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Concept Of Price War And Oligopoly Theories Economics Essay

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Published: Mon, 5 Dec 2016

Experts argue that the concept of price war is a fact of life in most industrialised countries, assess the arguments for and against such behaviour. Discuss the impact of this behaviour in any industry using different oligopoly theories.

In this essay I will address the subject of price war in industrialised countries. From different angles I will to try to break down and analyse the idea that ‘price war in industrialised countries’ is a ‘fact of life’.

The basic and underlying concept of a price war is that two or more firms in an industry lower or change their own prices with the knowledge that in an oligopolistic environment the other firms in that industry will lower theirs too so they match up. This is due to the interdependency in their interaction with all the firms in that industry. Price fixing plays a major role in a price war. My method of assessing whether said statement is true or false is to weigh up the pros and cons. From there I can make an informed decision and will be able to explain it through outlined discussions and ideas, and by visual aids if necessary.

By the end of my essay I will be able, also, to discuss, with help of oligopolistic theories, the effect that a price war has on any industry.

A price war is the concept that refers to economic activity of high competitive rivalry between a few firms in a particular industry, with complex rounds of price reductions. If one firm reduces their prices or a single price of a good, then the other firms in that industry will do the same to match that price.

In an industry, in which a state of oligopoly is apparent (i.e. only a few sellers operate), each firm is quite capable of producing enough of the industry’ total output, resulting in their ability to affect the market price.

A real world example of this is in the coffee industry where there are three major producers; Starbucks, Cafe Nero and Costas Coffee. These three large providers of coffee produce such large percentages each of the coffee industry that if, say, Starbucks were to increase their supply, the price of an average coffee would decrease considerably. An increase in output for one of the coffee providers will result in the price to decrease for the other firms in the industry.

To explain further, if Starbucks produces double its output, the price of coffee from Starbucks drops hugely. However, most people are not wholly loyal to a particular brand, so Costas Coffee and Cafe Nero drinkers will switch to the cheaper Starbucks. As a result, the price of Costas Coffee and Cafe Nero coffee drops too. These three major brands are part of a set of economic activities where each of their decisions on supple not only affects their

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own sales but also of the firms competing against them. Such strategic situations can involve competition or collusion.

Collusion= all firms in an industry agree to cut back on production by a certain amount to increase both prices and profits.

Competition= all firms in an industry try to increase production with the intent to undermine competitors and gain as many customers as can be attained.

The outcomes of both collusion and competition can be massively different for consumers and producers.

For example, collusion benefits producers most due to the fact that as long as they keep colluding, their profits will continue to increase. However, collusion has a negative effect on consumers because it results in higher prices and decreased output.

Collusion, unfortunately, is uncommon and many industries are dominated by heavily competing firms. If such collusion actually happened then government intervention may be necessary to protect consumers.

All these ideas of collusion and competition between firms in an industry are the major foundations and components of a price war. In the short term, consumers benefit very well from such activities, due to the chance of benefiting from lower prices. Also in the short run a negative impact can hit producers by the result of lower prices leading to reduced profit margins. In the long term, the major firms in any particular industry can gain from a price war with increased profits etc.

Price wars do seem to happen in every industry in some shape or form. There is a fair amount of reason why that is. To start with there are competitors whom might wish to concentrate on a particular product and through this product try to gain market share by producing its alternate good at decreased prices.

There is also ‘penetration pricing’ where firms may offer/provide lower prices of new brands of a good or product into an already highly established market.

‘Process optimization’ is also a cause in that firms may choose to reduce prices rather than output with the plan regulate and sustain the economy of scale.

A big cause for price wars is ‘predatory pricing’ (albeit illegal). This refers to when a firm may set the price extremely low, even too low, on a good, in order to ddestroy other firms completely in that industry.

Finally and in some ways most importantly, especially in context with this essay title, is the cause ‘oligopoly’. Oligopoly is where all economic actions on prices and outputs for each firm in an industry are interdependent.

Reactions to price changes and ultimately price wars can vary. The primary reaction to a price war price change or ‘price reduction’ is consideration and caution. For example, has the competing firm decided whether it is doing a short term or a long-term price

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change? If its short term, a firms reaction should normally be ignoring the change. Otherwise, short-term changes can be interpreted as cataclysmic changes and lead to big price wars.

However, for the long-term there is not just a singular reaction. A firm could maintain their price, split their product into a premium version and a basic. Or the most common highly anticipated reaction is reduce the price and keep in line with one’s competitors.

Now its quite easy to see why a price might be good and benefit certain people. We can see that producers and consumers can benefit from them in some way and at some point. But in the end there is also a negative impact of price wars. As previously stated two or more firms compete in an industry and in turn both reduce their prices. We see that one can benefit whether you are a producer or consumer due to lower prices but this is not always the case. When these firms compete and initiate a price war, it is normally understood that both firms lower value along with price. Ultimately the firms lose profit and the consumer loses value.

In my conclusion, I believe that price wars in the short-run can improve profits and can allow consumers a small space of time to take advantage of lowered prices. But in the end they cause more trouble than they are worth. However they also seem unavoidable as nearly every single industry in an economy has an event of a price war at some point. In the supermarket industry, Sainsbury and Tesco compete in a price war. O2 and T-mobile do the same in the mobile industry. Starbucks and Cafe Nero show signs too. The list of price wars in different industries is long but clearly outlines that the statement ‘the concept of a price war is a fact of life in industrialised countries’ is pretty much correct.


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