Conditions and Consequences of a Price War Essay

The objective of this essay is to use scotch theory and illustrative examples to emergeline the circumstances under which a expense war could come nigh and the likely consequences for the participating homes and their consumers. A impairment war is a period in which multiple firms competing in spite of appearance the same mart testament react to the other firms demoraliseing of footing by lowering their ingest footing. They have short-term and long-term advantages and disadvantages.There atomic number 18 many reasons for which a price war whitethorn occur, in all cases the reason for starting the price war is different but the reason for its extension is not to lose gross sales. They ar when a firm attempts to maximise depicted object, for survival purposes, in oligopoly markets, where there are homogeneous outputs and when a firm adopts a penetrative pricing strategy.Excess capacity refers to a detail where a firm is producing at a lower scale of output than it h as been designed for Excess capacity http//stats.oecd.org/glossary/ detail.asp?ID=3209 accessed tenth December 2006 If a firm has spare capacity to produce more of a swell it is likely they pull up stakes use this spare capacity to meshing maximise but to secure this they allow for have to lower prices to increase quantity demanded (see appendix item A). As they have rock-bottom their prices, other competitors will likely drop their prices so as not to loose customers, creating a price war.Companies who face bankruptcy may experiment to lower their prices so to attract more consumers and increase sales volume. However, if they cannot manage to increase volume enough to cover the fall in contribution then it will fail to cover its variable be and will be crusaded to leave the market. Other firms may recognise that the company is in trouble and in a bid to force the company out the market and not to loose their own customers will drop their prices below that of the company fa cing bankruptcy.An oligopoly is where a small number of firms share a large portion of the market political economy Handbook, David Gray and slam Clarke. In an oligopoly price is usually stable and constant as competing firms will not wish to lower price as its competitors will also drop theirs and so all they have discoverd is lowering their bread margins (see appendix item B). However, one firm may believe it stands to gain from a price-cut by accept they can under-cut the competition through economies of scale or other factors such as slow market reaction. A price war will begin as firms will drop theirs to avoid loosing customers.If in a market the hots are homogenous meaning they are the same for example utility work then price is one of the only means for a firm to distinguish it from others. In this blot a consumer will always purchase the lower priced product. This causes fierce pricing competition as each firm will exertion to maintain sales by dropping their price below the other competitors.Penetration pricing involves the setting of lower, rather than the higher prices in order to achieve a large if not dominant market share Pricing strategies http//www.tutor2u.net/business/marketing/pricing_strategy_penetration.asp accessed 10th December 2006. If this occurs the other firms in the market will recognise this and drop their own prices to stop that firm from gaining a dominant market share.The firm adopting this strategy may then also drop their prices to try continuing their pricing strategy causing a price war. This strategy can also be used to try and force firms out of the marketA price war causes more competition between firms, it has both(prenominal) positive and negative aspects for the consumers and the participating firms but these are different in the short-term and long-term. Competition is seen as a positive thing in any command saving.The short-run benefits for the consumer are obvious as firms lower their prices they will rec eive a bring out deal this can be seen in a movement along the demand rationalize, there will also be more consumers demanding the product for that lower price (see appendix item C). They are also likely to see improvements to the augmented products associated with the good as firms try to compete through non-pricing strategies. These services are things such as warranties, loyalty cards and other extras.The short-run effects upon the firms in the market are negative. Firms profits are reduced as the price of the good is reduced (see appendix item D). All firms in the manufacture will be forced to improve their productive competency to reduce total average cost, in an attempt to retain profit-margins whilst prices fall. They may also wish to attempt a heavier marketing campaign to try to distinguish itself from the other firms, but this incurs further costs for the firm. Firms are also likely to undergo a faster pace of invention and innovation as they differentiate themselves. Some firms in the market will be able to use their economies of scale to combat lower prices. But, other firms will not have such efficiencies and will not be able to afford variable costs and will therefore exit the market immediately (see appendix item E).The long-run affects of a price war are that a lot of firms will leave the market, this causes the demand curve to move backward to its original position, which increases market-clearing price creating a long-run equilibrium and so normal profits are re-established. This is a negative aspect to the consumers who will have to pay more than they have in recent periods, they are also more likely to try and shop round to find the best deal. The good itself is likely to have seen technological advances as firms competed to have the most innovative product. There will also have been improved services for the consumers. The firms left in the market are likely to have better control of costs this allows them to increase the contributi on towards profits as the average total cost has been reduced of the product.In conclusion, a price war can be initiated for many reasons such as efficiency by filling up spare capacity, as a means for survival, in intense tilt in oligopoly markets, to differentiate a product and to build up brand name or force other firms out of the market. However, the consequences are usually very similar, some firms will emerge as dominate and others will leave the market. This can have both good effects and bad effects as consumers will initially be happy with lower prices but when the long-run equilibrium comes into effect they will search harder for bargains. They will also see improvements made to the product and services. The surviving firms do well from the price war they are likely to see higher demand fortheir product, as there are few competitors.They also are likely to achieve greater productive efficiency and so greater profit margins. Vigorous competition between firms is the life blood of strong markets and is a central to productivity and growth in the economyInternational Competitiveness (2001) UK do work GovernmentBibliographyHardwick, Khan, Langmead (1994) An Introduction to Modern Economics 4th EditionLipsey, Forrest, Olsen (1993) An Introduction to dogmatic AccountsHunt, Sherman (1990) Economics An Introduction to traditional and radical viewsSloman, John (2000) Economics 4th EditionBegg, David (2005) Economics eighth EditionSloman, John and Sutcliffe, Mark (2004) Economics for Business 3rd Editionhttp//www.tutor2u.net accessed 10th Decemberhttp//en.wikipedia.org/wiki/Wiki accessed 10th December equipment casualty War, What is it good for? http//mba.tuck.dartmouth.edu/pages/faculty/koen.pauwels/pdf/Price%20War%20what%20is%20it%20good%20for.pdf accessed 10th DecemberReferencesExcess capacity http//stats.oecd.org/glossary/ detail.asp?ID=3209 accessed 10th December 2006Economics Handbook, David Gray and Peter ClarkePricing strategies http//www.tutor2u.n et/business/marketing/pricing_strategy_penetration.asp accessed 10th December 2006International Competitiveness (2001) UK Labour GovernmentAppendixItem AAs the firm increases the supply through using the spare capacity, supply curve shifts left from S1 to S2 as a result the market clearing price falls but quantity increases.Shifts in supply curve http//www.auhy69.dsl.pipex.com/images/dd202/b2p.jpg accessed 10th December 2006Item BIn this diagram you can see that in an oligopoly market it is unfavourable for the oligopoly firms to kind their price, so it becomes static.Price Competition in Oligopoly Market, Foundations of Economics Handbook (2006) David Gray and Peter ClarkeItem CA tendency along the demand curve will increase the quantity demanded but reduce selling price. contract and Supply www.investopedia.com/university/economics/economics3.asp accessed 10th December 2006Item DAs the price is set lower from P1 to P2