Pricing strategies for market structures
1. Perfect Competition
1.2. Pricing Strategies
2. Monopolistic competition
2.2. Pricing Strategies
3.2. Pricing Strategies
4.2. Pricing Strategies
5. Case Study
This paper sets out to explain the different type of market structures. These are perfect competition, monopolistic competition, monopoly and oligopoly. This paper gives descriptions of these marketing structures and how the pricing strategies are influenced by the market structures. The paper describes the number of firms in the market structure, the products involved and the barriers to entry and exit into the market.
The different market structures have different pricing strategies because of their nature. However, some of these pricing strategies may be similar thus applicable by more than one market structure. The paper will then identify a real world example to show the relationship between the market structures and pricing strategies.
A case study will later be provided as evidence of the relationship between pricing strategies and market structure. Finally, the paper will provide a conclusion that the pricing strategies indeed do relate to market structures.
Market structures do define the type of market in which a firm or business operates. This helps the companies in the market structure to define its pricing strategies thus ensuring that the firms operate at give costs and at the same time make a normal profit.
1. PERFECT COMPETITION
The following are the characteristics of a perfect competition market structure:
1.2 PRICING STRATEGIES
- The market consists of many sellers selling standardized products. There are many buyers of these products. The number of firms involved is large.
- The share of total output sold in the market is small.
- Firms in this market structure can easily respond to changing conditions because of availability of information about prices, technology and profit opportunities.
- Competitors are not a threat in this structure because competitors’ production decisions do not affect the other firms. This is because the decision of a single seller cannot affect the price in the market (William & Allan, 2011 )
- Minimal barriers to entry and exit into the market and out of the market by sellers. Firms can easily sell into the market and can choose to leave the market at any time.
The firms in this market are price takers. It is only demand and supply that do affect the prices hence no business can control the market shares. Optimality of pricing is achieved when the market is at its equilibrium, which is demand becomes equal to supply. This makes it impossible for a single seller to influence the price of products.
In the real world, this type of market structure does not fully exist. However, there are some businesses that are near to perfect competition market structure. For instance the agricultural market. Farmers produce similar types of vegetables and fruits that are made available in the groceries for sale. The buyers also have a substitute to plant their own vegetables and fruits. Some of these fruits and farm products are seasonal because they do not exist throughout the year. This will affect the price at which buyers are willing to pay to have the products. The buyers are aware of the prices of the products because the prices are tagged in the groceries. If a buyer does not want to buy products from one seller, hey move to the next seller.
When supply is high, prices tend to be low because the farmers want to get rid of excess inventory. On the other hand, when supply is low, prices tend to be high hence both the sellers and the buyers have to adapt to current prices.
2. MONOPOLISTIC COMPETITION
These firms have features of a perfect competition and a monopoly. The firms here enjoy monopoly power because they can control prices of their products. Each firm is the sole supplier of its own particular and unique product. The products in this market structure are differentiated.
Each product is sold by many firms making the structure to be perfect competition market structure. There are also minimal or non-existent entry and exit barriers. Freedom of entry and exit is high in this market structure.
There are relatively large number of firms who supply to a small market share of market demand the general type of products by the firms and rivals. Each firm produces one variety of products. Substitutes do exist in this market structure because buyers would switch to other products if prices were increase by one firm. These substitutes are imperfect.
However, entry is not as easy because new sellers with new brands or new services often have difficulty in establishing their reputations.
2.2 PRICING STRATEGIES
The producing company determines the pricing strategy in this market structure. Monopoly power makes it possible for them to make their own prices. This enables the companies under this market structures to produce the quantity of the products they want without having any effect on the market. Pricing strategies of these companies take the form of short run and long run approaches which involve heavy marketing campaigns to maintain the market share. “As such, the company will attempt to develop a difference in their product by using customer segments, branding, advertising, and personal selling to set their product apart from other similar but different products.” (Pricing chapter 9)
An example in this is the tooth paste industry. The toothpaste companies differentiate their products through since physical alteration of the composition of products. Special packages are used so as to claim superiority of products. This is based on their brand images and intense advertising
This is a market structure where few sellers of between two to ten dominate the sales of a product accounting for half or more of the sales. Some of these firms have a large market share than the other firms.. The products sold in the oligopolistic markets are either differentiated or standardized. Examples of differentiated goods in the oligopolistic market structure include cigarettes, beer and automobiles. Standardized products include aluminum.
Oligopolies are protected by barriers to entry making it impossible or difficult for new sellers to enter into the market. These barriers include natural oligopoly. This exists where a few firms can supply the entire market output at lower long run average costs than many firms. Other barriers include government licenses and regulations.
3.2 PRICING STRATEGIES
The pricing strategies of these companies are interdependent on the actions of another company. The companies are highly sensitive to the changes in the price of their competitors thus the prices are determined by competitors. This makes the companies to always revise their prices and adjust them from time to time so as to gain competitive advantage. This makes the companies to sell their products at competitive low prices. This is advantageous to the consumers even if it is not profitable to the company.
