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Transcript
Chapter 10: The Competition Environment Key Revision Points Introduction to the competitive environment Economists define markets in terms of the interaction between two groups: Those seeking to buy products Those seeking to sell them Economists distinguish between those economic influences that operate at the level of the individual firm and those that relate to the economy as a whole. The study of an organisation and its customers/ suppliers in isolation from the rest of the economy is generally referred to as microeconomic analysis. In this type of analysis, the national economy is assumed to be stable. Market structure The term market structure is used to describe: The number of buyers and sellers operating in a market The extent to which the market is concentrated in the hands of a small number of buyers and/or sellers The degree of collusion or competition between buyers and/or sellers Market structures range from the theoretical extremes of perfect competition and pure monopoly. In practice, examples of the extremes are rare. Perfect Competition This is the simplest type of market structure to understand. Although rarely found in practice, a sound understanding of the way they work is essential for understanding competitive market pressures in general. Perfectly competitive markets are attributed with the following principal characteristics: There are a large number of producers. There are also a large number of buyers. Buyers and sellers are free to enter or leave the market. There is a ready supply of information. Perfect competition implies that firms are price takers in that competitive market forces alone determine the price at which they can sell their products. The most important reason for studying perfect competition is that it focuses attention on the basic building blocks of competition: demand, supply and price determination. Demand Demand is measured in terms of how many people are actually able and willing to buy a product at a given price and given a set of assumptions about the product and the environment in which it is being offered. Demand is also expressed in terms of a specified time period, for example so many units per day. A demand curve is based on a number of assumptions. For example, that the price of substitutes for cheese will not change or that consumers will not suddenly take a dislike to cheddar cheese. Actually collecting information with which to plot a demand curve poses theoretical and practical problems. The main problem relates to the cross-sectional nature of a demand curve. However, this kind of information can often only be built up by a longitudinal study of the relationship between prices and volume over time. Supply Supply is defined as the amount of a product that producers are willing and able to make available to the market at a given price over a particular period of time. It is important to distinguish movements along a supply curve from shifts to a new supply curve. Price determination It is possible to redraw the demand and supply lines on a single graph. In perfectly competitive markets, the process of achieving equilibrium between supply and demand happens automatically without any external regulatory intervention. It is important to remember that in a perfectly competitive market, individual firms are price takers. The market alone determines the "going rate" for their product. Changes in the equilibrium market price come about for two principal reasons: Assumptions about suppliers' ability or willingness to supply change, resulting in a shift to a new supply curve Assumptions about buyers' ability or willingness to buy change, resulting in a shift to a new demand curve New equilibrium prices and trade volumes can be found at the intersection of the supply and demand curves. In practice, both the supply and demand curves may be changing at the same time. Elasticity of demand Elasticity of demand refers to the extent to which demand changes in relation to a change in price or some other variable such as income. Price elasticity of demand refers to the ratio of the percentage change in demand to the percentage change in price. Where demand is relatively unresponsive to price changes, demand is said to be inelastic with respect to price. A number of factors influence the price elasticity of demand for a particular product. The most important is the available of substitutes. The absolute value of a product and its importance to a buyer can also influence its elasticity. For any measure of elasticity, it is important to consider the time period over which is being measured. In general, products are much more inelastic to changes in price over the short term. Elasticity of supply The concept of elasticity can also be applied to supply, so as to measure the responsiveness of supply to changes in price. If suppliers are relatively unresponsive to an increase in the price of a product, the product is described as being inelastic with respect to price. If producers increase production substantially as prices rise, the product is said to be elastic. As with price elasticity of demand, time is crucial in determining the elasticity of supply. Limitations of the theory of perfect competition These are some of the more important reasons why perfect competition is rarely achieved in practice: Perfect competition only applies where production techniques are simple and opportunities for economies of scale are few. Markets are often dominated by large buyers who are able to exercise influence over the market. It can be naïve to assume that high prices and profits in a sector will attract new entrants, while losses will cause the least efficient to leave. A presumption of perfectly competitive markets is that buyers and sellers have complete information about market conditions. In fact, this is often far from the truth. Monopolistic markets In its purest extreme, monopoly in a market occurs where there is only one supplier to the market, perhaps because of regulatory, technical or economic barriers to entry. However, this rarely occurs in practice. Sometimes, monopoly control over supply comes about through a group of suppliers acting in collusion together in a ‘cartel’. Government definition of a monopoly is less rigorous than pure economic definitions. In the United Kingdom, two types of monopoly can occur: A scale monopoly occurs where one firm controls 25 per cent of the value of a market. A complex monopoly occurs where a number of firms in a market together account for over 25 cent of the value of the market and their actions have the effect of limiting competition. Effects on prices and output of monopoly A monopolist can determine the market price for its product and can be described as a "price maker" rather than a "price taker". In a pure monopoly market, consumers would face prices that are higher than would have occurred in a perfectly competitive market. Implications of monopoly power for a firm's marketing activities In a pure monopoly, a firm's output decisions would be influenced by the elasticity of demand for its products. So long as demand remained elastic, it could continue raising prices and thereby its total revenue. Organisations that think strategically will be reluctant to fully exploit their monopoly power. By charging high prices in the short-term, a monopolist