Pricing strategy varies significantly across different market structures. The pricing guidelines in a monopoly market are relatively straightforward. Since the company is the only producer offering the product, it can mark-up the price as far as the customer can bear. The pricing strategies for a producer operating in a perfect competition structure are also fairly intuitive. They are price takers, and hence price is set at the marginal cost of the product. This is due to the fact that there are many firms offering nearly identical products. However, there is optimal pricing for the market structures offering differentiated products with many competitors (oligopoly) or a few producers (monopolistic competition). These are much more complex and involved. It has been stated that differentiation in products that creates differences in customer valuation is the most prevalent type of competition. In such markets pricing strategies may include the three C’s of cost, competition, and customer.
Develop a paper detailing an analysis of market structures and relating pricing strategies that are suitable for each of these structures. Furthermore, include a real-world example of pricing strategy for a specific company by identifying its market structure.
Solution
Abstract
This paper puts a light on Pricing Strategy and Market Structures. There exist various market structures, for which a firm has to adopt a particular pricing strategy. These different market structures have particular features, which distinguish them from other markets. Also, the size and nature of relevant industry directly affect the structure of a market. For instance, in monopoly and oligopoly industries, the barriers to entry are high, and therefore, the structure of these markets is unique. In contrast, in perfectly competitive and monopolistically competitive industries the barriers to entry are low (non-existent in the case of hypothetical perfectly competitive industry), which give structure to relevant markets.
For a perfectly competitive market, the pricing strategy is to accept the prevailing price, as the firm has no power to influence the market. As the products are identical; therefore, it is easy for the consumers to switch. Also, because of the symmetry of information in the perfectly competitive market and industry, the cost incurred is almost similar. A competitive firm earns zero-profit in the long run, and it can change all its inputs.
In the monopolistically competitive market, there is asymmetry of information, which is why firms that sell differentiated products can earn normal profit. To some extent, monopolistically competitive firms can exert their influence on the market. The demand curve for such market is downward sloping, and pricing strategy is based on the differentiation of the product (quality).
In a monopoly, a single firm dominates the market, and its supply is the supply of the entire market. It produces where Marginal Cost equals Marginal Revenue, and it has a downward sloping curve. Its pricing strategy is based on manipulation of supply.
Oligopoly is a market, which is defined by its high barriers to entry and handful of firms earn zero economic profit in the long run because of mild competition between the firms. The cost incurred by these firms, to produce a product/service is similar; however, to expand consumer base, these companies rely on aggressive advertisement campaign and price reduction. However, they rely more on the former (advertisement campaign), instead of price reduction that leads price war. It is also apparent that markets transform or change their structure, as factors (that gives birth to them) change.
Introduction
Ultimate objective, of any firm, is to swell its revenue and maximize its profit. To achieve this objective, it devises and employs various kinds of strategies, which include pricing strategy. However, in different market structures and industries, a firm has to devise and employ different pricing strategy. In this academic exercise, we will discuss and examine various market structures and pricing strategies.
1-Perfect Competition
Perfect Competition is a hypothetical market, where there are buyers and sellers in large numbers. The sellers sell identical products, and there is symmetry of information in such market (perfect knowledge/complete Information).
1.1-Description
A market is defined and distinguished by its characteristics. This hypothetical market also has several characteristics, which are 1) a large number of buyers, large number of sellers, 3) identical products, 4) symmetry of information, 5) sellers are price takers, 6) Price-Average Revenue-Marginal Revenue-Demand are identical (represented by single curve), 7) free entry and exist and 8) zero economic profit in a long run. It suggests that firms, which operate in such market, earn a similar profit, if not identical. It also suggests that firms have very little power to influence the market and prices that prevail in the market (Askar, 2013).
The characteristic of this market, Free Entry and Exist, suggest that economies of scale are very small for such industry, which encourages a firm to enter easily into a market. It is a known economic fact that as more firms start to enter the market, the revenue, of a firm, starts to dwindle and therefore, the profit starts to reduce.
In the short-run, firms can earn an economic profit, which attracts new firms; however, in the long run, firms earn zero economic profit. Another characteristic is that only in the long run a firm can change its inputs, but in the short-run, it can only change its variable input, which labor.
