Price discrimination, Oligopoly, Mon Comp, Contestable Mkts, Comp policy. Flashcards
When does Price discrimination occur?
`When a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs.
Charging different prices for similar goods is not pure price discrimination. e.g. business class flights
What are the conditions for price discrimination to work?
The ability to charge different prices to different groups of consumers means that the firm must have a degree of price making power.
What are the 3 main condition required for price discrimination?
- The ability to identify different groups in the market
- The ability to keep the different groups separate AT LOW COST.
- Differences in price elasticity of demand between markets
How do firms identify different groups in the market?
Typical examples of how this is done include age, time and geography.
What is market seepage? (firms have to prevent it to price discriminate)
A process whereby consumers who have purchased a good or service at a lower price are able to resell it to those consumers who would normally have paid the higher price, at low cost.
How do firms keep different groups separate at low cost?
Can be done in a number of ways (such as issuing a ticket for train travel that can be checked by the ticket inspector) and is probably easier with the provision of a unique service such as a haircut rather than with the exchange of physical goods.
Why must there be differences in PED between each group of consumers for firms to price discriminate?
Because the firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand.
By adopting such a strategy, the firm can increase its total revenue and profits.
What is 1st degree price discrimination?
Where the firm separates the whole market into each individual consumer and charges them the price they are willing to pay. If successful, the firm can extract the consumer surplus beneath the demand curve and turn it into extra producer surplus e.g. extra revenue/profit.
This is impossible to achieve unless the firm knows every consumer’s preferences and, as a result, is unlikely to occur in the real world. The costs involved in finding out through market research what each buyer is prepared to pay is the main block to this form of price discrimination. (Cookies and tracking is making this easier for producers online)
What is 2nd degree price discrimination (Indirect- based on quantity)?
Involves businesses selling off packages of a product deemed to be surplus capacity at lower prices.
What is an example of 2nd degree price discrimination based on quantity?
Can often be found in the hotel and airline industries where spare rooms and seats are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are small and predictable. If there are unsold airline tickets or hotel rooms, it is often in the businesses best interest to offload spare capacity at a discount price, providing that the cheaper price at least covers the marginal cost of each unit as there is nearly always some extra profit to be made from this strategy. It can also be an effective way of securing additional market share within an oligopoly if the main suppliers’ are battling for market dominance.
What are Early Bird discounts?
Customers booking early with carriers such as EasyJet will normally find lower prices if they are prepared to commit themselves to a flight by booking early. This gives the airline the advantage of knowing how full their flights are likely to be and a source of cash-flow in the weeks and months prior to the service being provided. Closer to the date and time of the scheduled service, the price rises, on the simple justification that consumer’s demand for a flight becomes more inelastic the nearer to the time of the service.
What is peak and off-peak pricing?
Peak and off-peak pricing is common in the leisure retailing and travel sector. Electricity companies may also separate markets by time offering cheaper off-peak electricity during the night.
At off-peak times, there is plenty of spare capacity and marginal costs of production are low. Firms will reduce prices to take advantage of groups with more price elastic demand to sell off the surplus capacity. At peak times when demand is high, the supplier reaches capacity constraints and will raise price to take advantage of groups with more price inelastic demand.
What is another example of 2nd degree price discrimination that involved Qd?
Bulk buying discounts- where the seller will offer a lower price per unit to the customer who buys in larger quantities, the theory here being that customers will be more price elastic when deciding whether to buy in larger quantities but more price inelastic when buying in smaller quantities – e.g. whether to buy the product or not.
What is 3rd degree price discrimination?
This is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market. The key is that third degree discrimination is
Linked directly to consumers’ willingness and ability to pay for a good or service. It means that the prices charged may bear little or no relation to the cost of production.
What are examples of 3rd degree price discrimination?
The market is often separated by time or by geography.
For example, taxi drivers will often charge a higher rate after a certain time of night in part on the basis that fewer substitute transport methods are available and so demand is likely to be more price inelastic.
Exporters may also charge a higher price in overseas markets if demand is estimated to be more inelastic than it is in home markets.