could give signals to companies in related product fields to develop substitutes that would eventually provide effective competition. Imperfect competition Most firms would like to be in the position of a monopolist and able to control the price level and output of their market. This is an unrealistic aim for most firms, but, in practice, firms can create imperfections in markets that give them limited monopoly power over their customers. An entrepreneur can seek to avoid head-on competition with its competitors by trying to sell something that is just a little bit different compared to its competitors. If a trader has successfully differentiated its product, it is no longer strictly a price taker from the market. The role of brands The process of branding is at the heart of organisations' efforts to remove themselves from fierce competition between generic products. Branding simplifies the decision-making process by providing buyers with a sense of security and consistency which distinguishes a brand from a generic commodity. The traditional role of branding has been to differentiate products, but brands have been increasingly applied to organisational images too. Imperfect competition and elasticity of demand Firms face a downward sloping demand curve for each of their products, indicating that, as prices fall, demand increases and vice versa. In the market for breakfast cereals, the demand curve for cereals in general may be fairly inelastic, on the basis that people will always want to buy breakfast cereals of some description. Demand for one particular type of cereal, such as corn flakes, will be slightly more elastic as people may be attracted to corn flakes from other cereals such as porridge oats on the basis of their relative price. Price becomes more elastic still when a particular brand of cereals is considered. Total revenue is a function of total sales multiplied by the selling price per unit. Oligopoly Oligopoly lies somewhere between imperfect competition and pure monopoly. An oligopoly market is dominated by a small number of sellers who provide a large share of the total market output. All suppliers in the market are interdependent. One company cannot take price or output decisions without considering the specific possible responses of other companies. Oligopoly is a particularly important market structure in industries with economies of scale. Competition policy The vision of competitive markets that bring maximum benefit to consumers is often not achieved. The imperfections described above can be summarised as resulting from: The presence of large firms that are able to exert undue influence over participants in a market. Collusion between sellers (and sometimes buyers) Barriers to market entry and restraints on trade Rigidity in resource input markets Because of the presumed superiority of competitive markets, the law of most developed countries has been used to try and remove market imperfections where these are deemed to be against the public interest. A growing body of legislation based on statute law is now available to governments and organizations seeking to curb anticompetitive practices. Common law approaches to improving market competitiveness There is case law that holds that agreements between parties that have the effect of restraining free trade are unlawful. The "public interest" is important in deciding whether a restrictive agreement is reasonable. A claim of restraint of trade can also be made against a company buying a business that restricts the future business activity of the person from whom they have bought the business. If a clause in an agreement is deemed by a court to be unreasonable, it may remove it from the contract. It can however, be difficult to know what a court will consider to be "reasonable" in the circumstances of a particular case. Statutory intervention to create competitive markets Common law has been supplemented by statutory legislation, that is laws passed by government as an act of policy. One outcome of statutory intervention has been the creation of a regulatory infrastructure, which in the United Kingdom includes the Office of Fair Trading, the Competition Commission and regulatory bodies to control specific industries. Articles 85 and 86 of the Treaty of Rome Article 85 of the Treaty of Rome prohibits agreements between organisations and arrangements between organisations that affect trade between member states of the European Union and in general prohibits anti-competitive practices. Article 86 prohibits the abuse of a dominant market position within the European Community insofar as it may affect trade between member states. The EU often has difficulty in reconciling the need for firms to operate globally at a large scale, and the resultant domination of the EU market by that firm. UK Competition legislation In the UK, the 1998 Competition Act reformed and strengthened competition law by prohibiting anti-competitive behaviour. A number of agencies have responsibility for preserving the competitiveness of markets in the UK, the most important being: The Director General for Fair Trading The Competition Commission Public utility regulators Evaluating claims of anti-competitive practices A fine balance often exists between the co-operation among firms which leads to lower prices / better products for consumers, and co-operation which leads to collusion and a reduction in consumers' choice. There is diversity in interpretation of the notion of the "public interest", which may be explained partly by cultural/ political factors, and developments in our understanding of the consequences of market imperfection. Regulatory bodies are increasingly recognising that co-operative relationships between companies can become anti-competitive. Control on price representations One of the assumptions of a perfectly competitive market is that participants in it have complete information about competing goods and services. In reality, buyers may find it very difficult to judge between competing suppliers because prices are disclosed in a deceptive or non-comparable manner. Legislation, such as the Consumer Protection Act 1987, makes it illegal for a company to give misleading statements about the price of goods or services. Regulation of public utilities To protect the users of these services from exploitation, the government response has been twofold: Government has sought to increase competition, in the hope that the invisible forces of competition will bring about lower prices and greater consumer choice. Where competition alone has not been sufficient to protect the consumers' interest, government has created a series of regulatory bodies which can determine the level and structure of charges made by these utilities. In utility markets where competition is absent, regulators have to balance what is desirable from the public's point of view with the companies' need to make profits, which will in turn provide new capital for investment in improvements. Control of government monopolies There are still many services that cannot be sensibly privatised or deregulated. Therefore, where it is impractical to privatise publicly provided services, government has taken a number of measures to try and protect consumers from exploitation. These are some of the methods that have been used: Arms length organisations Market testing Customers’ charters