h2 econs c6&7 - firms and decisions

(competitive oligopoly, BUT NOT ALL) Price rigidity (why wont increase or decrease)

A rational competitive oligopolistic firm will not increase price If the firm increases its price above the existing market price, quantity demanded of its product will decline (according to the Law of Demand). Since this is an oligopolistic market, the final output will be affected by the reactions of rival firms. Given the similarity of the products offered, if a firm were to increase price, no other firm will follow. Rival firms will now enjoy their price advantage as consumers will switch to cheaper alternatives, thus benefiting the other firms with higher revenue. In this case, the rivals will be gaining the sales lost by the first firm, so they will have no reason to match the first firm's price increase. A rational competitive oligopolistic firm will not decrease price. On the other hand, if the first firm reduces its price below the existing market price, quantity demanded of its product will rise (according to the Law of Demand). Once again, the outcome will be affected by the reactions of rival firms. This time, the rivals will be losing sales to the first firm, so they will most likely match the first firm's price cut to retain their respective market shares. When these rivals reduce their prices, the first firm will not be able to increase its market share significantly, and the rise in the quantity demanded of its product will not be as great as intended. If a firm were to initiate a price cut, other firms have no choice but to also follow likewise. This leaves all firms with roughly the same market share, but they now have to sell the same level of output at a lower price. Overall, all firms suffer from a lower profit level.

Equity indicators (PC, MC, OLI, MONO)

Affordability of essential goods and distribution between producers and consumers

allocative efficiency (PC, MC, OLI, MONO) [most to least efficient]

Allocative efficiency is achieved where the scarce resources in society are allocated such that it is not possible to make anyone better off without making someone else worse off.

dynamic efficiency (OLI, MONO, MC, PC)

Dynamic efficiency refers to the situation when firms invest in technology so that productivity and product quality will improve over time. This is usually achieved through innovation, which can come in the form of product innovation and process innovation. Innovation refers to the efforts put in by a firm to come up with new, improved of differentiated products. Recall that -product innovation refers to the creation of new products and/or services over time. -process innovation refers to efforts by firms to lower costs of production and to increase productivity.

(collusive oligopoly) Cartel Theory (e.g. A well-known cartel example is that of the Organisation of Petroleum Exporting Countries (OPEC), a group consisting of 13 of the world's major oil-exporting nations. OPEC was founded in 1960 to coordinate the petroleum policies of its members, and to provide member states with technical and economic aid. OPEC is a cartel that aims to manage the supply of oil in an effort to set the price of oil in the world market, in order to avoid fluctuations that might affect the economies of both producing and purchasing countries.)

H: A cartel is a formal and explicit collusion whereby oligopolistic firms cooperate to establish a virtual monopoly. A cartel seeks to increase overall profits by restricting the total output for all members. To make up the total output level, individual firms are assigned a pre-agreed quota to produce. The firms will also agree on a common price to sell their output. Since they essentially come together to make a joint profit-maximising decision. (the diagrammatic analysis is the same as that of a monopoly diagram.) A: Raising revenue: Without a cartel arrangement, rival firms engage in aggressive competition which will likely incur higher costs that may only reap marginal benefits. Suppose all firms in the industry form a cartel and the output can be reduced to QM (as agreed). The new price is PM (cartel price) and there are supernormal profits equal to the shaded area, which can be shared among the members of the cartel. The profit level for each firm is likely to be higher under a cartel arrangement. This is because under a cartel arrangement, demand is more price inelastic due to the availability of few substitutes. A cartel will charge a higher price (as compared to a non-cartel arrangement), as this will lower the quantity demanded less than proportionately, leading to a rise in total revenue. Thus, the firms have an incentive to form a cartel and behave collusively rather than competitively. L: However, cartels are often illegal as many governments are concerned about how such an anti- competitive move will exploit consumers, forcing them to buy the same good at a higher price and with access to a lower output level. The Competition and Consumer Commission of Singapore (CCCS) enacts the Competition Act that prohibits agreements between competing firms to implement practices like price-fixing and bid rigging. Likewise, the Federal Trade Commission and the Justice Department enforces anti-trust laws in the US. Oligopolistic firms tend not to compete in a cartel. However, firms may tend to deviate from the cartel agreed price as this will allow them to make higher profits. This is because a cartel tends to sell similar products (and this makes the demand for each firm's product price elastic). A unil

