Why do firms compete?
- to increase their customer base
- to increase sales
- to expand market share
- to achieve product superiority
- to enhance image
- to maximise profits
What are the two types of competition?
- price competition (using pricing strategies)
- non-price competition (e.g. new product development, advertisements, prize competitions)
What are the two main types of advertising?
- informative advertising
- persuasive advertising
Why do firms advertise?
- to create consumer wants
- to create powerful brand images and customer loyalties
- to reduce competition
What are the benefits of brand loyalty for a business?
- it leads to repeat purchases
- it protects sales and market share
- customers are willing to pay more for the brand
- customers continue to buy the brand even if the producer increases its price or the prices of rival products fall
What factors influence the price of a product?
- the level and strength of consumer demand
- the amount of competition from rival firms
- the cost of production
- business objectives (maximise profits, increase market share, maximise sales)
What different pricing strategies are there that firms may adopt?
Demand-based:
- price skimming
- penetration pricing
Competitive:
- destruction/predatory pricing
- price leadership
Cost-based:
- cost-plus pricing
What is price skimming?
This is a pricing strategy used when there is little or no competition in a market for a new or improved product. It involves charging a high price to recover development costs and to yield a high initial profit.
What is penetration pricing?
This pricing strategy involves setting a low price for a new product to boost its sales and increase market share in a competitive market.
However, if sales do not increase rapidly, the firm may not be able to survive, or a price war could start with rival firms.
What is destruction pricing? (also known as predatory pricing)
This pricing strategy involves deep price cuts (often below costs) in order to ‘destroy’ the sales of a competitor. If the firm is successful in removing the competition, it can then raise prices again and recover its losses.
This strategy is mostly used by established and dominant firms to deter new competitors who cannot afford such deep price cuts. However, this may result in a price war.
What is price leadership?
This pricing strategy involves firms raising and lowering prices at the same time to avoid a price war. The firm with the largest market share will usually be the price leader.
What is cost-plus pricing?
This pricing strategy involves calculating the average cost per unit and adding a mark-up for profit.
Price = (total cost/total output) + mark-up for profit
However, this takes no account of what consumers may be willing to pay or how much competition there is to supply the market
What is a price war?
Price wars involve deep price cuts bewteen a small group of large competing firms continually trying to undercut each other to attract customers from their rivals.
Define
Market structure
The characteristics of a market, usually on the supply side, including how many firms compete for the market, the degree of competition or collusion between them, the extent of their product differentiation, and the ease with which new firms can enter the market to compete with them.
What is perfect competition?
A theoretical market structure in which there are many firms supplying identical products to an equally large number of consumers such that no individual firm has any influence over market price. All producers and consumers exchange at the equilibrium market price.
All firms in a perfectly competitive market are price takers as they have no power to influence the market price.
Few examples of perfect competition actually exist; this is a concept used by economists as a comparator for all other market structures.
What are the features of a competitve market?
- There will be vigorous price competition and non-price competition between firms
- Firms will pursue different pricing strategies
- Product features and brand images will be highly differentiated
- The range of product designs available and the quality of after-sales services will tend to change frequently
- Market shares and profits of competing businesses will vary over time
- New firms will be able to enter the market and less efficient firms that are unable to compete will be forced to close
What is imperfect competition?
This exists in less than perfectly competitive market structures in which one or more firms have some degree of influence over market supply and prices, usually by each firm differentiating its product from rival products through brand image and marketing.
What is a monopoly?
A monopoly is a single firm or group of firms acting together with sufficient market power to restrict competition and set the market price in order to earn excess/abnormal profits.
Because a monopoly can use its market power to increase the market price, it is known as a price maker.
What different types of monopoly exist?
- Pure monopoly: where one firm is the sole supplier of a product, i.e. it controls 100% of market supply
- Duopoly: where two firms are the primary suppliers of a market
- Oligopoly: where a small group of firms dominate the supply of a product
- Natural monopoly and legal monopoly which are good and encouraged types of monopoly
What is a natural monopoly?
A market structure in which there is a single firm controlling the entire market supply of a product because it has an overwhelming cost advantage over any other potential market structure involving more than one firm.
What are the disadvantages of a monopoly?
- Monopolies restrict competition so there is less consumer choice
- Monopolies may restrict market supply and set higher prices, especially if consumer demand is relatively price inelastic
- Monopolies have little incentive to increase product quality, and may reduce quality to cut costs
- A monopoly may be poorly managed and inefficient because it does not face any competition (x-inefficiency)
- Governments may have to use resources to investigate and punish abuses of market power (e.g. the existence of cartels and price collusion)
What is wasteful competition?
Product duplication or marketing rivalry between competing firms that uses up resources without adding value or creating further sales.
For example, it does not make economic sense to have more than one set of gas or water pipes or electricity cables supplying each house, office or factory in a country.
What is price collusion?
A group of firms acting together to determine or influence the market price of their product through their joint control over market supply.
Price collusion is outlawed in many countries as they arer deemed to be against the public interest.
What is a cartel?
A formal agreement between a group of powerful producers to control the market supply and price of their product.
OPEC (the Organization of the Petroleum Exporting Countries) is one of the most widely known examples of a cartel.
Cartels are outlawed in many countries as they are deemed to be against the public interest.
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Money and Finance40
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Occupations and Earnings27
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The Growth of Firms19
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Competition31
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Government Economic Policy30
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Organisation of Production16
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Social Costs and Benefits12
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Taxation18
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Types of Business Organisation34
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Price inflation24
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The Role of Trade Unions16
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Spending, saving and borrowing24
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International Specialisation and Trade17
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Balancing international payments31
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Employment and unemployment25
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Output and Growth16
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Developed and less-developed economies15
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Population17
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Economic systems1
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How markets work18
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The basic economic problem8
