Market Structure (MC & Oligopoly) Section 3 Q2

Part a)

Industries differ in their degree of competition and we divide them into perfect and imperfect compeition based on the degree of control that the firm have over price, freedom with which the firms can enter the industry and the nature of the product. Perfect competition is an economic model that describes a hypothetical market structure in which there are many producers selling identical product and have no market power to influence prices. I

n the case of the petrol retailing stations, as shown in the extract, the players in the industry are few and big. The four main players that can be found in Singapore are Caltex, Shell, Exxon-Mobil and SPC. Due to the small number of players in the industry, they each hold a large market share which enables them to influence prices. As seen in the extract, these petrol retailing stations are able to give discounts, which shows that they are price-setters, unlike perfect competitive firms, which are price-takers.

Next, unlike perfect competitive industries which have no barriers to entry due to the low start-up cost and small output, there is high barriers to entry for the petrol retailing industry. The barriers to entry include the high fixed costs of setting up the stations, obtaining of license to set up the stations and also the strong branding that had received loyalty from customers. In order for a new player that is attracted by the profits of the petrol retailing industry to enter, it will have to apply for a license, arrange for petrol supply and spend enormous sum of money in setting up the infrastructure of the station. Thus, it is different, compared to the easy entry to perfect competitive industry.

Another characteristic that the 4 petrol retailing firms exhibit that the perfect competitive firms do not is interdependence of the firms. Each petrol retailing firm is affected by its rivals actions. As given in the extract, there was a fierce price war among them. This is the result of the firms reacting to price cuts by their rivals. This is because, with the small number of firms in the industry, they have to fight aggressively for a bigger share of the industry profits. This is unlikely to happen in the perfect competitive firms as everyone is a price-taker, selling identical products.

Also, the petrol stations practise non-price competition such as advertising on TV, using posters to display their prices, providing services like wiping of the windscreen when a customer patronizes, giving accumulative loyalty points which may be used to redeem gifts. On the other hand, perfect competitive firms which sells identical products and are price-takers, do not engage in non-price competition as they have no incentive to do so. Therefore, from the above evidence, I conclude that the petrol retailing stations are definitely not operating in perfect competitive conditions as their characteristics are different. Looking at the characteristics that were discussed, classifying them under the oligopoly market structure will be more suitable.


Part b)

Price competition is where a firm attempts to distinguish its product from its rivals by reduction of price. This is contrasted with non-price competition, which is a market strategy where the firm distinguish its product on the basis of physical design, quality, extra services or through advertising. In this essay, I define "desirable" for the petrol retailing industry as the ability to receive higher profits and "desirable" for its consumers as the ability to enjoy better quality products, higher variety of products and low prices.

Price competition can be desirable for the firms. In the short run, a decrease in price due to discounts, will induce an increase in quantity demanded for petrol. This is especially so if consumers are indifferent to the different brands of petrol and deem them as similar. Demand is also more price elastic in the short run for the industry as rivals will not have made any responses to the price cut yet.

(click to enlarge image)

From the above diagram, we can see that as price is reduced from P1 to P2, revenue gained by the firm increased from the purple area to the green area. This is desirable for the firm as increasing total revenue is an aim of the firm.

In addition, market share is enlarged as customers may switch to buy from the firm which is able to give a larger discount, hence enlarge customer base. If the new customers can establish loyalty to the firm, it will enhance the firm's future revenue.

However, price competition can be undesirable, especially for the petrol retailing industry, which is oligopolistic. As a non-collusive oligopoly, the firms' behaviour can be explained by the kinked demand curve theory.

(click to enlarge image)

As shown in the diagram above, price increment of a firm will not be reacted by rivals and thus, demand when price increase is price elastic. However, due to the interdependent nature of oligopolistic firms, price reduction will be matched by the other firms, thus demand during price reduction is price inelastic. If Shell make a price reduction, it can be foreseen that the other petrol retailing firms will reduce prices too. When demand is price inelastic, price reduction will lead to a drop in revenue.

This is especially disastrous for a firm in an oligopoly as it has high fixed cost. The huge discounts given will eat into its profits. In the long run, the one of the firms may not be able to sustain the price competition and may be squeezed out as a result.

Although price competition is desirable for the consumers because it leads to lower cost in using the car, which means higher consumers' surplus, as a firm exit the industry, it is undesirable for consumers as they will now have less variety of choices. Also, with the exit of a firm, supply of petrol in the industry will decrease and prices are most likely to increase again.

Non-price competition, on the other hand, can be desirable for the industry. Through giving out of freebies and accumulated loyalty points and advertising, the petrol retailing firm will be able to make the demand for its product more price inelastic as consumers will perceive its product as more different to its rivals'.

Non-price competition can also allow the firms to attract customers who are interested in their promotional items.

However, non-price competition can be undesirable for the industry as the firms will have to incur a higher cost from the freebies and advertising. This will therefore reduce profits of the firms.

For the consumers, the advantage of non-price competition include getting freebies and getting better service at these firms.

Informative advertising is also desirable for the consumers as it reduces the search cost of the consumers and enable to make better informed decisions as to which product to choose.

On the other hand, advertising, in particular, persuasive advertising may be misleading. Persuasive advertising often sells a form of lifestyle without giving much real information about the product. Consumers may be mislead into believing the advertisements and make decisions that are not wise.

In conclusion, in the short run, price competition may be desirable for both the firm and the consumers, however, in the long run, there are more disadvantages than advantages because of the interdependent characteristic of the industry. As for non-price competition, it is dependent on how the firms are conducting it. If the firms are able to carry out improvement in quality service and provide useful information of their products, it will be desirable for both the industry and the consumers.





Citation:
Price elastic demand curve drawn by yours truly.
Kinked demand curve image taken from http://www.tutor2u.net/


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I think I missed out the P1 and P2 labelling, but I guess you should have no problem figuring out that one right?