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Chapter 23 - COMPETITIVE PRICE-SEARCHER MARKETS WITH LOW ENTRY BARRIERS Firms who are Price-takers just take the market price - there is no pricing decision, no advertising, no marketing, etc. They can adjust their output (expand/contract) and they can try to reduce costs of production, but they have NO pricing decision (corn farmer). We now look at Competitive Price-Searcher Markets , where: 1) firms face a downward sloping demand curve for their product or service, and 2) there is easy entry and exit . With low entry barriers, the "smell of profits" will attract competition. Price-searching firms face a more complex set of decisions - see opening quote on p. 490. Firms never really directly observe demand curves, so they have to engage in a process of trial-and-error to search for the price that maximizes profits. Since markets are continually changing, the price searching process is continual and ongoing, e.g. airlines, long distance, computers, online services, etc. Firms are now selling differentiated products with brand names and have pricing decisions - how to market, advertising, bundling (computer + printer), specials, discounts, promotions, rebates, coupons, quantity discounts, senior citizen discounts, price discrimination, etc. However, there are usually many close substitutes so these price-searcher markets are highly competitive - fast food, cell phones, airlines, computers, athletic shoes, etc. A price-searching firm can raise its prices and NOT lose all its customers, unlike a price-taker. However, because there are lots of close substitutes, the demand curve facing an individual price-search firm will be highly ELASTIC. The firm faces stiff competition from two sources: 1) all existing firms in the industry and 2) potential rivals or competitors who will enter the industry if profits are high, e.g. coffee shops, online services. "The smell of profits." Firms can set price, but then market forces determine how much is actually sold at a given price. Firms attempt to find the Price-Quantity combinations that MAX PROFITS. Firms also can control more than just Price, they can control other non-Price factors that affect consumer value: Quality, location, service, advertising, convenience, bonuses (frequent flier miles), etc. Main Point: price-searching firms face a complex set of decisions, compared to price-taker. PRICE AND OUTPUT How does a price-searcher decide on the Price-Output combination that MAX PROFITS? A firm faces a trade-off when changing its price. If price is lowered, more units are sold, but at a lower price for ALL units. If price is raised, fewer units are sold, but at a higher price for ALL units. See Exhibit 1, page 492. Firm lowers price from P 1 to P 2 and output expands from q 1 to q 2 . There are two effects: MGT 551: BUSINESS ECONOMICS CH – 22 Professor Mark J. Perry 1
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1. (P 2 - P 1 ) x q 1 = Loss of Total Revenue from selling the original units (q 1 ) at a new lower price (P 2 ), since the new price (P 2 ) applies to both new customers and old customers.
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