.g. petrol

 Penetration Pricing  New entrants will set a price below existing suppliers to gain a foothold in the market  The hope is that consumers will become loyal to the brand and continue to buy when the price is increased.

 Predatory Pricing  Used by existing firms to push out competition from the market.  The firm will lower their prices so that new entrants will not be able to cover its covers.  Existing firm covers its lost by CROSS-SUBSIDISING.

MONOPOLY PRICING  Charging what the market will bear  Suppliers of unique products can charge the highest price they think consumers will pay  Psychological Pricing  Products may be priced above competition to create the idea of better quality.

 Price Skimming  Suppliers of new products may charge a high price to begin with in order to maximise revenues before competitors enter the market.  Price Discrimination  Firms over the same product but over different prices to different types of consumers.