4.1.1 Spectrum of Competition

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    FEATURES OF PERFECT COMPETITION

    • Large numbers of small firms
    • Easy for new firms to enter the market
    • All products are homogeneous (identical)
    • Firms are price-takers and have no monopoly power must accept market price and decide on output
    • No individual producers can influence the market price as it is set by the intersection of demand and supply
    • Strong price competition so minimal (normal) profit made
    • There is perfect information, which means that new products and innovations can be copied quickly by other firms.
    • Also, firms cannot charge more than competitors as consumers will know and will find substitutes
    • Sometimes artificial differentiation is used to create a different perception of identical products
    • Price competition is used often, with profits being competed away by other firms

     

    Artificial differentiation – when identical products are perceived differently due to advertising, branding and celebrity endorsement. This creates the belief that products are different when they are identical.

    Perfect competition:

    • Keeps market prices low
    • Increases efficiency (as profits will drop otherwise)
    • Means businesses with high costs and prices will not survive

    Entering a perfectly competitive market and setting up should be easy for new firms as there are no barriers to entry and is the economic ideal.

    Imperfect competition – any market structure that is not perfect competition

     

    FEATURES OF MONOPOLISTIC COMPETITION

    • Large number of firms
    • Easy for new firms to join as no barriers to entry
    • Some differentiation between products
    • Lots of close substitutes
    • Firms have some control over prices due to this slight differentiation
    • Will compete through non-price competition
    • Small amount of market power that is the same as other firms

     

    FEATURES OF OLIGOPOLY

    • A few dominant firms and some smaller ones are in the market
    • High barriers to entry, and smaller firms usually struggle due to the big brands present
    • Firms are interdependent in an oligopoly, as the actions of one will affect another
    • They are price-setters and have a high amount of market power each
    • Product differentiation and non-price competition are used to compete against other firms

     

    FEATURES OF MONOPOLY

    • Single supplier in a market (pure monopoly)
    • Product has no clear substitutes
    • Significant barriers, often imposed by the dominant firm
    • They are also price-setters and choose to control either price or output
    • Often make supernormal/ abnormal profits in both short and long term

     

    Pure monopoly:

    • One supplier has 100% market share
    • No competition

     

    Legal monopoly

    • One supplier has 25% or more of the market

     

    Natural monopoly

    • Occurs when it is more efficient to have only one supplier
    • More than one supplier would involve wasteful duplication of resourcese. the National Grid

     

     

    PROBLEMS OF MONOPOLY

    • High prices (for customers)
    • Often poor quality good/service
    • No incentive to innovate
    • Less customer choice
    • Could restrict output by raising price
    • Often inefficient
    • High barriers to entry e.g. duplication of infrastructure in National Grid

     

    Monopoly/ market power – the amount of control that a firm has over the price

     

    Monopoly power can be affected by the following factors:

    • Barriers to entry
    • of competitors
    • Advertising
    • Degree of product differentiation

     

    HOW DOES PERFECT COMPETITION HELP EXPLAIN HOW MARKETS WORK?

     

    Perfect competition can be used as an ideal as it demonstrates high levels of economic efficiency and how the market forces of demand and supply interact with no other factors coming into play.

     

    PRICING STRATEGIES

     

    Cost plus – Cost of raw materials + mark up of a fixed profit margin

     

    Price skimming – This is a short-term pricing strategy which is used when the product has                             little or no competition, so a high price is set in the short term

     

    Penetration – Initially setting a low price to enter the market and encourages customers to buy. Once customer loyalty is earned, prices will increase

     

    Predatory pricing – This is when one firm sets prices low, taking losses to drive other firms out of business as they cannot take such losses. They will then raise                                             prices once the other firms have gone out of business

     

    Competitive pricing – Prices are based on the prices of competitors and is used when products are similar.

     

    Psychological – This is a pricing strategy which uses the emotional reactions to prices e.g. a                       good might be priced at 99p rather than £1, and since the 99p seems a lot cheaper, consumers might be more inclined to purchase the good.

     

    Different market structures will choose to use different pricing strategies due to the features of their market they can manipulate, this along with the other features of the market structures are shown in the table below:

    Non-price competition – when businesses compete on aspects of the product rather than                                               price e.g. quality, design, advertising.

     

    Through using non-price competition, products can become more desirable for customers and suits their wants more closely. This can increase demand for the product and also make it more price inelastic if it increases customer loyalty.

     

    LIMITATIONS OF PERFECT COMPETITION

    • In reality, there will usually always be barriers to entry for new firms
    • Products are not usually homogeneous e.g. onions differ in size therefore are differentiated
    • Perfect information is not always available
    • Customers are influenced by things other than price i.e. brand, convenience
    • Firms keep innovations and new technologies to themselves to stop people from copying them i.e. patents

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