1.2-Pricing Strategies
Pricing strategy can be understood as a firm’s design or plan to set price while keeping in consideration the prevailing market conditions. As a firm desire to maximize its profit; therefore, the pricing strategy inherently intends to maximize profit, irrespective of market conditions. In case of a perfectively competitive firm, operating in the perfectly competitive market, the ultimate objective, regarding profit, is to earn (at least) zeroes-economic profit (in the long run).
It is imperative to recognize that there are numerous factors, which affect pricing strategy for instance, Customers-Cost-Competition. From the study of this market, we know that the cost of production is similar, if not identical. We also know that this market is highly competitive, which reduces an ability of a firm to influence price. Regarding customers, we know that they have perfect information, which is why it is almost impossible to charge more than the prevailing price. Therefore, a firm takes the price, which is prevalent, irrespective of the cost it incurs in the production of the product or service. It implies that the pricing decision does not determine the pricing strategy, but rather the production decision (Cabral, 2017).
From this discourse/study, we learn that profit, of a firm, maximizes when the marginal cost equals the marginal revenue. At such point, where MR equals the MC, if a firm’s operating cost (variable cost) is less than the price, it will continue to operate. Therefore, the emphasis is on the cost, rather than the pricing strategy, which is why we can say that pricing strategy, of a competitive firm, is price acceptance.
2-Monopolistic competition
The characteristics of this market lie between perfect competition and Monopoly. In some of such markets, characteristics of the perfectly competitive market are stronger and more apparent; whereas in other such markets, the characteristics of monopoly are more visible and stronger (Josheski, Koteski, & Lazarov, 2011).
2.1-Description
The monopolistically competitive market is such market, which has the characteristics of both competitive market and monopoly. These characteristics could be 1) product differentiation, 2) many firms, 3) freedom to exist and entry, 4) independent decision making, 5) to an extensive influence on the market, and 6) asymmetry of information.
One of the prime features, of monopolistic competition, is that firms sell differentiated products. These products are similar, but they are not identical, as in the case of the hypothetical market of the perfectly competitive market. Another feature, of the market, is that there are many firms, as in the case of the perfectly competitive market. It suggests that entry to such market is easy and because of easy penetration into the market, the competition is stiff, which reduces both revenue and profit (Viani, 2003).
However, we learn that in such markets, firms can take independent decisions. However, these firms can take independent decisions to an extent, as drastic changes regarding price and production will have strong outcomes (in a particular direction). For instance, the demand curve of the monopolistically competitive firm is usually downward sloping, but it could also be kinked. The upper part of that kinked demand curve is flat, whereas the lower part of that demand curve is steep. It implies that when a firm increases the price, demand for its product drops evidently; whereas when it drops the price, the demand for its product increases slightly. However, there are some markets, in which quality of the product remains the most influential factor, rather than price. Since the product differentiation primarily defines this market; therefore, it allows the company to influence the market to an extent. For instance, a company that produces a high-quality product can increase the price of its product, after ensuring that taste factor is dominant over price factor (Guangliang, 2006).
Production is determined where Marginal Cost and Marginal Revenue are equal the price is set where it hits the demand curve. The average total cost determines economic profit. Also, the asymmetry of information allows companies to earn unusual profits in the short-run, but in the long run, they earn a normal economic profit. Competition brings down the profit and the ability to manipulate the prices. Consumers have adequate information and companies incur a similar cost for producing the product.
2.2-Pricing Strategies
It is apparent from the discussion that the market is defined by product differentiation and it is the product differentiation, which gives not only a competitive advantage, but also the ability 1) to take independent decisions and 2) exert influence over the market (prices). Therefore, pricing strategy primarily depends upon product differentiation. If a taste factor dominates the market, then to an extent, a firm can experiment with price. However, if the taste or quality factor is not the dominant factor, then the experimenting with price can adversely affect revenues. When taste-factor is not dominant, and the competitors are few, the demand curve is kinked (still down sloped) (Jbdon, 2017).
3-Oligopoly
It is a market structure, where a limited competition exists, and the entire market is dominated a handful of companies. Such markets are not hypothetical, but in fact real. For instance, Internet Service Providers, in the United States, constitute such market. Oligopoly markets have been thoroughly discussed and debated, and it is believed that such markets are detrimental to the economy. It necessitates government intervention, direct or indirect, to address this matter (Guangliang, 2006).
3.1-Description
It is true that such markets are not rare; however, economists still consider oligopoly markets as an anomaly, which requires a certain political-economic condition that facilitates its emergence. This market has a few characteristics, which are 1) an industry dominated by handful firms, 2) these firms are large, and they influence the supply of industry significantly, 3) firms sell identical or differentiated products and 4) there are significant barriers to entry.