(collusive oligopoly) Collusion

H: Collusion refers to the situation where firms in a market cooperate to jointly fix prices or output. Explicit-cartels Implicit-price leadership firms in more concentrated/less competitive industries tend to experience a higher degree of mutual interdependence and are thus more likely to collude and employ non-price competition over price competition. Collusion more likely to occur and continue if -market is more concentrated -clear market leader -extent of product differentiation is low A: Raising revenue, firms can raise prices together to earn higher revenue L: collusion collapses when one or more of the firms involved cheat by charging less or producing more than the agreed price and output respectively, resulting in price war and thus huge losses for all firms involved. IMPACT ON... Consumer welfare -fall in consumer surplus -no change in consumer choice and product quality Other rival firms (NOT APPLICABLE) Society -Allocative efficiency worsens, no change in productive and dynamic efficiency EQUITY WORSENS

(non pricing strategy) Diversification E.g. Ikea (food, furniture, interior design) E.g. Amazon (books, groceries, Amazon prime ie tv shows)

H: Diversification enables a firm to find new sources of revenue and allows it to spread its risks as losses incurred for one product can be offset by profits earned from another. Vertical integration i.e. merging or acquiring another firm in the same industry but at a different stage of production A: Raise revenue, secure access to retail markets and find new sources of revenue, higher demand and AR A: Lowering costs using sunk cost fallacy, a fall in the demand for a particular product could be compensated by continued/increased sales in other products or markets, maintaining/increasing its output, therefore maintain/reducing unit costs. With a well-diversified product range, the costs of risks relating to changing market conditions will fall, firms can spread their cost of uncertainty and enjoy risk-bearing IEOS over a wider range of products and hence reduce their average cost. L: Diversifying into a new market is risky and costly IMPACTS ON... Consumer welfare: no change in consumer surplus, consumer choice increases but no change in product quality. Other rival firms: no change in cost, fall in total revenue and hence fall in profits Society: no change in allocative efficiency, productivity efficiency improves from firm's POV, no change in dynamic efficiency EQUITY UNCHANGED

(monopolist and oligopolist) Limit Pricing

H: For entry deterrence, to deter entry of new firms by reducing its price to that below the new entrant's average cost i.e. P/AR<AC A: Raising revenue: Unable to make at least normal profits, potential competitors will not be attracted to enter the industry. Allows monopolist to maintain market share and market power, so supernormal profits can still be retained in the long run. L: Monopolist will likely earn less revenue because of the lower price set than at the profit-maximizing price level. This would likely result in lower profits. in extreme cases, the firm may even be earning subnormal profits in the short run.

Third degree price discrimination (Conditions: -some degree of monopoly power -market can be effectively segmented such that resale is impossible -PED value differs for different markets *NO difference in production costs *the 2 goods are perfect substitutes)

H: Price discrimination means the charging of different prices to different customers or for different units of the same product when there are no differences in costs. Higher price charged in the market where PED<1, while lower price charged in market where PED>1 A: Raising revenue: Higher price charged in the market where PED<1, leading to a less than proportionate fall in quantity demanded, so total revenue rises. Lower price charged in the market where PED>1, leading to more than proportionate rise in quantity demanded, hence total revenue rises. A: Lowering costs: Reaps Economies Of Scale by producing a greater output, thus lowering per unit costs L: Revenue will not increase if firms are unable to segment the markets appropriately IMPACT ON... consumer welfare: -consumer surplus falls and no change in consumer choice and product quality Other rival firms -no change in cost, revenue and profits Society: allocative efficiency improves for those charged lower prices, worsens for those charged higher prices, no change in productive and dynamic efficiency EQUITY IMPROVES

(Monopolies and oligopolistic firms) Innovation, research and development (non pricing strategy) (they have incentive and financial ability, incentive depends on contestability and creative destruction by Joseph Schumpeter)