What are two-part pricing tariffs?
A fixed fee is charged (often with the justification of it contributing to the fixed costs of supply) and then a supplementary “variable” fee is charged based on the number of units consumed.
What are some examples of two-part pricing tariffs?
Taxi fares and the fixed charges set by the utilities (gas, water and electricity). Price discrimination can come from varying the fixed charge to different segments of the market and/or varying the charges on marginal units consumed (e.g. discrimination by time).
How can consumer welfare be negatively affected by price discrimination?
Consumer surplus is reduced for those having to pay the higher price, representing a loss of consumer welfare. In this case, the price charged will be significantly above the marginal cost of production. Those consumers in segments of the market where demand is inelastic would probably prefer a return to uniform pricing by firms with monopoly power. Their welfare is reduced and monopoly pricing power is being exploited.
How can consumer welfare be positively affected by price discrimination?
some consumers who can buy the product at a lower price may benefit. Previously they may have been excluded from consuming it. Low-income consumers may be “priced into the market” if the supplier is willing and able to charge them a lower price. Good examples to use here might include legal and medical services where charges are dependent on income levels. Greater access to these services may yield external benefits (positive externalities) which then have implications for the overall level of social welfare and the equity with which scarce resources are allocated. Educational rates for some products/services would be another good example of this.
How is price discrimination in the interest of profit and revenue maximising firms in less competitive markets?
A discriminating monopoly is extracting consumer surplus and turning it into extra supernormal profit. Of course businesses may not be driven solely by the aim of maximising profit. A company will maximise its revenues if it can extract from each customer the maximum amount that person is willing to pay, subject to the revenue maximisation criteria – MR=0.
What is predatory pricing?
Setting prices below cost to certain customers - to harm competition at the supplier’s level and thereby increase a firm’s market power.
How could price discrimination make a market more contestable in the long-run?
Firms may offer low prices in one segment as a way of gaining entry into the market, despite potentially making losses as a result, and then use the profits from other market segments to cover the losses and still make profit overall.
How can profits made from price discriminating one area of the market have important social benefits?
For example profits made on commuter rail or bus services may allow transport companies to support loss making rural or night-time services.
Without the ability to price discriminate these services may have to be withdrawn and employment might suffer.
What is price discrimination?
Price discrimination occurs when a firm charges different prices to different groups of consumers for an identical good or service, for reasons not related to costs.
How does price discrimination differ from product differentiation?
Product differentiation involves varying the product’s quality or features, while price discrimination charges different prices for the same product to different consumer groups.
In what type of market structure can price discrimination occur?
Price discrimination can only take place in imperfectly competitive markets where firms have some price-making power.
What are the three main conditions necessary for price discrimination?
- The ability to identify different groups in the market.
- The ability to prevent market seepage (reselling between groups).
- Differences in price elasticity of demand between groups.
Why must firms prevent “market seepage” for price discrimination to work?
If consumers who buy at a lower price can resell to those who would pay more, price discrimination fails.
How does price elasticity of demand affect price discrimination?
Firms charge higher prices to groups with inelastic demand and lower prices to groups with elastic demand to maximize revenue.
What is first-degree price discrimination?
It is when a firm charges each consumer the maximum price they are willing to pay, capturing all consumer surplus.
Why is first-degree price discrimination difficult to implement?
It requires perfect knowledge of each consumer’s willingness to pay, which is often impractical.
What is second-degree price discrimination?
It involves charging different prices based on quantity purchased or timing, such as bulk discounts or last-minute airline ticket sales.
What is third-degree price discrimination?
It involves charging different prices to identifiable consumer groups based on characteristics such as age, geography, or time.
Give an example of second-degree price discrimination.
Early-bird discounts, peak and off-peak pricing, or bulk purchase discounts.
How do taxi fares demonstrate third-degree price discrimination?
Taxi drivers may charge higher rates at night when demand is more inelastic due to fewer transport alternatives.
How do electricity companies use price discrimination?
They charge lower prices for off-peak electricity consumption.
