Recently in the UK, there have been price wars in both the supermarket and mobile phone industries. These price war are a natural part of competition in a market economy, and the behaviour of these firms can be understood using microeconomic principles. This paper will examine both the supermarket and mobile phone wars using microeconomic models in order to demonstrate how these basic economic principles are applied in the real world.
While there are many types of competition in microeconomic models, most industries in market economies operate under the condition of monopolistic competition. This condition is where firms have many competitors, and each competitor seeks to differentiate itself in some way from the other competitors (Economics Online, 2014). In the supermarket industry, companies require fairly broad target markets in order to generate the revenue they require to survive. Thus, we see for example that Waitrose will tend towards higher-end products and pricing, compared with a company such as Iceland that is strictly low-end on both. Marks & Spencer focuses on own-brand items, and Tesco aims strictly for the mainstream of the supermarket industry. For most consumers, convenience and price are the two most important variables. Moving store locations is not very easy -- this is a sticky variable -- but changing prices can be done with little effort. Thus, the major British supermarket chains have been undertaking price wars in recent months in order to win consumer loyalty. Discount food chains appear to be winning the price wars. Sales figures show that Aldi and Lidl in particular are gaining in sales at the expense of Tesco, and this price war has encouraged Sainsburys, Asda to join in as well (Rayner, 2014).
Similar competition is occurring in mobile phones. Now that mobile, smartphones in particular, are reaching the saturation point, there is little in the way of new market share to gain. As a result, firms are fighting intensely over existing market share. It is difficult to differentiate mobile phone service.. However, firms in the industry have high fixed costs. Thus, every new customer is a contribution to fixed costs that adds very little in the way of variable cost. By lowering prices, mobile companies are able to win customers from their competitors. Three sparked the price war in early 2013 in a bid to increase its market share by offering better value for money than its competitors (The Telegraph, 2013).
The first, basic microeconomic concept at play here is the law of supply and demand. Under equilibrium conditions, supply and demand will be equal at a price X. Under the basic scenario, when supply exceeds demand, someone will exit the industry in order that supply and demand remain in equilibrium. The problem in both of these industries, exit costs are high. Typically, if a firm can make enough money to cover its fixed costs, it will remain in business, even if the firm consistently fails to earn a profit. Firms in these industries face significant exits costs in terms of the debt they owe, disposal of assets and unwinding their operations. Thus, even though there is oversupply in the marketplace, the response of companies in these two industries is to remain in the market.
This drives down the price. Firms need to earn enough revenue to cover their fixed costs, and preferably will want to earn enough to turn a profit. With both food and mobile, there is a certain amount of customer loyalty from which profit-taking can be done. In mobile, a customer pays every month, and once with a company may be reluctant to switch lest their lose their number. With grocery stores, discounts on staple items get customers in the door, and at that point higher-margin items can make up the difference.
There is an interesting case study to be made with the supermarket wars in particular. The supermarkets have strong bargaining power over suppliers, so they drive down prices on staple goods. The problem is that when prices decline, some suppliers are no longer profitable. This is because in condition of equilibrium, nobody is profitable, so when prices decline some supply needs to be flushed out of the market just to get back to that equilibrium point. In the UK, milk producers are exiting the business in response to lower prices, to the point where there are fewer than half the number of producers as there were in 2005 (Gilbert, 2014). It is a natural consequence that as the price drops, suppliers exit the market whilst demand increases. There is...
For dairy farmers, however, there are opportunity costs -- farmers have always preferred to use their land for whatever agricultural endeavour would bring them the best return, and that may well be the case here as they exit the dairy business.
In mobile, price discrimination is a factor worth examining as well. Price discrimination is the idea that some consumers pay a different price for what is essentially the same product/service. In mobile, bandwidth is an undifferentiated service. Price discrimination occurs typically on the basis of usage, where heavy users pay less for their bandwidth than casual users, being given the advantage of their buying power. Competition is in particular to bring those customers on board, because their volume helps to fill capacity at mobile companies.
Mobile Macroeconomic Analysis
The proposition is that mobile phone costs have fallen to such a level that mobile telephony has become more affordable in emerging markets. That ship has sailed -- mobile phones are standard in emerging markets and the cost is indeed low. This is a microeconomics question, referring to buying patterns. When the price of a good falls, demand for that good rises. The reason is that mobile telephony for people in emerging markets is an opportunity cost. With scarce income, they have to choose carefully what things they value in terms of spending their limited funds (Investopedia, 2014). This is a much more real choice than it is in the West, where many of us have the means to purchase mobile telephony without really thinking about it.
However, the lower the price of mobile telephony, the more people will find that the utility of mobile telephony justifies its purchase. Utility is basically the value that people get out of a good, and it can be directly related to price. The money that someone spends on mobile telephony could be spent on other things -- that is the opportunity cost of the mobile telephony. What is occurring in emerging markets is that people's rising incomes combined with a decrease in the price of mobile telephony is essentially reducing the opportunity cost of this technology, increasing its utility and therefore increasing the demand for it. It is also worth noting that most emerging market consumers use pre-paid plans, which reduces brand loyalty and increases price competition (Bhargava & Gangwar, 2013).
To tie this into macroeconomics we have to consider why people in emerging markets are better able to afford mobile telephony. Many emerging market economies are expanding. This expansion is typically measured using the gross domestic product, which the total output of the country, including the activities of foreign firms within the country. When the total GDP increases, this typically means that this income is distributed throughout the economy. The degree to which this occurs is dependent on a number of different factors, but rising real GDP will typically mean rising real wealth. The term 'real' refers to post-inflation. There are cases where the GDP will increase on a nominal basis because of high inflation. Inflation reduces the buying power of money through price increases. Many growing economies will have some inflation, but in many cases emerging markets are seeing real GDP gains, which means more money for purchases like mobile telephony.
When the GDP increases, this usually also means that jobs are created. This is especially true in countries where there is some element of market forces behind the diffusion of wealth. In emerging markets, there are often many small businesses that drive the economy, so a growth economy creates opportunity for small business. The result is lower unemployment, and high incomes, both of which spur demand for mobile telephony. In response to higher demand, mobile telephony companies will invest in infrastructure in order to increase supply. The result of these investments is better economies of scale, and that should in turn serve to lower prices further.
The concept of exchange rates does not apply here, but can be explained anyway. Exchange rates reflect the price of one currency in relation to another. When foreign trade is conducted, there is often the need for the exchange of currency. One party will have wealth stored in sterling, while perhaps the other party has their wealth stored in euros. When these parties want to trade, one will have to convert their…
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