There are considerable examples of such markets around the world, where a handful of firms is dominating the market, and there is limited (less intense) competition between them. For instance, in the United States, there are a handful of Internet Service providers in the United States, which can exert their influence to manipulate both supply (speed) and prices. Similarly, there are a handful of smart-phone producers that dominate the smart-phone industry and market (Harris, 1981).
In both examples, about oligopoly, it is apparent that the size of these companies is large. It means that these companies can affect supply and prices. However, the emphasis is not mostly on maintaining the supply to keep prices stable. Oligopoly firms work in collusion (usually informal) to avoid price wars. These firms prefer to take a type of consensus decision regarding the price. However, to increase consumer base, these firms can opt for aggressive advertisements and price reduction (Jbdon, 2017).
In some markets, such as Internet Market, oligopolistic firms sell an identical product; however, in the smart – phone market, oligopolistic firms sell a differentiated product, which allows them to exert more influence on the market and experiment with prices. The economies of scale keep other firms out of the industry, and therefore, few firms dominate the market. It also suggests that firms earn zero economic profit in the long run, as the competition exists (Edlin, 2012).
3.2-Pricing Strategies
The pricing strategy, of an oligopoly firm, can be based on various factors. If firms are producing differentiable products, then the firms’ strategy will be based on the quality of the product. However, if the firms are selling identical products the price-leadership model or aggressive advertisement strategy a firm may opt as a pricing strategy.
However, the reduction in price usually leads to a price war, which only hurts firms and it benefits consumers as it increases consumer surplus because of the decline in prices (Josheski, Koteski, & Lazarov, 2011).
4-Monopoly
In a monopoly market, a single individual/seller, who is selling a specific and unique product in the market that the others aren’t selling, characterizes the market. The seller doesn’t have to face any competition as there is no other company competing close to it. A pure business monopoly consists of a single seller, and that seller would control more than 25% of the entire market, which makes it hard for other competitors to compete. A monopoly could charge the consumer as high as it wants, and dominate the market at the expense of the consumers. The seller in a monopoly could fix his prices, artificial scarcities, and could bend the natural laws of supply and demand. In short, a monopoly is a kind of a business strategy where the product seller is selling is 100 times better than its competition. One of the biggest examples of a monopoly is Google and Microsoft, as they both dominate their markets, and earns high profit from it (Askar, 2013).
4.1-Description
In a business monopoly market, a seller would require a government license, copyrights, patent, and ownership of resources and high starting cost, which in return would make him the sole owner of those goods restricting other sellers competing in the same market (Viani, 2003). Monopolies have certain knowledge that is not made available to other sellers in the market, which helps the seller become the only entity and price maker. The seller enjoys full power over his market. The U.S District Court declared Microsoft, in 1998 as it had the controlling position over other operating systems for computers. Microsoft had so much power that it intimated other suppliers like Intel, IBM, and Apple from crossing Microsoft’s superior technology. The U.S District Court made Microsoft share information regarding their technology, which led other competitors to develop more innovative products using the Windows. On the other hand, Google also holds monopoly and power over the internet search market. Most people prefer using Google for searching things across the internet, the closest competitor in the recent years has only been Microsoft’s BING, and Yahoo search, which makes up 34% total searches combined. However, despite that, Google controls over 80% of all the search advertisements, and Google owns the Android operating system across most of the smart phones today. Google has managed to buy every major platform; there is slow (Edlin, 2012).
4.2-Pricing Strategies
In a monopoly, the company can create a pricing strategy to gain maximum profit. The market price in a monopoly is set by the demand of the consumers. The company could set the highest price, and still manage to sell their products. As in a monopoly, the seller has an advantage over other companies in holding maximum power, which lets them set high prices, as the consumer would not get anything better than the product offered even at a lower price, such as there is no substitute for electricity. In a monopoly, the seller has to keep three important things in mind to engage in successful and profitable price discrimination. First, the company must be the dominant one in the market. Secondly, the seller must know how much the customers are willing to pay, and thirdly the firm must be able to prevent reselling of their products (Harris, 1981)
5-Case Study
There are several examples of Monopolistic competition and oligopoly. There is one example, which fits both oligopoly and monopolistic competition. It is the example of Pepsi and Coca-Cola. A couple of decades ago, Pepsi and Coca-Cola competed in an oligopoly market, where they sold almost identical products at a similar rate. To increase their revenue, both companies opted aggressive advertisement campaign, which aimed to increase the consumer base. Both companies did not reduce the price to increase the consumer base, as it could have triggered a price war. Therefore, companies relied on aggressive advertisement campaigns. As the economies of scale dropped of this industry, more companies entered (barriers to entry softened), which transformed its industry/market structure for monopolistic competition. It made very difficult for the firms to change the price, as it kinked demand curve (Jbdon, 2017).
