Several of Positive Roles to the Average Consumers - Essay Example

?PRICE DISCRIMINATION Price discrimination is a practice of selling the same product at different prices to different s (Mankiw, 2009). This refers to a situation where a firm decides to sell a product at different prices for different sets of customers. REASONS FOR PRICE DISCRIMINATION Firms indulge in price discrimination for several reasons. Armstrong (2006) identify two of the most cogent reasons for price discrimination. First of all, a firm might utilise price discrimination to ensure that it gets the highest economic returns from consumers. In this vein, a firm might use price discrimination to increase sales. Secondly, a firm might use price discrimination to prevent other competitors from capturing the market, for example, a UK business might want to lower prices in a town where cheap Chinese competitors are trying to penetrate. CONDITIONS FOR PRICE DISCRIMINATION For price discrimination to be successful, there are two main conditions that must exist in the market (Tutor2u). First of all, there must be differences in price elasticity of demands between the different markets within which a firm operates. This means that the firm can increase the price of a given product where the demand is inelastic because customers will buy anyway. However, where demand is elastic, prices need to be kept low because it can lead to buyers refusing to buy and the firm will run at a loss. The second condition necessary for price discrimination is that there should be barriers that prevent consumers from switching from one supplier to another. This is because when consumers have options, they are likely to switch to other brands or substitutes when prices fluctuate in a way they find unfavourable. Price discrimination could be beneficial or detrimental to consumers. It could be beneficial when the prices are reduced or promotions are run. However, there are some price discrimination drives that exploit consumers. FORMS OF PRICE DISCRIMINATION First degree price discrimination is where prices differ for customers based on the amount of money groups of consumers are willing and able to pay for a given product (Fisher & Waschik, 2002). An example is where global newspapers like Time Magazine is sold for different prices in the US, UK and the EU. Another example is the fact that some professional groups like Chartered Institute of Marketers charge different prices for students and different prices for members although they can access about the same privileges. Second degree price discrimination occurs when prices are varied based on quantities of goods purchased by a consumer (Fisher & Waschik, 2002). An example is a situation where a person gets a discount for buying a certain quantity of goods. Another example is where businesses run promotions where people are given extra units of a product when they buy a given quantity of the product. Third degree price discrimination is where a producer segments the market and varies prices because of distance, cost of production in zones or customers’ identity (Fisher & Waschik, 2002). An example is where a factory based in London charges clients in New York more. Another example could be the situation where university students from some countries are charged higher fees. CASE STUDIES When Tesco sells Digestive biscuits at ?2.10 per pack, but also have a ‘3 for the price of 2’ offer, there is a second degree price discrimination. The rationale for this is that Tesco wants to increase sales and with a large volume of biscuits sold, they will get a large volume of profits which will be collectively higher than the profits they would have gained by selling a smaller quantity of biscuits at ?2.10 per pack. Also, the profits will come in faster and they can use the revenue for other business activities. In a situation where the return train fare from Birmingham to London is ?35 at 11am, but is ?200 at 8am, it can be concluded that the managers are utilising the principles of the elasticity of demand here. This is because at 8am, there is a high number of people ready to travel from Birmingham to London (mainly to work) and they are willing to part with whatever amount to arrive on time. Their demand at this point is inelastic so the train company charges more. However, at 11am, few people are willing to move from Birmingham to London so demand falls. At this point, passengers are not willing to pay much so the train company sets the price lower to ensure a steady flow of revenue at off-peak times. This is first degree price discrimination. In a situation where KLM airlines have a return fare of ?550 from Birmingham to Shanghai for a economy class ticket, and ?2,000 for a business class ticket, there is a third class price discrimination. This is because KLM segments the markets and finds out that there is a group of richer travellers who can pay some extra money for a more luxurious place on the