pricing strategies and contestable markets
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Pricing Strategies and Contestable Markets
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Pricing Strategies and Contestable Markets
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Pricing
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Pricing
• Pricing – How a business approaches its pricing strategies depends on the market structure it operates in
• Pricing can be a means of competing – not only to take customers of rivals but to prevent competition from rivals
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Price Takers• Price takers – have little or no control
over the price they charge• Perfect Competition – P = MR = AR = MC =
AC Firms have to take the price set by the market Large number of sellers – each has small market
share and therefore no control over the market Examples may include agricultural products, some
types of financial product – stocks and shares
• Price Leadership – Dominant firm sets price, rest have to take this price
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Price Leadership
• Price leadership occurs where a dominant firm in an industry in which products are good substitutes is able to set price which others in the industry, on account of their smaller size, will follow
• Examples include: Some commodity markets where there is a dominant seller, the computer software industry (Microsoft), petroleum, some forms of pharmaceutical products
• May tend to exist in ‘micro-markets’ rather than the whole company market – e.g., no real price leadership in cereal market except for Weetabix?
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Price Fixing• Price Fixing – where firm/s fix
prices at levels above equilibrium on account of their market power or through selling/distribution arrangements generally termed collusion. e.g. sports replica kits, children’s toys and games, steel, motor vehicles
• Cartels – Organised price fixing – e.g. OPEC (Organisation of Petroleum Exporting Countries)
• Price fixing is illegal – type in ‘price fixing’ into a search engine to get details of companies and organisations around the world accused of, and convicted of, price fixing!
OPEC Meeting in Vienna – OPEC influences the supply of oil to fix prices
Copyright: Getty Images available from Education Image Gallery
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Price Discrimination
• Charging different prices for the same product or service.
• Necessity of distinctive markets with different price elasticities
• Necessity of being able to prevent movement between the markets
• Examples: train travel – peak time and off peak, electricity charges – off peak metering, telephone calls
Busy times on the trains means a lower price elasticity of demand and a higher price to maximise revenue
Title: Tokyo trains. Copyright: Getty Images available from Education Image Gallery
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RPI minus/plus formulas (Redistribution Pricing)
• Price regime imposed on privatised utilities to help protect the public from monopoly exploitation of essential services (Remember RPI now replaced by the CPI)
• RPI minus – price changes in line with the annual rate of inflation minus a set percentage, e.g. RPI – 4% - if RPI was 3% implies the firm would have to look at cutting prices to consumers by 1%
• RPI plus – imposes maximum price increases, e.g. RPI +2%, if RPI was 2% firm only able to increase prices to customers by max 4%
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Contestable Markets
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Contestable Markets• Theory developed by William J. Baumol,
John Panzar and Robert Willig (1982)• Helped to fill important gaps in market
structure theory• Perfectly contestable market – the
pure form – not common in reality but a benchmark to explain firms’ behaviours
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Contestable Markets
• Key characteristics:– Firms’ behaviour influenced by the threat
of new entrants to the industry– No barriers to entry or exit– No sunk costs– Firms may deliberately limit profits made
to discourage new entrants – entry limit pricing
– Firms may attempt to erect artificial barriers to entry – e.g…
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Contestable Markets• Over capacity – provides
the opportunity to flood the market and drive down price in the event of a threat of entry
• Aggressive marketing and branding strategies to ‘tighten’ up the market
• Potential for predatory or destroyer pricing• Find ways of reducing costs and increasing
efficiency to gain competitive advantage
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Contestable Markets
• ‘Hit and Run’ tactics – enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit)
• Cream-skimming – identifying parts of the market that are high in value added and exploiting those markets
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Contestable Markets
• Examples of markets exhibiting contestability characteristics:– Financial services– Airlines – especially flights
on domestic routes– Computer industry – ISPs, software,
web development– Energy supplies– The postal service?