Another example, of oligopoly, is Internet Service Providers in the United States. There are a handful of companies, which are providing internet services. These firms can affect the price by manipulating supply; however, because of certain regulations, they cannot exploit their advantages fully. However, they still influence the market in very subtle ways.
An example of perfect competition is few and by no means is they perfect. These examples come from the agriculture market, where producers sell similar products at a certain price (agriculture product price change very little over the time). Also, these markets are few, and there is almost perfect information about it (Cabral, 2017).
Electric Power Transmission and Defense are examples of Monopoly. However, these are government authorized monopoly. There are some examples of monopoly, one of which is Microsoft’s monopoly that was systematically dismantled by the government after the court decision.
6-Conclusion
In the end, it is concluded that most of these market structures, such oligopoly-Monopolistic Competition-Monopoly, exist in reality and there are numerous examples of them. However, a perfectly competitive market is a hypothetical market, which existence is extremely rare and if it exists, it exists for a very short span of time. For instance, we can consider a typical agriculture product market a perfectly competitive market. As this market is small; therefore, there is symmetry of information. Also, producers of agriculture products (of particular locality) sell similar products, if not identical (no product differentiation), which is another characteristic of the perfectly competitive market. Furthermore, there are no barriers to entry and exit, which is a feature of the perfectly competitive market.
In this discourse, we have thoroughly examined different types of markets, and we identified different features or characteristics of different markets. From the study, we learned that some markets have the market structure, which is a blend of two different market structures. For instance, the monopolistic competition has features of both competitive market and monopoly. We also learned that monopolistic market structure is the most common of all the structures and there are numerous examples of monopolistic competition. The fewest of all the market structures were Monopoly and Oligopoly. We discussed and studied these market structures with examples.
What was most striking was that markets transform as time progresses. For instance, the product of Coca-Cola Company had a monopoly (almost) in the market; however, because of the introduction of Pepsi and similar products, the market transformed into Oligarchy. As the economies of scale dropped, the barriers to entry softened, which transformed the industry/market into a monopolistically competitive industry/market.
The structure of a market provides very crucial information regarding both sellers and buyers. For instance, we know that in a monopoly, the producer surplus is usually greater than consumer surplus. In the monopolistically competitive market, price strategies opt with great care and it’s essential to learn whether taste is a dominant factor or price.
7-References
Askar, S. S. (2013). On complex dynamics of monopoly market. Economic Modelling, 31(1), 586-589.
Cabral, L. M. (2017). Introduction to Industrial Organization. Cambridge: MIT Press.
Edlin, A. S. (2012). The role of switching costs in antitrust analysis: a comparison of Microsoft and Google. Yale Journal of Law and Technology, 15(12), 169-213.
Guangliang, Y. (2006). Four essays on regulating market power: I. Mixed oligopoly and spatial price discrimination. II. Delegation, welfare and privatization in a mixed oligopoly. III. Endogenous timing in a mixed oligopoly with both a domestic and a foreign private firm. IV. T. The University of Wisconsin, 4(7), 1-88.
Harris, M. a. (1981). A theory of monopoly pricing schemes with demand uncertainty. The American Economic Review 71.3, 71(3), 347-365.
Jbdon. (2017, December 31). Pricing under monopolistic and oligopolistic competition. Retrieved from http://www.jbdon.com/pricing-under-monopolistic-and-oligopolistic-competition.html
Josheski, D., Koteski, C., & Lazarov, D. (2011). Monopolistic competition: Critical evaluation the theory of monopolistic competition with specific reference to the seminal 1977 paper by Dixit and Stiglitz. Munich Personal RePEc Archive, 1-18.
Viani, B. E. (2003). Why do governments award monopoly rights to privatized telephone firms and what are the consequences? E-Library, 17(6), 1890-1890.
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