H: Process innovation refers to new or improved production processes perhaps using machines (ii) Product innovation such as improving the packaging of the product (relatively low cost in nature) or may involve more costly R&D, especially if it is technology related. A: Raising revenue, product innovation if successful, improves quality and increases variety of products to increase its demand/AR and make demand more price inelastic. Raises firm's market power by capturing greater market share and deterring the entry of new firms, thus earning higher revenue A: Lowering costs, process innovation allows the firm to raise productivity and lower costs by finding more efficient methods of production, both MC&AC falls L: R&D is expensive, long drawn process, revenue may not rise and cost may not fall in the short run, results not guaranteed.

Shut down

H: Subnormal profits in the short run , needs to decide whether to continue producing or shut down to minimise its losses. If the revenue earned is less than the variable costs, the firm should shut down so that its losses are limited to only the fixed costs. In the long run, the firm should only continue producing if it can cover all costs. (AR>= AVC is short run, dont shut down) (AR<AVC is long run, shut down) A: Shutting down allows firms to minimize its loss and relocate resources for more efficient usage L: Demand and costs condition may change in the future, might not be rational to shut down IMPACT ON... Consumer welfare: fall in consumer surplus since qty falls but final change in market depends on other firms. Fall in consumer choice and no change in product quality. Other Rival firms: No change in cost, total revenue and hence profit increase Society: allocative efficiency worsens, no change in productive and dynamic efficiency EQUITY WORSENS

(monopolist and monopolistic firms) Price competition

H: The monopolist, as with all price-setters, will choose to maximize profits by producing the output, QM, at which MR = MC and MC is rising, and sell at the corresponding profit- maximising price as seen in Figure 4 below. The profit-maximising output, Qs, is similarly determined by the intersection of the MR and MC curves. Monopolist will lower prices if demand for product is price elastic, occasional price cuts to get customers from rivals A: Raising revenue - if demand for product is perceived to be price elastic, lower prices mean more than proportionate rise in quantity demanded which translates to higher revenue L: Other firms may start to reduce prices as well, leading to price war because total revenue may fall instead if other firms are able to reduce prices more significantly due to lower costs of production IMPACT on.. consumer Welfare: Consumer surplus increases, no change in consumer choice and product quality Other rival firms: no change in costs, fall in total revenue and hence fall in profits Society: Improved allocative efficiency, no change in productive efficiency and dynamic efficiency EQUITY IMPROVES

(monopolist and oligopolist) Predatory pricing

H: To drive out existing competitors by reducing its price to P/AR<AC A: Raising revenue: drive out existing competitors by increasing demand for their own products and reduce PED resulting in higher revenue L: Short term subnormal profits to drive out other small rivals. Doing so will certainly require the monopolist/oligopolist to tap on its past profits to sustain its existence

(non pricing strategy) Growth/merger/acquisition E.g. Walt Disney Company acquired 21st century fox in 2019 E.g. Exxon and Mobil in 1999

H: growth i.e. output expansion achieved through internal expansion, or horizontal integration i.e. by merging with or acquiring another firm in the industry and in the same stage of production A: Raising revenue capture greater market share, raise market power and tap on the ready base of existing consumers of the other firm, increase the firm's demand and AR. Also, reduce its PED value (with stronger BTEs and fewer competitors), allowing it to charge higher prices but quantity demanded falls less than proportionately, increasing total revenue. A: Lowering costs Serves a larger combined market so increase scale of production, produce a much larger output, enjoy substantial IEOS, lower per unit cost, lower both AC and MC L: Excessive growth could lead to a fall in demand for the firms' products due to fall in product quality, resulting in fall in Total Revenue and hence lower profits. Internal diseconomies of scale may lead to higher average costs which will lower profits. It is risky because could be unprofitable IMPACTS ON... consumer welfare: Consumer surplus decreases unless firms pass on the lower unit cost in the form of lower prices, and no change in consumer choice and product quality Other Rival firms: no change in cost, fall in total revenue and hence fall in profits Society: -allocative efficiency worsens, productive efficiency improves from firm's POV, no change in dynamic effiiciency EQUITY WORSENS

