1. 1 Market Structure and Pricing References “Economics” Sloman, J – chapters 2, 6 “International Business” Hill, C W (6th edit., 2007), Chapter 17 “International Business”, Ball, D et. al. (11th edit.), Chapter 18 “International Business”, Morrison, J (2012), Chapter 8, Palgrave McMillan

2. 2 Market Structure According to Porter’s Five Forces model one of the key elements in determining success in either domestic or international markets is the extent of rivalry The level of competition is influenced by the number of substitutes a product has, the possibility of new firms entering the market and the respective power and influence of buyers and sellers This is closely related to the market structure that the firm is operating in – which in turn will differ from industry to industry

3. There are 4 different market structures 1)Perfect Competition – there are many buyers and sellers in the market, the firms make an identical product, they have perfect knowledge about the market and set up costs are negligible 2)Monopolistic Competition – as in perfect competition there are many buyers and sellers and set up costs are negligible meaning new firms can easily enter or leave the market BUT under monopolistic competition the firm sells a differentiated product 3

4. 3)Oligopoly – occurs where a few dominant firms have significant power over pricing and output in the industry The firms operate strategically and they are interdependent i.e. the price or output chosen by one firm will affect the price or output chosen by others Set up costs tend to be relatively high and firms cannot enter/leave the industry easily 4)Monopoly – where one firm produces all the output of an industry and has significant power over pricing 4

5. The market structure of an industry affects pricing, output, advertising, R&D and strategy For example in small scale agriculture farmers tend to be growing near identical crops, there are many small producers and there may be many small buyers Farmers have very little control over the price they can set as this is dictated by the market price – they are said to be price takers This would suggest that they are operating under perfect competition 5

6. How does this example compare to a situation where a few large companies provide gas or electricity to customers? The firms can cooperate or compete through advertising or product differentiation It is expensive to set up competition and the buyers of the service are relatively small compared with the providers This scenario suggests that the firms are operating under oligopoly 6

7. Type of MarketNumber of Firms Entry Barriers Product TypeExamplesDemand Curve Perfect Competition ManyNoneIdenticalAgricultural Products Horizontal Price Taker Monopolistic Competition Many to Several NoneDifferentiatedRestaurants, Small Plumbing Firm etc. Downward Sloping Fairly Elastic OligopolyFew Dominant RestrictedEitherBanking, Supermarkets Cars Downward Sloping Fairly Inelastic Pricing depends on rivals MonopolyOneVery Restricted UniqueDrug Companies, Local Utilities Downward Sloping Very Inelastic Price Setter Comparing Market Structure

8. Price Elasticity of Demand Notice in the above table that the demand curves in each case are different ranging from completely elastic for perfect competition to very inelastic for monopoly Price Elasticity of Demand (PED) is the responsiveness of quantity demanded to a change in price and is found from the formula PED = %ΔQ d %ΔP 8

9. Comparison of Elasticities 9 Inelastic Demand Elastic Demand £100 £80 40 50 20 50

10. In both cases the price increases from £80 to £100 In the first example this results in a decrease in the quantity demanded from 50 to 40 In the second case the quantity falls from 50 to 20 Applying the formula for PED = %ΔQ d %ΔP For the first case the change in quantity is -10 and as a percentage change %ΔQ d = -10/50 x 100% = - 20% 10

11. In the second case the change in quantity is -30 and as a percentage change this is -30/50 x 100% = - 60% Divide through by the percentage change in price %ΔP = 20/80 x 100% = 25% The price elasticity of demand in the first example is -20/25 = -0.8 which is relatively inelastic In the second example it is -60/25 = -2.4 which is relatively elastic over this price range 11

12. This is significant as it affects the price a firm can set for its products Under perfect competition the firm is at the mercy of the market and is faced with fierce competitive pressures Inefficient firms are driven out of the market and price is set at the point where P = MC MC is marginal cost i.e. the extra cost associated with producing ONE more unit of output At P = MC the firm is said to be earning ‘normal’ profits 12

13. The Firm and the Industry in the Long Run under Perfect Competition Industry Output Q P S D Firm AC P Output MC P=MR q The price P charged by the firm is determined by the market in the long run