The companies only affect the market but have no ability to control prices. The main focus of firms in this type of market structure is on competitive structures such as product differentiation, provision of services and advertising. They do don focus on price wars. Their pricing strategies are often based on collusion, market manipulation and end game strategy. Game theory seeks to explain the nature of oligopolies and their pricing strategies. The firms closely monitor each other’s prices so as to adjust accordingly. ” For instance, if one company was to lower the price of their product and the other companies selling the same product don’t lower theirs, the company that lowered their price will obviously increase its sales over the others.” (“Jbdon: Aspiring to,”)
An example of an oligopoly is Coca-Cola Company which is the leading manufacturer of soft drinks. Coca-Cola’s strategy ever since its existence in 1886 was to be the best seller of quality branded beverages. Today Coca-Cola sells over 500 brands to more than 200 companies worldwide. Pepsi is Coca-Cola’s competitor and this makes them a duopoly selling homogenous soft drinks. Coca-Cola Company pays great attention to kinked demand because this company depends on the demand curve so as to control its prices.
The duopoly enables Coca-Cola to use low price strategy so as to maximize profits. During holidays, they reduce the price of their products so as to maximize sales and increase their profits. “To attract more customers, Coca-Cola uses cut-throat competition to outdo its main competitor: Pepsi. After driving out the competitors, Coca-Cola raises its prices back to the normal price” (Henry, 2012) .The lower prices act as a barrier to enter into the market because it discourages new sellers from entering into the market. Coca-Cola has signed a cartel contract with Pepsi so as to avoid losing their market to new or potential competitors. This type of duopoly acts as monopoly in the soft drinks industry.
The word monopoly is derived from the Greek words ‘mono’ meaning one and ‘polein’ meaning seller. Therefore, this structure exists when an industry contains only one single seller of a product with no close substitutes. This is more common in local markets than in national markets.
Barriers to entry include:
Natural monopoly- this is where a firm is capable of driving out competitors because of economies of scale involved due to lower production costs.
Governmental license and franchise grants a single-seller status to firms. This is evidenced in the transport sector, communication sector and essential public utilities such as electric power.
Patents or copyrights provide monopoly powers. However, these provide monopoly for a limited period of time or limited number of years.
Ownership of the entire supply of a resource or unique ability and knowledge gives a company or individual monopoly.
A firm may also be able to erect barriers against competitors seeking to enter into the market.
4.2 PRICING STRATEGIES
Monopolies are price makers. They set their own prices but they are regulated by the government. Their main aim is profit maximization and to eliminate other industries from entry into the market.
The markets are divided into two or more segments. Different prices are then offered to different classes of buyers. This strategy requires control between the segments to ensure that there is no possible leakage.
Different prices are charged on the same products and to the same consumer. Prices of the first blocks are higher and fewer charges are imposed on the second block produced.This pricing also entails higher transaction cost for the seller.
Perfect price discrimination
Under this pricing strategy, the monopolist charges a different price for each excessive unit bought by each consumer.
An example is electricity supplier. These are the only companies that do exist in the country. They sell the first blocks of their electricity at higher price and charge the second unit at lower prices. This also leads to price discrimination.
5. CASE STUDY
There are many different sellers of personal computers selling hardware components. This makes the demand of these computers to be highly elastic. Thus we can say that personal computers are in the perfect competition type of market structure. The existence of many different sellers leads to low barriers of entry. This makes it possible to easily penetrate the market. The sellers are therefore said to be price takers.
As we know, the personal computers need software parts for them to operate. This is what makes a great difference in the market structure of personal computers. These have different operating systems. The main operating system is the Microsoft windows which include windows 7, windows 8 and so on. Other operating systems are the Apple’s IOS and Linux.
Those personal computers that sell windows compete among themselves. The personal computers using Apple’s IOS and Linux have largely differentiated their products. Therefore this makes them to be in a monopolistic competition rather than perfect competition. The monopolistic market structure makes them to make their own prices. This makes the personal computers that use Apple’s IOS and Linux to charge higher prices for their products as compared to lower prices of personal computers using the windows operating system.
Interestingly, personal computers have three types of market structures. These are: perfect competition, monopolistic competition and oligopolies. Personal computers thus have subsets for elasticity of demand. The demand for personal computers by consumers from manufacturers is highly elastic whereas demand to suppliers from manufacturers is said to be inelastic. Prices are based on elasticity of demand for each given market structure.
Elasticity of demand in a market structure affects the pricing strategy. In perfect competition, there are many sellers hence making companies in this structure to be price takers because they have no control over prices. In monopolistic competition, demand is less elastic because of product differentiation hence enable the firms to have control over prices. In oligopoly, demand is inelastic because there are fewer firms hence interdependence of pricing strategy. A monopoly only consists of one firm with no substitutes making the firms to be price makers. Irrespective of the market structure, the pricing strategy of a firm should be to maximize total profits.
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