How does price discrimination affect consumer welfare?
It reduces consumer surplus for those paying higher prices but may increase access to goods/services for those paying lower prices.
How does price discrimination benefit firms?
It increases revenue and profits by capturing more consumer surplus.
How can price discrimination benefit society?
It can increase access to essential services (e.g., lower medical or educational fees for low-income individuals) and allow firms to cross-subsidize loss-making services.
How might price discrimination reduce efficiency?
It can result in monopoly pricing power being exploited, reducing overall consumer welfare.
How does the internet enable price discrimination?
Firms use online data tracking (cookies, social media) to personalize pricing based on consumer behavior.
What is a two-part pricing tariff?
It is a pricing strategy where a fixed fee is charged upfront, followed by a per-unit usage fee (e.g., gym memberships, taxi fares).
How can price discrimination be used as a predatory pricing strategy?
Firms may set prices below cost for certain customers to harm competition and gain market power.
What is an oligopoly?
An oligopoly is a market dominated by a small number of large producers, each having some control over the market.
How is an oligopoly technically defined?
An oligopoly exists when the top five firms in a market account for more than 60% of total market demand or sales.
What are the key characteristics of an oligopoly?
- Product branding
- Entry barriers
- Interdependent decision-making
- Non-price competition
Why do oligopolies exhibit interdependent decision-making?
Firms must consider the likely reactions of their rivals when making changes to price, output, or marketing strategies.
What is non-price competition?
It refers to competition through means other than price, such as advertising, branding, customer service, and loyalty programs.
What is the kinked demand curve model?
A model illustrating that firms may not change prices frequently due to interdependence; rivals may ignore price increases but match price cuts.
What happens when a firm in an oligopoly raises its price according to the kinked demand curve model?
If other firms keep their prices constant, demand is price elastic, and the firm loses market share.
What happens when a firm in an oligopoly lowers its price according to the kinked demand curve model?
If other firms follow suit, demand becomes inelastic, total revenue falls, and there is little gain in market share.
What is collusion?
Collusion occurs when two or more firms work together to reduce competition rather than competing independently.
Why do firms in oligopolies have an incentive to collude?
Collusion reduces uncertainty and helps maintain high profits by limiting price competition.
What is explicit collusion?
A formal agreement among firms to fix prices, control output, or divide markets, often illegal.
What is tacit collusion?
An informal, unspoken agreement where firms follow each other’s pricing strategies without direct communication.
What is price leadership?
A form of tacit collusion where a dominant firm sets prices that other firms in the industry follow.
What is game theory?
A tool used to analyze strategic interactions between firms, often used to explain collusion and competitive behavior.
How does the Prisoner’s Dilemma relate to oligopoly?
It illustrates how firms may be better off colluding but have an incentive to cheat for short-term gain, leading to potential breakdowns in agreements.
What is a cartel?
A formal agreement between firms in an oligopoly to restrict output and raise prices, similar to a monopoly.
Why do cartels often break down?
Firms have an incentive to cheat by secretly undercutting prices to gain market share, leading to the collapse of the agreement.
What are the effects of collusion on consumers?
Higher prices, reduced output, and limited choices, which reduce consumer welfare.
What is non-collusive (competitive) oligopoly?
A market where firms compete independently, leading to greater innovation and potential economies of scale.
How can oligopolies benefit consumers?
If firms compete rather than collude, they may invest in research, innovation, and efficiency, potentially lowering costs and improving products.
What is a concentration ratio?
What is a concentration ratio?
A ratio that indicates the total market share of the leading firms in a market, expressed as a percentage of the total market output.
How are concentration ratios calculated?
By adding up the market shares of the leading firms in descending order, starting with the largest firm.
How are concentration ratios usually expressed?
In terms of the number of firms included, such as the three-firm or four-firm concentration ratio.
What is a highly concentrated market?
A market where the leading firms have a very high market share, leading to little competition.
What is the Prisoner’s Dilemma?
A game theory scenario where two individuals make decisions independently, often leading to worse outcomes for both than if they had cooperated.
