Price Makers and Price Takers

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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
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When demand is strong and rising (e.g. during the upturn phase of the economic cycle), a business will have more “pricing power” than when demand is much weaker and falling (e.g. during a recession).
Often a market may be affected by a demand-side “shock” which takes away the pricing power of suppliers. The airline industry in the wake of the terrorist attacks in 2001 could be considered as an example of this.
Summary of the main factors affecting a firm’s pricing power
Influence on Pricing Policy
In order to make a profit, a business should ensure that its products are priced above their average cost. In the short-term, it may be acceptable to price below AC if this price exceeds marginal cost – so that the sale still produces a positive contribution to fixed costs.
If the business is a monopolist, then it has price-setting power. At the other extreme, if a firm operates under conditions of perfect competition, it has no choice and must accept the market price. The reality is usually somewhere in between. In such cases the chosen price needs to be considered relative to those of close competitors and with one eye to the likely reaction of rival firms when a business changes its pricing strategy.
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