Pricing strategies

Pricing strategy and promotions

These never exist with perfect competition – as all firms are price takers! There is no need to advertise one’s own product as the tiny firm can sell all that it can produce at the same market price.
Under monopoly there is some need to advertise to keep the product name alive; some of the ads might be of the “Our Company is really nice” type which you will see on TV now and then.
Oligopolistic firms very commonly advertise because they have a competitive structure and a downward sloping demand curve. They have constantly to compete with their rivals.
With monopolistic competition there is also a lot of advertising, again because of the very competitive structure and the downward sloping demand curve for their product.

Cost-plus pricing

The price is set as the average cost of item + a percentage mark-up.

Predatory pricing

This is when a firm deliberately makes a loss by charging a low price in the short term in order to drive out rivals or new entrants; in the long term this means higher profits for the firm as it can enjoy a higher price. It also means an easier life with fewer worries about the actions or reactions of rivals.

Limit pricing

This can be a feature of oligopoly: the firms may try to prevent new entrants by agreeing on a price that they will all charge. It will ensure that they all make good profits but not maximum profits. The price and profits are not quite high enough to attract other firms to the industry but will be above those set in perfect competition.

Advertising and sales promotion policies

Advertising is designed to move the demand curve outward and to the right. It may also serve to make the demand curve for the firm’s product less elastic when compared with competitors’ curves. This means a higher price can be charged and more revenue and profits gained.

Non-price competition

One often sees this with supermarkets. It may include:

Special promotions. These may take the form of competitions where one has to send in two or more box tops to enter; or special offers like 2 for 1 – a form of price competition that can stopped and started easily without changing any printed advertising material.
Home delivery.
Store loyalty cards (which also track what each customer buys and how often, which is most useful information for the store).
Extended opening hours, including Sundays and holidays. Selling petrol on the forecourt.
Services such as a chemist being available, dry-cleaning, or photo-printing.
Internet shopping facilities.

“Contestable markets”

This occurs where we have a monopoly or oligopoly, but that has few or no barriers to entry and exit. This can force the firm(s) to keep price reasonably low and competitive in order to prevent others entering. So although it may be a monopolist it does not actually behave like a monopolist and therefore does not enjoy high monopoly profits.

William Baumol invented the model. He saw such firms producing at the bottom of their average cost curve. They have to be efficient or other firms would enter.

For policy purposes, it means it may be better to consider reducing the barriers to entry and exit rather than focussing on the degree of competition or market concentration ratios as we usually do.

Barriers to entry include:

High sunk costs (fixed costs).
Whether a firm can lease equipment or not. If it is possible to lease, then a new firm can enter or an existing one leave easily, because it does not have to buy or sell the aeroplane or whatever is necessary.
Advertising and brand recognition. It is harder to break into an industry if there is a well-known product already dominating it.
The existence of over-capacity which was deliberately built so that the existing firm can flood the market quickly with more products at lower prices, if a new entrant tries to get in.
Predatory pricing. The simple undercutting of the newcomer until he goes bankrupt.