Conditions and Consequences of a Price War Essay

The goal of this composition is to “use economic theory and illustrative examples to outline the circumstances under which in turn a price war could take place and the very likely consequences intended for the taking part firms and their consumers”. An amount war is actually a period by which multiple firms competing inside the same industry will react to the various other firms decreasing of price by decreasing their own value. They have immediate and long term advantages and disadvantages.

There are plenty of reasons for which will a price war may take place, in all instances the reason for starting the price warfare is different but the reason for the continuation is definitely not to shed sales. They can be when a company attempts to increase capacity, to get survival reasons, in oligopoly markets, where there are homogeneous products and when a firm switches into a penetrative pricing technique. “Excess capability refers to a predicament where a firm is producing at a lesser scale of output than it has been designed for” Excessive capacity http://stats.oecd.org/glossary/ detail. or net?

ID=3209 [accessed tenth December 2006] If the firm provides spare capacity to produce mare like a good it’s likely they will use this spare capacity to profit maximise but to accomplish that they will have to lower prices to enhance quantity demanded (see appendix item A). As they include decreased all their prices, different competitors will more than likely drop their very own prices in order not to loose customers, creating a price war. Companies who face individual bankruptcy may make an effort to lower their prices so to attract more consumers and increase sales volume. Nevertheless , if they can manage to maximize volume enough to cover the fall in contribution then it is going to fail to cover its adjustable costs and you will be forced to leave the market.

Additional firms may possibly recognise the fact that company is within trouble in addition to a bid to force the organization out the marketplace and not to loose their particular customers will certainly drop their particular prices beneath that of the business facing individual bankruptcy. An oligopoly is exactly where “a few firms discuss a large percentage of the market” Economics Guide, David Gray and Philip Clarke. Within an oligopoly price are usually steady and constant as competing firms is not going to wish to lower price as its opponents will also drop theirs so all that they have achieved is lowering their very own profit margins (see appendix item B).

Yet , one company may imagine it stands to gain coming from a price-cut by thinking they can under-cut the competition through economies of scale or other factors just like slow marketplace reaction. An amount war will start as companies will drop theirs to stop loosing customers. If in a market items are homogenous meaning they are the same one example is utility providers then price are one of the simply means for a strong to distinguish that from others.

In this condition a consumer will always purchase the less costly product. This cause’s fierce pricing competition as each firm will endeavour to maintain product sales by dropping their price below the different competitors. “Penetration pricing entails the setting of reduced, rather than the larger prices in order to achieve a large if certainly not dominant industry share” Charges strategies http://www.tutor2u.net/business/marketing/pricing_strategy_penetration.asp [accessed 10th January 2006]. If perhaps this takes place the additional firms in the market will recognise this and drop their particular prices to avoid that firm from attaining a dominating market share.

The firm taking on this strategy will then also drop their prices to try continuing their particular pricing approach causing an amount war. This tactic can also be used in an attempt to force organizations out of the marketA price war causes more competition among firms, it has both great and bad aspects for the buyers and the engaging firms but these are different in the short-term and long-term. Competition is seen as an optimistic thing in any command overall economy. The short-run benefits for the consumer will be obvious because firms reduce their prices they will be given a better offer this can be seen in a motion along the require curve, there will also be even more consumer’s strenuous the product for the lower price (see appendix item C).

They are also likely to see improvements towards the augmented goods associated with the good as businesses try to compete through non-pricing strategies. These types of services are things such as warranties, loyalty greeting cards and other ‘extras’. The short-run effects after the firms in the market are negative. Firm’s profits will be reduced since the price of the favorable is lowered (see appendix item D). All companies in the industry will be forced to improve their productive effectiveness to reduce total average cost, in an attempt to retain profit-margins whilst prices fall season.

They may also wish to make an effort a heavier marketing campaign to attempt to distinguish by itself from the other firms, although this incurs further costs for the firm. Organizations are also likely to undergo a faster speed of technology and advancement as they distinguish themselves. A few firm’s in the market will be able to work with their financial systems of range to fight lower prices. However other businesses will not have this sort of efficiencies and may not be able to manage variable costs and will for that reason exit the market immediately (see appendix item E).

The long-run affects of a value war are that a lot of firms will keep the market, this kind of causes the demand curve to go back to the original situation, which boosts market-clearing price creating a long-run equilibrium therefore normal earnings are re-established. This is a negative aspect to the consumer’s that will have to pay a lot more than they have in recent periods, also, they are more likely to try and shop round to find the best offer. The good itself is likely to have seen technological advancements as businesses competed to have the most innovative item. There will likewise have been superior services intended for the customers.

The companies left on the market are likely to include better control of costs; this enables them to raise the contribution to profits as the average total cost has become reduced from the product. In summary, a price conflict can be started for many factors such as efficiency by completing spare potential, as a means intended for survival, in intense competition in oligopoly markets, to differentiate a product or service and to build up brand name or force other firms out of your market. Yet , the consequences are usually very similar, several firms will emerge since dominate and others will keep the market.

This can have both good results and bad effects since consumers can initially be happy with lower prices but when the long-run equilibrium makes effect they are going to search more difficult for bargains. They will also see advancements made to the item and solutions. The living through firms excel from the price war; they are likely to discover higher demand for their product, as there are fewer competitors.

Additionally they are likely to attain greater successful efficiency therefore greater profit margins. “Vigorous competition between organizations is the lifeblood of solid markets and is also a central to output and growth in the economy” International Competition (2001) UK Labour GovernmentBibliography•Hardwick, Khan, Langmead (1994) An Introduction to Contemporary Economics fourth Edition•Lipsey, Forrest, Olsen (1993) An Introduction to Positive Accounts•Hunt, Sherman (1990) Economics An intro to traditional and major views•Sloman, David (2000) Economics 4th Edition•Begg, David (2005) Economics 8th Edition•Sloman, John and Sutcliffe, Mark (2004) Economics for people who do buiness 3rd Edition•http://www.tutor2u.net [accessed 10th December]•http://en.wikipedia.org/wiki/Wiki [accessed tenth December]•Price War, What exactly is it good for? http://mba.tuck.dartmouth.edu/pages/faculty/koen.pauwels/pdf/Price%20War%20what%20is%20it%20good%20for.pdf [accessed 10th December]References•Excess ability http://stats.oecd.org/glossary/ depth. asp? ID=3209 [accessed 10th 12 , 2006]•Economics Handbook, David Gray and Peter Clarke•Pricing strategies http://www.tutor2u.net/business/marketing/pricing_strategy_penetration.asp [accessed 10th December 2006]•International Competitiveness (2001) UK Work GovernmentAppendixItem AAs the company increases the source through using the spare ability, supply shape shifts left from S1 to S2 as a result industry clearing cost falls although quantity increases.

Shifts in supply shape http://www.auhy69.dsl.pipex.com/images/dd202/b2p.jpg [accessed 10th December 2006]Item BIn this picture you can see that in an oligopoly market it is usually unfavourable intended for the oligopoly firms to change their selling price, so it becomes static. Value Competition in Oligopoly Market, Foundations of Economics Guide (2006) David Gray and Peter ClarkeItem CA Movement along the require curve increases the quantity demanded but decrease selling price. Require and Supply www.investopedia.com/university/economics/economics3.asp [accessed 10th December 2006]Item DAs the price is set reduce from P1 to P2