airline whilst there is another set of customers who can only afford the basic no-frills package. In a situation where students pay different rates for movies, we can say there is a third degree price discrimination because the movie company identifies that although students are potential clients, they might be priced out if they are made to pay what everyone else pays so they decide to reduce the price to an amount they can afford, to ensure that the company gets some income from these students. When a printer is almost as expensive as an ink cartridge, it can be inferred that the seller is using first degree price discrimination. This is because the seller reduces the price to ensure that people buy those printers. However, the ink cartridge is complementary with the printer so the printer must always be used with an ink cartridge. The seller therefore sets the prices of cartridges higher to ensure that customers keep on returning and they keep on making sales. MARKET STRUCTURES Market structures can be defined as the shared characteristics of a given market including relative strengths of buyers and suppliers, level and form of competition, extent of product differentiation and ease of entry and exit (Business Dictionary). There are four main types of market structures: 1. Perfect competition, where there are many buyers and sellers and no one can influence prices. An example is the deregulated European airline industry. 2. Oligopoly: Where there are several large sellers with some control over prices. An example is the software industry where Microsoft and Linux have a considerable control over the industry 3. Monopoly: Where there is a single seller with a high degree of control over supply and prices. An example is OPEC, which is the sole producer of petroleum for a number of nations. 4. Monospony: Where there is a single buyer with considerable influence over demand and prices. An example is Cuba, where the government is the main buyer of most of the services produced within the nation and has considerable influence over prices and demand (Business Dictionary). THEORY OF CONTESTABLE MARKETS The theory of perfectly contestable markets is concerned with markets where there is ‘ultra-free’ entry, that is barriers of all kinds do not exist and exit is costless (Baumol et al, 1982). In the UK airline industry, there is free entry this is because there is no regulation that prevents people from entering the industry. There are no unfair monopolies and cost advantages and patent rights that are required by new entrants. Once an entity has enough capital, they can start operations. Entry into the airline industry is absolute, in that once you enter and maintain the right practices, you can operate without interruptions. So once your financial position is clear and sufficient, you can stay in as long as you please, until you decide on your own accord to fold up. Thirdly, there are no sunk costs, in that a new entrant in the airline industry is not required to make some deposits (like banks are). These three points; free entry, absolute entry and no sunk costs make the UK airline industry a perfectly contestable market. OPEC AS A NATURAL MONOPOLY AND ITS IMPLICATIONS TO CONSUMERS ‘OPEC is an example of a natural monopoly and is beneficial to consumers’. Discuss OPEC The Organisation of Petroleum Exporting Countries (OPEC) was formed in 1960 with the aim of pooling the bargaining power of petroleum exporting nations mostly in the developing world (OPEC.ORG). Petroleum is vital in the economies of all nations around the world. Nations use petroleum products to run their industries and ensure that there is the production of goods for consumption in nations. Additionally, petroleum products act as fuel for cars and several vehicles that ensures that goods and persons are moved from place to place. This puts crude oil at the centre stage of performance in the global economy. FUNCTIONS OF OPEC OPEC is a bloc of nations in the developing world that acts as intermediary for the control of the sale and production of oil. The mission statement of OPEC is as follows: “To coordinate and unify the petroleum policies of member states and ensure stabilisation of oil markets to secure efficient, economic and regular supply of petroleum to consumers and steady income to producers and a fair return on capital” (OPEC.ORG). OPEC ensures that all member states use the same standards and policies for the production and export of petroleum products. OPEC also sets quotas for its member states and this ensures that there is a regular supply of oil for nations around the world. With OPEC’s role in producing and selling petroleum products, they have a wide scope of control and influence in setting a reasonable price for petroleum and these prices are fixed for all nations around the globe. NATURAL MONOPOLIES “A natural monopoly is an industry in which advantages of large scale production makes it possible for a single