Summary
Highlights
The session kicks off by exploring a key question from the January 2013 Unit 3 paper: why are there many hairdressers but few large supermarket chains in the UK? This question leads into a discussion of monopolistic competition versus oligopolies, high concentration ratios (e.g., supermarkets at 76.1% compared to hairdressers at less than 5%), and the significance of barriers to entry.
The concept of Minimum Efficient Scale (MEES) is introduced, representing the lowest point on the average cost (AC) curve. Using the example of Tesco vs. a small hairdresser, the instructor illustrates how large firms like Tesco achieve vast economies of scale through bulk buying, extensive distribution, and large warehouses, leading to significantly lower average costs. Hairdressers, in contrast, face diseconomies of scale if they attempt similar bulk purchases, explaining why their MEES is achieved at a much lower output level and why the industry comprises many small firms with similar cost structures. The evaluation considers franchise hairdressers (e.g., Tony & Guy) who can achieve larger economies of scale.
Additional barriers to entry for large supermarket chains include strong brand loyalty, significant advertising budgets, and high sunk costs, making markets less contestable. However, the instructor also notes that market gaps, such as the rise of online shopping (e.g., AO) and the cost of living crisis leading to the growth of discount retailers like Lidl and Aldi, can present opportunities for new firms to enter and challenge established players.
This section examines the impact of fines on firms, particularly those found guilty of colluding. A large fine can cause reputational damage, decrease brand loyalty, and make the market more contestable. In response, incumbent firms might adopt strategies like limit pricing (setting prices below a potential entrant's average cost) to deter new competition and maintain market share, even if it means foregoing profit maximization. The evaluation addresses the persistence of habitual consumer behavior and the possibility that high inherent barriers to entry may still prevent new firms from joining.
From a cost and revenue perspective, a fixed fine increases a firm's average cost (AC) curve, potentially leading to reduced profits or even losses while the profit-maximizing output remains unchanged. This can decrease dynamic efficiency as firms have less capital for investment. A counter-argument suggests that profits from prior collusion might offset the fine, allowing firms to continue operations without significant long-term impact.
The discussion shifts to pricing strategies designed to increase profitability or market share. Limit pricing involves setting prices low enough to deter new entrants, as illustrated by an example with Walkers crisps. Predatory pricing, on the other hand, involves selling below average variable cost to force smaller competitors out of the market. While effective for large firms that can absorb short-term losses (e.g., Costa vs. small coffee shops), predatory pricing is illegal, and highly loyal customers may resist switching.
Collusion, where oligopolistic firms work together to fix high prices and restrict output, is explained. Conditions for successful collusion include a market with few dominant firms (oligopoly) and inelastic demand. However, the Prisoner's Dilemma illustrates that such cartels are inherently unstable due to the individual incentive for firms to undercut their partners for short-term gain, often leading to a mutually destructive price war. A payoff matrix using Tesco and Asda is used to demonstrate this concept.