Product differentiation/Advertising/Marketing (Monopolitically compeititve + oligopolists)

H:The aims are to produce a product that will sell well (i.e. one in high demand) and that is different from rivals' products (i.e. has a relatively price inelastic demand due to lack of close substitutes). For example, this could include a big range of different products of many different flavours, different functions, different specifications and even different packaging, each meeting the different requirements of different consumers. Efforts taken by the firm to promote its product, sometimes drawing on the idea of salience bias. This largely takes the form of advertising, although it can also be done through other means. The firms advertisements to highlight both real and perceived differences. Firms working on a lower budget can do so through low costs ways such as flyers, coupons, banners, promotions, photos with public figures, etc. A: Raising revenue, product differentiation via marketing or advertising aims to produce a product that will sell well, different from rivals' products, increasing demand/AR for firm's products. Degree of substitutability between products are weakened, making demand for its products more price inelastic. Firm charge higher prices and sell more output, hence earning more revenue. Reduces degree of suitability of other products for firm's product, hence lower cross elasticity of demand ie XED value, firm's demand/ARTR falls to a smaller extent if competitor lowers price. L: marketing is expensive, ie the costs incurred to engage an advertising firm to conceptualize and run the advertising campaign, and result is not guaranteed. IMPACT ON... consumer welfare: fall in consumer surplus for revenue-raising strats, but rise in consumer surplus for cost reduction strats (assuming firm passes on cost savins in the form of lower price), consumer choice increases through improvement in product quality. Other rival firms: no change in cost, fall in total revenue and hence fall in profits Society: Allocative efficiency worsens for revenue raising strategies, but improves for cost reduction strategies (assuming firm passes on the cost savings in the form of lower prices), productive efficiency improves from firm's POV for cost reduction strats, dynamic efficiency improves EQU

(competitive oligopoly, BUT NOT ALL) Price rigidity (HAL)

HAL: a competitive oligopolistic market adopts price rigidity -- a scenario where prices of goods and services are often observed to remain relatively unchanged and seldom practices price competition (i.e., neither increase/decrease its price). The underlying assumption is that rival firms will match each other's price reductions but not each other's price increases. This highlights the concept of mutual interdependence between oligopolistic firms and explains why competitive oligopolistic firms seldom change prices even when production costs may change slightly. Any attempt to reduce prices will be matched by rivals, resulting in a loss in total revenue. This same reason also explains why competitive oligopolists tend to be extremely aware of their rivals' decisions and strategies (high rival consciousness). An attempt by any firm to engage in price competition can quickly escalate into a price war, which will be detrimental to all competitive oligopolists in the industry.

oligopoly characteristics E.g. Banks, car manufacturers, supermarkets, petroleum industry and airlines

High barriers to entry which are either natural or man-made, little freedom of entry and exit a few large firms/retailers leading to firms being mutually interdependent products can be slightly differentiated (i.e. some variety and choices for consumers) or homogenous Higher degree of imperfect knowledge

monopoly characteristics e.g. Microsoft, public utilities

High barriers to entry which are either natural or man-made, no freedom of entry and exit due to high BTEs and exit costs One dominant firm Unique product with no close substitutes Highest degree of imperfect knowledge (since monopoly knows everything and refuses to share)

Shut down condition

In the event that a firm is making subnormal profits in the short-run, it will choose to shut down if P/AR < AVC, but remain in operation if P/AR ≥ AVC.

Monopolistic competition characteristics Example: restaurants, fashion retailers, fast food outlets, bbt shops, travel agencies, hawker stalls

Low barriers to entry and exit, freedom of entry and exit many small firms or retailers slightly differentiated products ie many close subs available imperfect knowledge

Perfect Competition Characteristics example: Commodities, agricultural produce like wheat, stock market

No barriers to entry, complete freedom of entry and exit of firms very large number of small firms Homogenous/identical products that are perfect substitutes for one another Perfect Knowledge

Productive efficiency (PC & MC, OLI, MONO) [MOST TO LEAST EFFICIENT]

Productive efficiency is achieved when a given level of output is produced at the lowest cost.