Auto Edges Market Structure - Coursework Example

Auto Edge’s Market Structure Introduction Before we categorize the automobile industry and thus Auto Edge, it is important to study the inherent characteristics in the individual market structures. In a perfect competition, the economic factors must all be available. They include all firms selling identical products, all firms having a relatively small market share, the firms are price takers, there is freedom of entry and exit by the firms and the buyers know the nature of the product being sold, as well as, the prices charged by each of the firms. However, in practice, these factors seldom exist together in any given industry because degrees of differentiation exist in them. A market structure will, therefore, be built around factors like the entry and exit, extent of the government involvement, mechanisms of pricing (is the firm a price taker or giver), the number of players, the elasticity of demand, and the profits. Other market structures are such as, the monopolistic competition (where the products are differentiated either by quality or brand and, which a firm takes the price charged by its rivals as given completely ignoring the effects of its own prices on others). Monopoly (this is the price maker and the producer exists in the market alone), monopsony (where there is only a single buyer in the given market). In a monopoly, factors such as the economies of scale, acts of parliament, high initial investment amount, to mention but a few, might contribute to their establishment and thriving (McEarchen, 2013). So, what market structure does the automobile fit in? Oligopoly is seen to be the most prevalent kind of market organization in the manufacturing sector in most countries (Falter, 2011). Auto Edge fits in the oligopolistic competition market structure. Oligopoly is defined as a form of market structure where there are few sellers of a homogenous or sometimes differentiated product. When there are two sellers only, the structure is then called a duopoly. When the product being sold is just homogenous, then we have a pure oligopoly and when the products pass for differentiated, it is then classified as a differentiated oligopoly. Because there are few firms selling a differentiated or homogenous product in oligopolistic markets, the activities of one firm affect the other firms in the industry. For example, when General Motors had price rebates in the sale of its automobiles, Ford immediately followed with its own price rebates. Additionally, because price competition usually amount to ruinous price wars, oligopolists will prefer to compete on the grounds of product differentiation, service, or advertising. These strategies are termed as non-price discrimination (Falter, 2011). Since this market structure is laced with interdependence, every oligopolist knows that their own actions have a very significant effect on the other oligopolists. Thus, they must consider the proximal and necessary reaction of its competitors when deciding its own pricing policies, level of advertisement to be undertaken, the amount and kind of service to provide, and the degree and levels of product differentiation to be employed (Falter, 2011). What breeds oligopoly? One or all of these factors can bring about an oligopoly structure: Massive capital investments, as well as, specialized inputs that are usually needed to enter this industry. It normally act as a very significant barrier to new entrants. Economies of scale. They may operate over a sufficiently large range of outputs to leave very few firms to supply the entire market. A few firms usually have loyal customers. It is commonly based on the product quality and service that new firms find very difficult to match or beat. The government can give a franchise to only a few firms to operate in the market. Few firms might control or own the entire supply of a raw material that might be required for the production of the product or service (McEarchen, 2013). According to economists, (McEarchen, 2013), the type of the product produced can affect the strategic behavior of oligopolists giving rise to two contrasting behavior of oligopolists namely; cooperative oligopolists (where an oligopolistic firm conforms to the pattern of the rival firms) and non-cooperative oligopoly (the oligopolistic firm will not follow the rival firm). In this scenario, for instance, when General Motors raises the prices for its products, Auto Edge might respond by keeping its prices low in a bid to retain its customers or lure the customers away from GM. However, as noted above, this behavior is only strategic because factors such as consumer loyalty, the product quality and other marketing strategies play an integral part in determining the direction of prices, competition and the elasticity of demand (Falter, 2011). In this market structure, with each firm trying to make a resounding effect on the rival firms, price rigidity is a common occurrence. A study into this market structure has suggested that a firm will maximize profits when MC=MR. A good example of a model explaining the concept of price rigidity and consequently the firms decisions not to compete on the price is the Paul Sweezy’s kinked demand curve model (McEarchen, 2013). Proponents of this theory claim that the kink in the demand curve is occasioned by the asymmetric behavior of the firms that makes the prices remain stable or “stick” to a large extent. For example, when Auto Edge decreases its prices, other firms are likely to follow suit. If it decides to increase its prices though, other firms are likely to remain exactly where they are. Thus, according to (McEarchen, 2013: 220-4), a reduction in price from P1 to P2 will result in a movement along the demand curve increasing sales from Q1 to Q2 having a net effect of Q (2-1) units in sales. Since other firms are selling at relatively the same prices, this effect of price reduction is a movement down the relatively inelastic demand curve as illustrated in the figure below. At the kink, the marginal revenue is seen to have a discontinuity at AB depending on the elasticities of the different parts of the demand curve. When the firm is profit maximizing, where MR=MC, it will not change its prices even when the costs change. Figure 1: Oligopolies and competition (McEarchen, 2013). As already discussed, many of the firms in an oligopolistic structure may not entertain competition because it is mutually disadvantageous. Not to forget that in this case competition is measured in terms of advertising, prices, and the product quality. For example, for Auto Edge to compete in the market, it might end up selling its products at low prices or employing high advertising that will translate to very high production costs and consequently lower profits. Strategic decision-making and thus game theory is utilized. A very simple illustration for game theory is the “prisoner’s dilemma”. Suppose that two prisoners are arrested and charged with stealing. They are then held and interrogated separately (McEarchen, 2013: 230). However, each is told the same thing: if your partner confesses, and you refuse to, you will face five years in prison. If your partner confesses and you confess, you will face one and a half years in prison. However, if you both refuse to talk, you will receive eight months in prison and a stern talking. The interrogator explains to each that they are better confessing than not confessing in case the other one refuses to confess (McEarchen, 2013). Evidently, two firms in an oligopoly may be in a position whereby they can maximize their joint profits through agreeing to restrict the output and drive the prices up. However, if one suspects the other will cheat, each of the firms will resort to producing more than was agreed on making competition much more complex. When these companies, for example Auto Edge and General Motors and Maruti may not reach a consensus to collude, repetitive games will result in a kind of collusive agreement (McEarchen, 2013). However, when it is a one shot game like in the prisoner’s dilemma, competition is much difficult to grasp and undertake. In conclusion, players in the automobile industry have a host of factors that influence the prices, the elasticity, the competition levels, as well as, the behavior of their rivals (Falter, 2011). These business practices such as price leadership can be used as an alternative and cooperative method in avoiding tough competition, harmonizing prices, regulating profits and having a good business environment for Auto Edge. In addition, there is no clear cut between monopolistic competition and oligopoly although they seem different on the surface. While for a firm industry, it is most certainly an oligopoly and a 4000 firm industry a monopolistic competition, a 40 firm industry will fall in between these two. References Falter, R (2011). The effects of Oligopoly in the US Automobile Sector on Pricing and Development. Norderstedt: GRIN Verlag. McEachern, W. A. (2013). Microeconomics: A contemporary Introduction. Boston; Massachusetts: Cengage Learning. Read More