Occasionally, some parts of a monopolist’s
product range are sold under highly
competitive
conditions, while other items are sold under monopoly conditions.
In that
event, the MR # MC rule continues to apply, with allowance being made
for the
different demand conditions in each market.
Take, for example, the pricing policy of a
large supermarket. Part of its sales
consist of
products whose price is well known, such as milk, bread and hamburgers.
These are
called known-value items .Also on the supermarket’s shelves
are many
goods whose price is not familiar to the average customer .
Once inside
the store, the customer is likely to purchase both types of good. In a
one-stop
shop, KVIs and non-KVIs are complements. The supermarket can be
viewed as
being able to exercise a certain degree of monopoly power
over its
customers, once they are inside the store. In such circumstances,
it can be
shown that the supermarket’s profit-maximising strategy might lead it
to charge
below-cost prices for the KVIs in order to attract customers and recoup
these losses
through sales of non-KVIs at monopoly prices
A loss-leader price strategy can,
therefore, be compatible with profit maximisation.
In this
instance, the important point is to ensure that the MR of KVIs is
properly
defined so as to include the revenue obtained from additional sales of
non-KVIs to
customers attracted to the supermarket as a result of the loss leaders.
A multi-plant monopolist, by contrast,
faces a single MR, but a different MC
schedule in
each plant. The profit-maximising rule ordains that the cost of
producing
the last unit in each plant should be the same for all plants and equal
to the
common MR: where n is the number of plants. Suppose this rule were breached. MR
was £10;MC_1 was £8 and MC_2 was £12 in plants 1 and 2. By
transferring production from plant 2 to plant 1, profits could be increased.
Such allocation will continue until the MCs are equalised.
This rule can have important practical application when allocating quotas
between different participants in a cartel the MCs are equalised. This rule can have important practical
application when allocating quotas between different participants in a cartel
When competition
induces pricing below cost
Loss-leading is a pricing strategy which is
widely used in multi-product retailing. It
involves the
sale of a subset of ‘traffic building’ items at below-cost prices. This appears
to contradict the rule of profit maximisation. Another interpretation is that
it is an outcome of anti-competitive behaviour, i.e. large firms price below
cost in order to
drive the
weak out of business. However, closer analysis shows that it is perfectly consistent
both with profit maximisation and with competition in the market. The critical issue
in selecting the optimal price of a retail product is the correct definition of
marginal revenue. In multi-product retailing the marginal revenue of any one
product must incorporate the spillover effects arising from the pricing of
other products in the store. These effects include the mark-up earned on goods
purchased by customers attracted to the store by loss leaders.
Loss-leading is an inherent feature of
supermarket retailing. The distinguishing
feature of
the retail market is the vast range of product categories and different brands
offered to the consumer. The average American supermarket of 40,000 square feet
typically carries between 20,000 and 30,000 different products.
Consumers
will only have prior knowledge of prices in a subset of known-value items that
are characterised by frequently purchased standardised staple products such as
bread and milk. The prices of all other products,non-KVIs, will be unknown to
the customer prior to entering the store.
Consumers are rational and enter stores
that are deemed to offer lower retail prices. Given the costs and disutility
associated with acquiring price information, customers’ entry decision will be
based upon their perceiveed value for money from shopping in a particular store,
as indicated by KVI prices. Retailers will therefore compete for market share on
the basis of KVI prices. The information costs that are associated with finding
out the relative price of non-KVIs in different stores generate switching costs
for consumers.Once consumers have entered the store, therefore, switching costs
result in spatial market power that allows the retailer to extract price_–_cost
mark-ups on non-KVIs.
Thus
retailers sell certain ‘traffic building’ KVI items below cost in an endeavour
to
attract
consumers into the store, and to charge higher prices on other goods.
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