What happens if both prisoners plead innocent in the Prisoner’s Dilemma?
They both receive a light sentence.
What happens if one prisoner pleads guilty while the other pleads innocent?
The one who pleads guilty is set free, while the one who pleads innocent receives a severe sentence.
What happens if both prisoners plead guilty?
They both receive a medium sentence.
Why do both prisoners end up pleading guilty in the Prisoner’s Dilemma?
Each prisoner reasons that pleading guilty is the safer option, as it guarantees a lesser sentence than risking the other pleading guilty while they plead innocent.
How does the Prisoner’s Dilemma relate to business competition?
Firms bidding for contracts face a similar dilemma where setting a low price ensures winning but lowers profits, while setting a high price could lead to both firms sharing the contract and earning more.
What is the ideal outcome in the Prisoner’s Dilemma?
Mutual cooperation (both pleading innocent), but because of distrust, they often end up in a worse situation.
What are the key features of a monopolistically competitive market?
Large number of buyers and sellers, independent firms, freedom of entry/exit, perfect information to a large extent, and differentiated (non-homogeneous) products.
How do differentiated products affect pricing in monopolistic competition?
They give firms some control over price, making them price makers instead of price takers.
Why are AR and MR curves downward sloping in monopolistic competition?
Because of product differentiation, firms face a downward sloping demand curve.
Why are demand curves in monopolistic competition elastic?
Many substitutes are available due to product differentiation, so consumers are responsive to price changes.
What are some examples of monopolistically competitive industries?
Coach industry, hairdressers, restaurants (e.g., fish and chips), and the hotel industry.
What happens in the short run equilibrium in monopolistic competition?
Firms can earn supernormal profits due to some control over price.
What causes new firms to enter a monopolistically competitive market in the long run?
Supernormal profits attract new firms due to free entry.
What effect does new firm entry have on the AR and MR curves in the long run?
Shifts them leftward until only normal profits are made.
What is the long run equilibrium outcome in monopolistic competition?
Firms make only normal profits, with AR tangent to AC at MR=MC.
Is monopolistic competition efficient in the long run?
No, it is neither productively nor allocatively efficient.
How does perfect competition compare with monopolistic competition in terms of efficiency?
Perfect competition achieves lower prices, higher output, and both productive and allocative efficiency.
What is one potential benefit of monopolistic competition despite inefficiency?
Greater consumer choice due to product differentiation.
What types of non-price competition are common in monopolistic competition?
After-sales service, advertising, promotions, and branding.
Why is PED (Price Elasticity of Demand) relatively elastic in monopolistic competition?
Due to the availability of close substitutes.
Why can’t firms make supernormal profits in the long run in monopolistic competition?
New firm entry increases competition and reduces prices and profits.
What are some review questions to check understanding of monopolistic competition?
- Name 4 features of monopolistic competition. 2. Why is PED elastic? 3. Why are supernormal profits unsustainable in the long run?
What is a perfectly contestable market?
A market with no entry or exit barriers, no sunk costs, and equal access to technology for all firms.
What are the key conditions for a contestable market?
Low barriers to entry and exit, absence of sunk costs, and access to the same level of technology.
What are sunk costs and how do they affect contestability?
Sunk costs are unrecoverable expenditures; they deter new entrants, reducing contestability.
What is hit-and-run competition?
When firms enter a market temporarily to earn supernormal profits and exit once profits fall.
How do contestable markets differ from perfectly competitive markets?
Contestable markets can have dominant firms and product differentiation, unlike perfect competition.
What determines firm behaviour in contestable markets?
The threat of potential competition, not just actual market structure or number of firms.
Why do firms behave competitively in a contestable market?
The threat of entry forces them to act as if in a competitive environment.
What factors have increased market contestability in recent years?
Entrepreneurial zeal, competition policy, the EU single market, technological change, and e-commerce.
How does entrepreneurial zeal affect contestability?
Entrepreneurs introduce competition and innovation despite dominant existing firms.
How does competition policy impact contestability?
