Price Makers and Price Takers

Topics: Supply and demand, Price elasticity of demand, Monopoly Pages: 4 (968 words) Published: November 19, 2008
Market Structure
o Perfect (pure) competition
Price–taking firms each with no influence over the ruling market price (see diagram below)
Free entry and exist of businesses in the long run – drives down profits towards a normal profit equilibrium level
Each supplier produces homogeneous products – each a perfect substitute – hence the perfectly elastic demand curve for the individual supplier Key factor - interdependent nature of pricing decisions between rival firms Each firm must consider strategic behaviour of other “players” in the market Objective might be protecting market share or increasing market share Game theory can help to model different types of behaviour (both price and non- price competition)

Kinked demand curve model is another possibility
o Contestable markets
Markets where the entry and exit costs are low
Potential for hit and run entry to cream off profits if incumbent firms are being inefficient (e.g. exploiting the consumer by charging monopoly price, failure to control production costs and other inefficiencies including lack of innovation) Always the threat of new entry from new suppliers or new products – this affects the current behaviour of existing firms (may force them to price more competitively – less scope for monopoly pricing)

There are barriers to contestability in most markets – but the higher the barriers, the greater the pricing power in the hands of the incumbent firms because the risks of “hit and run entry” from new rivals is lower

Price and Cross-price Elasticity of Demand
Elasticity of demand remains a fundamental factor affecting a firm’s pricing power When demand is price inelastic, the business can raise price without losing a disproportionate level of demand / sales (see left hand diagram on next page)

When demand is price elastic, the potential to raise price and extract consumer surplus, turning it into higher producer surplus / profit is much reduced – see the right hand diagram on the next page Cross...
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