14. In all other circumstances the individual firm has some influence on the price it charges for its products The only difference here is that the price elasticity of demand will vary – i.e. under monopolistic competition the demand curve is fairly elastic but under oligopoly or monopoly the curve is steeper i.e. more inelastic The firms now set their output where MR = MC or where the extra revenue in producing and selling ONE more unit of the product is the same as the extra cost The following diagram shows how this operates 14

15. AC 1 Profit Maximisation by a Monopolist Profits are maximised where MC = MR P1 is greater than AC1 The firm makes supernormal profits shown by the shaded area Output Price P1P1 Q1Q1 MC AC D = AR MR

16. Pricing Strategies When firms do have some degree of control over prices there are a number of pricing strategies available to them E.g. a monopoly may lower prices when it believes that there is a risk of a new competitor emerging or it could use supernormal profits on advertising Oligopolies are characterised by periods of intense price competition followed by tacit collusion i.e. competing on non-price areas 16

17. Other pricing strategies include:- Penetration pricing – for new products or in new markets where the company sets a low price for a short time until the brand name becomes familiar Market skimming – charging a high price for a time to recoup expenditure on product development Predatory pricing – driving out weaker competitors by undercutting on price until rivals leave the industry Price discrimination – charging a different price in different markets for the same product 17

18. Pricing Strategies in International Markets Many of the same considerations for price setting in domestic markets are also true in international markets There are however some additional issues to address a)Trade barriers can prohibit or restrict access to certain markets b)Lower input prices – e.g. labour or raw materials as well as availability of cheap credit 18

19. c)Increased competition as businesses become multinational corporations – economies of scale are greater at an international level d)In order to stay ahead firms will need to remain innovative and be able to adapt quickly to changing technologies e)Geographical isolation allows price discrimination to take place more easily than in domestic markets – the price elasticities of demand for a product are likely to vary from country to country 19

20. f)Government policy on tax, tariffs, FDI, competition and many other issues will have a major influence on pricing This would include the extent to which the country enforces fair competition through legislation The imposition of anti-dumping measures such as tariffs or quotas The power of lobby groups – e.g. consumer groups, producers, environmental organisations, trade unions, etc. 20

21. g)Transportation costs may be higher for more remote or inaccessible locations even in more developed countries – this would have an impact on competitive advantage h)More extreme differences in tastes and preferences for certain types of goods especially traditional foods or dress i)The possibility of monopolising production via mergers and acquisitions – a more concentrated industrial sector would lead to lower output and higher prices 21

22. Price Discrimination In an international setting price discrimination exists where different countries are charged different prices for the same product In a highly competitive market multinational companies will set prices at a competitive level In a country where the company faces little competition i.e. where it has a monopoly the price will be set at a higher rate 22

23. In order for price discrimination to work three conditions must be met 1)The firm must be a price setter – i.e. not perfect competition 2)The markets must be separable or isolated – i.e. geographically, type of user or by time 3)The demand elasticity must differ between markets When all 3 are present a firm can increase revenues by price discrimination 23

24. Price Discrimination Bangladesh Output (m) 10 20 P £5 D Norway £3 P Output (m) £8 8 10 Charging different prices in the two countries will increase the total revenue earned by the firm £5

25. Norway is relatively inelastic in terms of price elasticity of demand compared to Bangladesh If the firm charges £5 in both markets it will earn a total revenue of £5 x 10 million = £50 million in Norway and £5 x 10 million = £50 million in Bangladesh or £100 million overall If the firm price discriminates it could earn more by increasing prices in Norway and lowering them in Bangladesh In Norway the firm raises its price to £8 and earns £8 x 8 million = £64 million 25

26. In Bangladesh the firm now charges £3 per unit and sells 20 million to earn £3 x 20 million = £60 The firm has increased revenue from £100 million to £124 million If the two markets were not separable then arbitrage would occur and the system would break down i.e. firms would buy the product in Bangladesh for £3 and sell it in Norway for below £8 per unit thus reducing the supernormal profits of the multinational 26

27. Multipoint Pricing This occurs where 2 international companies are competing against each other in at least 2 foreign markets The company’s marketing strategy in one market will have an effect on the its rivals strategy in the other markets i.e. if the company aggressively reduces the price of its product in one market the other firm may do the same in another market where the first firm makes good profits 27