Laws against anti-competitive practices make it easier for new firms to enter markets.
How does the European Single Market increase contestability?
By opening markets to cross-border competition among member nations.
What role does technology play in increasing contestability?
It lowers entry costs and enables innovation, making markets more accessible.
What is the impact of contestability on prices and output?
It lowers prices and increases output, improving consumer welfare.
What is X-inefficiency and how does it relate to contestability?
X-inefficiency is when firms operate above minimum cost; contestability reduces it through competitive pressure.
How does contestability affect monopoly behavior?
It forces monopolists to lower prices and increase efficiency to deter new entrants.
Why is market share not a reliable indicator of contestability?
Because even markets with dominant firms can be contestable if barriers to entry are low.
What is the focus of modern competition policy regarding contestability?
Opening markets and encouraging new entrants, not just analyzing market share or profitability.
What is the main market failure discussed in the presentation?
Lack of competition.
What are the learning objectives in addressing lack of competition?
- Identify different policy options.
- Assess options in terms of efficiency.
- Make judgments about the best policy in a specific economic situation.
What is a windfall tax?
A tax on supernormal profits, often applied occasionally, like the energy companies tax under Tony Blair’s Labour government in the late 1990s.
How does taxing supernormal profits affect the market?
It improves equity through redistribution, but not efficiency since prices and output remain unchanged.
What is the purpose of price controls in monopolistic markets?
To prevent abuse of dominant market position and limit supernormal profits.
Give an example of recent price controls in the UK.
Price caps set by Ofgem on gas and electricity companies.
Which UK industry commonly uses price controls?
The rail industry, using the RPI +/- X formula.
How do price controls improve efficiency compared to taxation?
They reduce prices and increase output by flattening the demand curve (perfectly elastic at the control price).
What is the goal of nationalisation in correcting market failure?
To set business objectives that align with economic efficiency, e.g., ensuring price equals marginal cost (P = MC).
How can privatisation or deregulation improve competition?
By introducing new competitors (e.g., gas markets) or removing regulatory barriers (e.g., bus services).
How can reducing entry barriers increase competition?
Through competition authorities’ interventions and government support for new businesses.
What is one way the government can break up monopolies?
Forcing firms to sell parts of their business to reduce market dominance.
What is an example of breaking up monopolies in the UK?
The breakup of BAA, which was forced to sell some airports.
How can mergers be affected by competition regulations?
Authorities may require firms to sell business elements before approving a merger or acquisition.
What example shows a merger influenced by competition rules?
Asda and Sainsbury’s offering to sell stores to gain approval for their proposed merger.
What are the learning objectives of the lesson?
- Define nationalisation and privatisation.
- Explain advantages of nationalisation and privatisation.
- Understand how arguments for one are against the other.
- Be aware of private sector roles in public services.
Define the term ‘Private sector’
Part of the economy that is run by individuals and companies for profit.
Define the term ‘Public sector’
Part of the economy controlled by the government.
Define the term ‘Nationalisation’
Transfer of private sector assets into public ownership.
Define the term ‘Privatisation’
Transfer of public sector assets into private ownership.
What are some arguments in favour of nationalisation?
- Achieve economies of scale.
- Control monopoly power.
- Maximise social benefit instead of profit.
- Ensure essential industries survive.
- Fairer income distribution.
What are some arguments in favour of privatisation?
- More efficiency through competition.
- Better quality products and more consumer choice.
- Investment and dynamic efficiency.
- Less reliance on government funding.
- Revenue from sale of businesses.
What are some problems with privatisation?
- Success depends on competition, which isn’t always present.
- Some industries became private monopolies.
- Regulatory bodies needed to control monopoly power.
What is a case study mentioned in the lesson?
UK railways: debates on renationalisation.
How is the private sector involved in public sector service provision?
- Contracting out (e.g. road building, rubbish collection).
- Competitive tendering.
- PFIs/PF2s - private funding and construction of infrastructure.
What is competitive tendering?
A process where private firms bid for public contracts; the most competitive bid wins.
What are PFIs/PF2s?
