S12

IGCSE®/O Level Economics

4.4 Competition

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Why do firms compete?
Firms compete to:
• increase their customer base
• increase their sales
• expand their market share
• achieve product superiority
• enhance their image and the image of their products
and ultimately to:
• increase profits
Competition between firms is good for the consumer. Competition
encourages profit-seeking firms to use their resources efficiently to
compete on prices and products, so that consumers buy from them
© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Types of competition

Price competition Non-price competition

Competing with rival suppliers on product Competing on all other product features other
price than price

But if demand is price inelastic, revenue will For example, new product development, after-
fall; if price is cut below average cost, each sales care, and promotions including
unit will be sold at a loss advertising, in-store displays, competitions,
etc.

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 The power of advertising
• It can create and increase consumer wants
for a product

• It can create a powerful brand image for a

product and increase customer loyalty
Brand loyalty has the following benefits:
 It leads to repeat purchases
 It protects sales and market share
 Customers are willing to pay more for the
brand
 Customers continue to buy the brand if the
producer increases its price over rival
products

• It can reduce competition

Smaller firms will be unable to spend as heavily
on advertising as larger rivals
© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Pricing strategies

Demand-based pricing Competition-based pricing

Price skimming: setting the price if Predatory pricing: undercutting the
there is little competition prices of rival firms in an attempt to
drive them out of business
Penetration pricing: setting a low Price leadership: rivals setting their
price for a new product to boost its prices at or near the price charged by
sales and increase market share the market leader to avoid a price war

Cost-based pricing
Cost-plus pricing: setting price
equal to average cost plus a fixed
or percentage mark-up for profit

But this takes no account of what But predatory pricing

consumers may be willing to pay or (also called destruction
how much competition there is to pricing) can result in
supply the market damaging price wars

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Market structure
The characteristics of a market include how many firms compete to supply it, the degree
of competition between them, the extent of their product differentiation, and the ease with
which new firms can enter the market to compete with them

PERFECT PURE
COMPETITION MONOPOLY

Number of firms supplying market

Many suppliers Single large supplier
with identical products rising : falling

Individual firms have The monopoly firm

no control over can determine
market price Pric market price
es

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Competitive markets
A competitive market will display many of the following features:

•There will be vigorous price competition and non-price competition between

firms

•Firms will pursue different pricing strategies

•Product features and brand images will be highly differentiated
•The range of product designs available and the quality of after-sales
services will tend to change frequently

•Market shares and profits of competing businesses will vary over time
•New firms will be able to enter the market and less efficient
firms that are unable to compete will be forced to close

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Monopoly
A single firm or group of firms acting together with sufficient market power
to restrict competition and set the market price is a monopoly

A pure monopoly controls the total

supply of a product to a market
A monopoly may restrict supply to
force up the market price and earn
abnormal profits
i.e. excess profits above what they
would be if there was competition

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Problems with monopolies
A monopoly may abuse its market power to:
Swisscom may be fined
restrict market supply to force up market price for overcharging
customers
restrict competition and consumer choice Regulator
promises
energy su to
ppliers mo end
cut product quality to save costs nopoly
EU investigates IBM over
In addition, there may be: ‘abuse’ of market power
x-inefficiency
A monopoly may be poorly managed and inefficient because it does not face any competition

a need for regulation

Governments may have to use resources to investigate and punish abuses of market power

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 How monopolies can restrict competition

Artificial barriers to entry may be used by a monopoly to restrict competition unfairly by:
•using predatory or destruction pricing to force rivals out of business
•threatening major suppliers that it will stop buying from them if they supply rival firms
•threatening retailers to stop supplying them with their product if they stock rival products
But:
Natural barriers to entry are not necessarily bad. They occur because large-scale
production is often more efficient.
Smaller firms may be unable to compete with larger firms on costs and revenues because:
•large firms may enjoy significant economies of scale that give them a natural monopoly
•small firms cannot match the capital investment needed for large-scale production
•large firms may have built up significant customer loyalty over time
•some large firms may have a legal monopoly because they have patents to protect their
innovative products and technologies from being copied
© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Regulating competition
Competition policy refers to measures governments
use to control the behaviour of firms acting anti-
competitively and against the interests of consumers

(1) Regulating the prices and service levels of

monopolies
(2) Imposing fines on firms that abuse their
market power
(3) Forcing monopolies to break up into smaller,
competing firms

Consumer protection laws protect consumers from exploitation and harmful

business activities, e.g. it is an offence to sell goods or services which are unsafe or
in an unsatisfactory condition or to mislead consumers about prices and products

© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
 Not all monopolies are bad
A firm that is a monopoly may still act competitively and be good for consumers if:

• It is a more efficient producer

with lower costs than smaller
firms

• It faces competition from firms

overseas and consumers are
able to choose products that are
close substitutes

▲ Some revolutionary products, like the jumbo jet and photocopier, may
never have been developed if the business organizations that invented
• Its market is contestable, i.e.
them were unable to enjoy monopoly profits. Abnormal profits were a there are few or no barriers to
reward for their significant investment risks. entry

• It invests its profits in new

product developments
© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute