Price and non-price policy

Pricing policy

Firms operating under perfect competition cannot influence the price they get in the market.

If the firm reduces price in an attempt to increase sales, it faces the problem of not breaking even, or even shutting down. This is because, in the long-run, it operates where price equals average cost, and total revenue equals total cost. Any reduction in price not matched by a reduction in costs will mean it will make a loss. If it cannot cover at least its average variable cost, it will shut down.

In fact, a firm operating under perfect competition can sell all it produces and does not need to reduce price.

If the firm tries to raise price, it will suffer a complete collapse in demand - the demand (AR) curve is perfectly elastic (and horizontal).

Non-price policy

There are several reasons why a firm operating under perfect competition does not need to introduce non-price competition.

Firstly, as mentioned, the firm can sell all it can produce.

Non-price competition, such as advertising and sales promotion, creates a cost that will push the firm towards shutting down.

In theory, consumers have 'perfect knowledge' of the market and its competitors, and firms have no reason to advertise.

Read more on perfect competition.

Pricing policy

Firms operating under monopolistic competition are price makers and face a downward sloping demand (AR) curve, and therefore can influence the price they get in the market.

A key feature of a firm operating under monopolistic competition, such as a local restaurant, is that it can differentiate its products, and charge various prices.

This means that they can offer price discounts to attract new customers - how successful this is depends upon the price elasticity of demand for their own products. If they face an elastic demand (perhaps because there is considerable choice in the market) a price discount is both possible, and desirable in terms of its objectives.

Non-price policy

Monopolistically competitive firms may use non-price strategies to differentiate, depending on the nature of the market. For example, a local restaurant may differentiate in terms of opening hours; the menu; whether it offers a take-away or delivery option; the quality of the staff; and the restaurant decor.

This also means they need to communicate this to potential customers, and may use local advertising or targeted internet advertising, special promotions, and gifts.

A successful advertising campaign will mean that D(AR) shifts to the right (along with MR), leading to an increase in super-normal profits. However, in the long run this will attract new entrants into the market, eventually reducing supernormal profits back to zero (with only normal profits being made.)

They could also use billboards and 'ambient' advertising on local buses and taxis.

Read more on monopolistic competition.

Pricing policy

Firms operating under conditions of oligopoly can influence the price they charge in the market.

Given that firms operating in oligopolistic markets are mutually interdependent, they operate under conditions of considerable uncertainty. This means the temptation to collude is great.

This could take several forms, including operating a price leadership strategy - perhaps where the dominant firm raises price, and smaller firms follow the leader. This strategy avoids the price-war problem, illustrated by the kinked demand curve.

Both raising and lower price is risky because rivals may or may not follow suit - when price is raised, rivals are more likely not to follow suit, and quantity demanded falls to Q1. When an oligopolist lowers price, rivals are more likely to follow suit, and demand rises, but only to Q2. The increase in demand occurs because there is likely to be a lag between the reduction in price, and the response of rivals. In both scenarios, revenue falls. This means there is a tendency to stick at one price.

However, price leadership can avoid this issue, and all firms can gain if they all raise price together (in concert). If the market has created an unwritten rule that when firm X raises prices, firms Y and Z also raise theirs, then the collusion has been tacit and is hard for regulators to identify.

A similar 'rules based' pricing strategy is to employ a 'cost-plus' pricing strategy. If all firms in the market face similar costs, and if all use similar pricing formulae, then a rise in costs will lead to price rises across the whole market. Again, this removes the need for a high-risk competitive strategy. See more on cost-plus pricing.

Like monopolies, oligopolists can also employ price discrimination as a profit maximising strategy. (See more on price discrimination).

In addition, oligopolists can attempt to limit entry into the market by reducing price to limit entry into the market. In this case, limit pricing is also a strategy to retain market power by creating a barrier to new entrants.

If the firm tries to raise price, it will suffer a complete collapse in demand - the demand (AR) curve is perfectly elastic (and horizontal).

Non-price policy

Building a brand name and brand reputation is especially important to oligopolists, who may use a range of non-price strategies to achieve their objectives:

Oligopolists may use national and international advertising including targeted internet advertising.

They are also likely to use special promotions, gifts and offers, and could introduce a national billboards campaign.

Oligopolists often use PR (public relations) to help build their brand to create loyalty and built trust.

Read more on oligopoly and game theory.

Pricing policy

Monopolists have the potential ability to raise their price, without the uncertainty of what rivals will do. However, a monopolist cannot force consumers to purchase their products, and must take market demand into account. For example, if demand is elastic, then raising a price is counter-productive as total revenue will fall following a price rise.

Although a monopolist has no close substitutes there is always an alternative that consumers could use. For example, while London Underground is a monopoly in terms of metro travel, there are other alternative ways to travel.

Monopolists can also use price discrimination to separate up its market - indeed, price discrimination is most strongly associated with monopolies, although any firm with monopoly power could price discriminate.

A monopolist could also use limit pricing to reduce price to the level that prevents new firms entering.

Non-price policy

Although a monopolist has no direct competitor it may still choose to advertise. This is because, despite being a price maker, it cannot force consumers to purchase products.

In attempting to maximise its revenue or profits it will attempt to increase demand and, graphically, push its demand (AR) curve to the right, as shown:

As with oligopolists, monopolists may use national and international advertising including targeted internet advertising.

Monopolists are also likely to use special promotions, gifts and offers, and could introduce a national billboards campaign.

Read more on monopoly.

Pricing policy

However, because they face extremely high start-up and distribution costs (including the cost of building and operating supply infrastructure), they would clearly prefer to set high prices. However, to benefit from economies of scale they need a high level of sales volume to operate at a low cost which would act as a constraint on setting high prices.

For example, a gas or electricity supplier may face high costs in building an infrastructure and maintaining it. If it charges an excessively high price the quantity sold will fall - consumers will cut back on their usage of gas and electricity. This may create a social harm to those on low incomes. This means regulators may prevent the natural monopolist from setting unaffordable prices by using a price cap.

Like all monopolists, the natural monopolist has no close substitutes but there may be an alternative that consumers could use. For example, users of gas for central heating could switch to electricity. However, unless the market is effectively regulated, natural monopolists supplying essential services, such as water and energy, could exploit their monopoly status.

It is for this reason that prices are likely to be heavily regulated to ensure that 'social objectives' are achieved alongside the business objectives of the operators.

Natural monopolists commonly use price discrimination to separate up its market, and frequently use peak and off-peak pricing to maximise revenue (or profits).

Non-price policy

Although a natural monopolist has no direct competitor it may still choose to advertise. This is because, despite being a price maker, it cannot force consumers to purchase products, and it needs to obtain the highest level of sales possible to gain from economies of scale.

In attempting to maximise its revenue or profits it will attempt to increase demand and, graphically, push its demand (AR) curve to the right, as shown:

As with pure monopolists, natural monopolists may use national and international advertising including targeted internet advertising.

They may also use special promotions, including loyalty schemes and gifts.

Read more on natural monopoly.