firm to produce the entire output of the market at lower average cost than a number of firms each producing smaller quantities.” (Baumol & Blinder, 2009) A natural monopoly comes about when a business has the ability to produce a very large quantity of goods and sustain very high cost advantages that ensures that other businesses cannot compete effectively with them. According to Baumol & Blinder, natural monopolies often come up when there are legal restrictions in an industry or there are patents. A firm can also become a natural monopoly when it controls scarce resources or there are deliberately erected entry barriers. Additionally, a business might become a natural monopoly when it has large sunk costs, has technical superiority or very huge economies of scale. OPEC AS A NATURAL MONOPOLY Currently, OPEC is made up of 12 countries and produces 110 billion barrels of petroleum each day (OPEC.ORG). This represents 44% of the world’s oil consumption and collectively, OPEC nations control 79% of the world’s oil reserves (Turquoise Partners). OPEC can be seen as a natural monopoly because it is seen as a dominant force in the oil production business on the global level. Due to this, OPEC is respected in negotiations about oil prices because they have the power to influence the flow of petroleum around the world. This gives OPEC a legal status in the international community that cannot be disregarded. Crude oil is a scarce commodity that many nations cannot produce on a substantial level. This creates a clear distinction between OPEC members and non-OPEC nations. Due to the fact that OPEC can produce excess quantities of crude oil, it has the power to determine the prices and supply of crude oil around the world. OPEC members are nations that have sunk huge amounts of money for the drilling and transportation of oil. These costs range from exploration to extraction through to the transportation of crude oil. These infrastructure costs a lot of money that other nations cannot easily set up to begin competing with OPEC nations even if they discover oil in their nations. Also, other nations might have limited reserves of oil. However, due to the fact that OPEC nations have large quantities of oil reserves, OPEC nations enjoy extremely high economies of scale that nations with limited reserves stand to gain if they invest as much as OPEC nations have invested. This ensures that OPEC nations remain the only dominant force in the mining and export of oil resources. ADVANTAGES OF OPEC TO CONSUMERS With the fact that many nations and individuals are heavily dependent on crude oil, it looks like OPEC has the power to exploit average consumers. On the contrary, OPEC plays a number of positive roles to the average consumers. First of all, due to the large volume of production of OPEC, it enjoys a lot of economies of scale, in that a lot of the infrastructure in OPEC nations was set up many years ago and these nations have reached break even points so they do not incur much by way of cost of production. This therefore means that the cost handed over to the final consumer is much lower than it would be if there were smaller firms producing crude oil. Secondly, each member state of OPEC has a daily quota of oil production it has to honour. This ensures that there is regular and sufficient supply of oil for every consumer around the globe. Again, OPEC acts as an institution that encourages bulk and large scale technical and financial investment. This brings about specialisation and efficiency which ensures that the final consumer gets petroleum products at a cheaper price Also, with OPEC negotiating as the main face of petroleum producing nations, stakeholders can easily approach them and make demands that can be met uniformly without much issues. In conclusion, OPEC can be considered a natural monopoly. However, acting as a monopoly comes with some positive attributes to the world and the final consumer. References Armstrong, Mark (2006) Price Discrimination UCL Department of Economics. Available at: http://else.econ.ucl.ac.uk/papers/uploaded/222.pdf Baumol, W., Panzer, J. & Wellig, R. (1982) Contestable Markets & The Theory of Industry Structures NY: Harcourt Brace Jovanovich Baumol, William & Blinder, Alan (2009) Economics: Principles & Policy Mason, OH: Cengage. Business Dictionary: Market Structures. Available Online at: http://www.businessdictionary.com/definition/market-structure.html. Accessed: 11th March, 2011 Fisher, Timothy & Waschik, Robert (2002) Managerial Economics: A Game Theoritical Approach Abingdon, Oxon: Routledge Mankiw, Gregory, N. (2009) Principles of Microeconomics Mason: OH: Southwestern Cengage Organisation of Petroleum Exporting Countries Website. Available Online at http://www.opec.org/opec_web/en/about_us/23.htm Accessed 10th March, 2011 Turquoise Partners. Available online at: http://www.turquoisepartners.com/iraninvestment/IIM-Nov10.pdf Accessed: 11th March, 2011 Read More