- There are many firms in the industry, thus an individual firm's contribution to total industry supply is so small that whether a firm produces at full capacity or not at all, market price will not be significantly affected.
- There is a freedom of entry into and exit from the industry firms. There are no significant financial, legal, technological or other barriers to new firms entering the industry or existing firms leaving it.
- All firms in the industry sell identical/homogenous product. It makes perfect competition so extremely competitive and so rare. The important thing is that the product of a firm is considered by the buyers to be the same as that of any other firm. This ensures that no buyer has any economic incentive to pay any firm higher price for the product than is charged by other firms.
- Each firm is a price taker and has no influence on the market price. They are unable to affect the prices by changing the amount of product that is offers for sale (Fig 1). This is because the output is such a small portion of total industry supply that has nearly no effect on market supply. Therefore the firm has to be a price taker; otherwise, it will reduce profit.
Fig 1: Market price and demand for the perfectly competitive firm
In the real world the perfect competition is rare. The model of perfect competition serves usually as a benchmark of economic efficiency against which real world markets can be measured. Nevertheless, it is still beneficial to study it as a model. Market power refers to the ability to influence price of a product. In a perfectly competitive market, there is little market power for producers.
In contrast, Oligopoly refers to a market where a few large firms sell a product that may be alike or different which dominates an industry. Steel and motorcar industry and examples of products that are alike that makes up an oligopoly market. Because of the few sellers, the key feature of oligopoly is the tension between cooperation and self-interest. Otherwise, if there are only two sellers this is called a 'Duopoly', which is the simplest oligopoly. Of course, there are a number of characteristics that define an oligopoly market.
-
Few sellers dominate the market such like Phillip Morris (49%), RJR Nabisco (24%), Brown and Williamson (15%)in tobacco industry, offering similar or identical products.
-
Mutual interdependence is a term used in economics to describe how an action by one oligopoly firm will cause a reaction by other oligopoly firms. For instance, if GM produces a new type of vehicle or a price change, it needs to consider how the other automobile manufacturers will react.
- There are often many barriers that exist to discourage entry into the oligopoly market. Most of these barriers are related to economies of scale. This is, because there are huge start-up costs to enter an oligopoly market.
Generally speaking, the main form of oligopoly competition is a strong non-price base, high levels of branding and brand loyalty; prices tend to be stable, high degree of interdependence between the main rivals - all of them watching what the other is doing and seeking to react and pre-empt their rivals; high of barriers to entry; strong emphasis on advertising; economies of scale; a possible price leader whose actions are followed by rivals and the potential for collusion.
PART B
In the UK, the concentrated supermarket industry structure emerged in 1980 and during the 1990s the major supermarkets began to open many stores in order to increase their market share from under 20% to over 60% and because many shoppers visit the shop which is nearest. Till nearest years, the supermarket continues to grow. In 2002, retail sales of food through supermarkets and superstores reached an estimated ₤83.68 billion, a growth of 5.1% on the previous year.
In order to classify such large industry within the market structures categories, it must, firstly, describe this industry as a number of features.
During decades’ development, although the retail grocery market contains many hundreds of firms, several major firms that see Table 2 dominate the whole industry. These five firms account for 75% of the total market share in
Table 2: major dominators in UK supermarkets’ market
the industry. If considering the acquisition by Morrison of Safeway, this becomes a 4 firm concentration ratio. Moreover, there are a large number of much smaller firms in the industry, who may not be able to compete in the intensive battle for market share, sales growth and so alike. This is a situation of a market that will become more concentrated in next years.
Secondly, current supermarket market cannot be just identified as pricing bases. ‘Product’, these supermarkets are selling is not just the items which customers can buy in the store like bread, eggs, jam, cheese, beer etc but more the whole experience of shopping. People are moving focus from price to more such likes brand and value-added services.
On the other hand, firms who dominate the industry tend to benefit from economies of scale through intensive expansion. In gaining these economies they have to make supply chain improvements, because they all sell similar ranges of products that makes them harder to compete with each other. Making price and investment decision are the core issues for them to consider. If one of them is making the change of sales and offers, it might cause their rivals’ reaction.
According to above listed and Part A mentioned previously, these features definitely match the key characteristics of oligopoly. It, therefore, implies that the market structure of UK supermarket industry is an oligopoly, which refers to competition between the few and occurs where a few large firms dominate an industry.
PART C
Back in January 2003, Morrisons, the mostly north of England based supermarket chain, announced that it had been in discussions with Safeway over a proposed takeover. In September 2003, the acquisition was allowed so to enlarge Morrisons to hold over 500 stores and gain more than 15% market share in UK grocery market.
As outline above, the acquisition changes the structure of market, and affects competitive dynamics after a reduction of dominators. There are a few implications for the UK supermarket industry after the acquisition.
In competitive rival aspect, Morrisons combines with Safeway would not only retain the fourth national player in the market, but would also reinvigorate them as a more effective competitor to the big three. These competitions would base on different strategies and interests.
In regards effects to customers, due to the entrant of enlarged Morrisons, in the short-term, aggressive price cutting referred to above is a tactic to drive out competition. In the longer term, once competition is removed or significantly reduced, prices can be raised again. On the other hand, it is not only price reductions that would benefit consumers but also the high-quality products and high value-added services are provided.
Moreover, for suppliers, the acquisition will bring benefits. Transaction costs for suppliers would be reduced because they would be dealing with fewer points of contact, and cost savings are likely to arise in administration and invoicing, as well as distribution, packaging, and longer production runs. The acquisition would generate additional sales for certain products, and would create a fourth national competitor with growth potential to offer an additional outlet for suppliers’ products. Firms, however, who dominate the industry and usually tend to benefit from considerable economies of scale. In gaining these economies they will require the supply chain to change and put the supplier under huge pressure to deliver higher and higher quality and standardisation at lower and lower prices by the power of the supermarkets who drive prices to them down but do not pass on the same price rises to consumers.
Increasing the barriers of entrant is one negative influence which cannot be ignored. When the industry is becoming higher concentrated structure by the acquisition, that means the market will be made even harder for new shops, especially the small firms who may not have abilities to compete, offering a new shopping experience to enter the market. Because of the barriers, it causes some limitation on the customer choices.
As above mentioned, the Competition Commission’s decision of acquisition by Morrisons of Safeway motivates the UK supermarket industry to be more monopolistic while maintaining the scope of competitiveness. Of course, there are a few potential problems that might express in next few years, when the competition is gradually reducing and balancing.
Source by Sloman & Sutcliffe, Economics for Business, 1998
Source by Competition Commission, 2004