Sunday, February 28, 2010

Unit 4 - Market Power

The unit was separated into four sections, Market Structure, Monopoly, Monopolistic Competition, Oligopoly.

Market Structure and economic profits is argued by Porter (2008) to be determined by five forces, "Threat of New Entrants", "Bargaining Power of Buyers", "Threat of Substitute", "Bargaining Power of Suppliers" and "Rivalry Among Existing Competitors".

Most companies try or would like to be in a position where threat of new entrants are low due to strong entry barriers. Some companies are naturally in industries where these barriers are strong. The barriers can be like supply-side economies of scale or network effects of existing companies. Some companies like Apple have tried to create strong barriers to enter markets, which were not really there to begin with. For example, when Apple first launched itunes where people could purchase songs via internet downloads. They captured a market who found the convenience of the uniqueness of Apples product. The main unique aspects of the product is that you can listen to a preview, and buy only one song of an album without paying for all the other songs. Songs were brought and uploaded within minutes. However, Apple only allowed the songs to be played on their devices through a formating copyright. This meant it was costly for uses of itunes to switch to substitute products. Therefore Apple managed to limit new entrants into the MP3 device and music downloading industries.

Bargaining power of suppliers is another force that determines the market structure. For example, if a supplier does not depend on a seller for its revenue then the supplier is in a position to dictate the price/quality at which a product is supplied to the seller. Or if the seller is not relent of the supplier, i.e. there are other suppliers that can supply similar products, the seller will have more bargaining power over the supplier.

Bargaining power of the buyer is another import force that determines how a market structure is shaped. If the buyer has many sellers selling similar products to choose from, the buyer has a large bargaining power with the supplier, however if there is only one seller selling the product of interest to a buyer the buyer has limited bargaining power with the seller, especially if the seller knows that the buyer views the product as a necessary.

Threat of substitutes can shape a market as a substitute product will increase completion for selling products.

Rivalry among existing competitors shapes how the market structure is, i.e. the economic profit, demand etc. Companies can compete with each other by price discouting, new products, advertising campains and service improvements. They can be particularly intensive rivalry if competitors are numerous or are similar size and share similar market powers, industry growth is slow therefore trying to gain customers off another rival, exit barriers are high meaning that they will run at a loss while a rivalry is played out etc.

Markets definitions can be defined by different scope. The broader the scope it is more likely that a firm has more competitor products or substitute products it is competing with in a market. However, if the market is narrow, the number products viewed as competitive/substitute products will be significantly less.

Monopolies have low threats of new entrants, the bargaining power of buyers and suppliers is low, the threat of substitute products low and rivalry among existing competitors is nearly or is non-existent. This is because a monopoly company is the dominate seller, has no close substitutes, is the price maker, has low threat of entrants usually due to strong entry barriers.

For a pure monopolist company the companies demand curve is the markets demand curve, is downwards sloping. The marginal revenue for producing an additional unit of product is always less than price whenever the monopolist charges the same price to all buyers. A monopolist company will maximize their economic profit when marginal cost equals marginal revenue, as they are the dominant competitor in the market they should be able to achieve this if they have good data and analysis of demand for their product/s.

Some monopolist companies are controlled/regulated by governments to adopt pricing policies that do not maximize profit. Two common pricing policies are "Fair-Return Price" and "Socially Optimum Price". Fair-Return Price is to set a maximum price by still allow the monopolist company to earn normal profits by not economic profits. The fair-return price is at the lowest point of the ATC curve where the MC curve interests the ATC curve meaning ATC=MC.

Socially Optimum price is where the government operates a monopoly themselves in a way which maximizes the net benefit to society. This occurs when the marginal cost is equal to the price buyers are willing to pay i.e. MC=AR=Demand.

Another concept introduced this unit is price discrimination. This is where a company charges defined segments of the market different prices to maximize the total economic profit. However some companies try and define to many segments which adds complexity into the purchase decision or lose customers to making their own substitutes.

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