Private Finance Initiatives where private sector builds infrastructure and rents it to the government. PFIs/PF2s are now withdrawn.
List two advantages of nationalisation.
- Economies of scale.
- Focus on social benefit over profit.
List two advantages of privatisation.
- Increased efficiency.
- Better quality and more choices for consumers.
When and under which government did most privatisation occur in the UK?
During the 1980s under Margaret Thatcher’s Conservative Government.
List three methods a government can use to control monopoly power other than regulation.
- Nationalisation.
- Breaking up monopolies.
- Taxation or price controls.
What is a Public Private Partnership (PPP)?
A collaboration between public bodies and private companies, aimed at delivering better value for money by combining public oversight with private sector efficiency.
Why did New Labour promote PPPs?
They believed private companies were more efficient and could deliver better value for taxpayers.
What concerns did unions have about PPPs?
Unions were concerned about private sector involvement in schools and hospitals and the potential impact on employees’ wages and benefits.
What is PFI?
Private Finance Initiative—private contractors finance and deliver public projects, then rent them back to the government.
Who introduced PFI and who expanded it?
Introduced by the Conservative government in the 1990s and expanded by New Labour in the 2000s.
What are the arguments against PFI?
- Long-term cost to taxpayers was high.
- Some projects paid back construction costs quickly, leading to excess profits.
- Early projects had quality issues.
- Employee wages and benefits decreased.
What are the arguments in favour of PFI?
- Enabled infrastructure development without tax increases.
- Introduced business culture and efficiency.
- Performance-related penalties improved outcomes.
How much was PFI estimated to cost?
By 2012/13, total repayments were £301.3bn on a capital spend of £54.7bn across 719 projects, with 39 more in the pipeline.
How did the 2008/09 financial crisis affect PFI?
Private firms faced funding issues, forcing government bailouts—ironically using public money to support privately funded projects.
What was the government’s justification for PFI bailouts?
It helped save projects and jobs, and maintained private sector risk for cost overruns.
What were some criticisms of these bailouts?
Critics argued public money was propping up a failing system with poor returns compared to traditional procurement.
What did Budget 2018 announce about PFI?
Government would no longer use PFI/PF2 for public projects, though existing contracts would be honored due to high compensation costs for termination.
What does the PFI project graph show?
A peak in signed projects during late 1990s-2000s, followed by a decline after 2010 and ending in 2016.
What were the main concerns after privatising utilities in the 1980s?
There was little effective competition, and some industries had natural monopolies, leading to concerns about firms exploiting their dominant position to raise prices and reduce economic welfare.
What was the solution to prevent monopolistic exploitation in privatised utilities?
Regulatory bodies were created for each industry to control them and protect consumers.
Name the regulatory body for the water industry.
Ofwat
Name the regulatory body for the rail industry.
ORR
Name the regulatory body for the telecommunications industry.
Ofcom
Name the regulatory body for the gas and electricity industries.
Ofgem
What pricing formula was commonly used in the early days of privatisation?
The RPI +/- X formula
What industries still use the RPI +/- X formula for price controls?
The water and rail industries
What pricing mechanism has Ofgem used to control tariffs recently?
Price caps
What is one role of regulators in preventing anti-competitive practices?
Investigating and acting against anti-competitive behaviors that harm consumers.
How can regulators increase competition?
By reducing barriers to entry, such as forcing established firms to allow competitors to use their networks.
Why do regulators set minimum investment levels?
To ensure money is reinvested into industries rather than just increasing profits and shareholder dividends.
Which two industries are commonly linked with minimum investment levels?
The water and rail industries
Give an example of performance targets set by regulators.
Rail industry punctuality targets and water industry leakage reduction targets.
What is regulatory capture?
A situation where regulators act in the interests of the industry they regulate rather than consumers.
Why is regulatory capture a problem?
It leads to ineffective regulation, allowing firms to act against consumer interests.
What are three main causes of regulatory capture?
(1) Close relationships between regulators and industry, (2) industry influence over regulatory decisions, (3) industry providing key information to regulators.
