Quiz 23: Price-Searcher Markets With Low Entry Barriers
It is true that price searchers can set the prices of their products but this does not mean that they will charge the highest possible price for their product. This is because in competitive price-searcher market good substitute are readily available and this made demand curve faced by a price-searcher being downward sloping but highly elastic. If price-searchers charge highest possible price and substitute for its product are available at lower price, keeping in to account highly elastic nature of demand curve, consumers can shift towards rivals resulting in sale of fewer units for the given price-searcher. Secondly, with ease of entry, profit depicted by charging of highest possible price can attract new firms thereby increasing the competition for given price-searcher firm making it impossible for it to remain charging highest possible price. So, like other firms, a price searcher will charge that price and will produce that quantity at which its marginal revenue is equal to its marginal cost.
a. Price is affected by market condition: Concept of price searcher market: Price searchers market has the following features- 1. Many firm 2. Products manufactured are not same. They are close substitutes. Differentiation is created by advertisement, packaging, design change etc. Due to such differentiation even after price increase some customers remain loyal to the firm. They do not change the seller. 3. Entry of new firm and exit of existing firm is easy. So new firm will enter whenever there is scope of making high economic profit. Due to above properties, firm has some control over the price. It can decide the price at which product will be sold. Effect of demand curve on price and quantity: Setting of price does not mean that price is unaffected by market condition. Firm has to consider demand curve which is down ward sloping and highly elastic. If firm set the price then it cannot decide on the quantity to be sold. It will depend upon demand curve. If price set is high, then quantity will be low otherwise a portion of the quantity will remain unsold. Further demand curve is highly elastic. So market is very sensitive to price change. A little increase in price will reduce the quantity significantly. Thus market searcher has to set profit maximizing point only after considering the demand curve of the product in the market. It cannot fix both selling price and quantity at the same time. a. Economic profit in the long run: Price searchers market with low entry barriers can make economic profit, suffer abnormal loss or may earn only normal profit in the short run. But it is not possible in the long run. Only normal profit is possible in the long run. Concept of long run: In economy time can be grouped as- 1. Short run and 2. Long run. Short run is a time when everything cannot be changed according to requirements. At least one factor will remain constant. Production capacity or entrepreneurial skill cannot be changed in the short run. Long run, on the other hand, is a time when supply of all factors can be changed to adjust the production requirement. Concept of economic profit: It is the excess of total revenue over total cost. Total revenue is the total money value of quantity sold. Total cost includes payment to all factor owners for using the factors in production work. It includes normal profit which is considered as opportunity cost of entrepreneurs. If the normal profit is not realized, then entrepreneur will stop production and divert to some other best possible alternatives to realize that opportunity cost. If total revenue and total cost is equal, then firm will recover only normal profit. If total revenue exceeds total cost, then firm is earning economic profit. In opposite situation the firm is suffering abnormal loss. Suppose price searcher firm is making economic profit in the short run. It will attract many new firms to enter the industry. Since entry is easy, they will enter the business and will increase the supply of product. Also existing firm in the long run will increase the production capacity to manufacture more units so that profit can be increased. Thus total supply of the industry will rise. As the market has a downward sloping highly elastic demand curve, the price has to be cut. Otherwise produced quantity will not be sold in full. Due to cut in price, economic profit will gradually decrease. This process will continue until the entire economic profit is eliminated. The adjustment process as described can be explained with the help of understated diagram- In diagram 1, marginal cost curve MC 1 has intersected MR 1 curve at OQ 1 quantity. It is profit maximizing quantity. Against this quantity, average cost is bQ 1 and average revenue is aQ 1. Therefore, ab is economic profit. Total economic profit is shown by the violet colored area P 1 abc. Now consider diagram 2. It is long run situation after entry of new firm and expansion of production capacity by the existing firm in the long run. Due to expansion in quantity supplied in the industry, AR 1 curve has shifted to AR 2. Also MR 1 curve has changed to MR 2 curve. Average cost curve has also changed to AC 2. Now MC 2 curve has intersected MR 2 curve at OQ 2 units of production. Long run equilibrium price has fallen from OP 1 of diagram 1 to OP 2 in diagram 2. Both average revenue and average cost here is aQ 2. Thus only normal profit is earned. Economic profit has been totally eliminated in the long run. c) Price searcher competitive firm has to take all possible effort to influence the customer. They have to add quality, style, variety, location etc. Also they can provide different types of services to attract them. Further they may spend lot of money on advertisement. All these efforts will convince customers that firm is capable of adding value to the product which customers like most. In this manner they will succeed in altering demand of their product. Customer of rival firm will shift in its favor. Turnover will go up. Firm will succeed in making economic profit.
Competition in the market is the most important key element. Competitive searcher market is a market where product styles, design etc are very significant. A competitive searcher market has following properties. 1. Many firms 2. Products manufactured are not same. They are close substitutes. Differentiation is created by advertisement, packaging, design change etc. Due to such differentiation even after price increase some customers remain loyal to the firm. They do not change the seller. 3. Entry of new firm and exit of existing firm is easy. So new firm will enter whenever there is scope of making high economic profit. Due to above properties, firm has some control over the price. It can decide the price at which product will be sold. But firms cannot control both price and quantity at the same time. If it fix price, then market demand curve will fix the quantity to be sold. Here demand curve is downward sloping. If price is raised then quantity should be reduced. Otherwise full quantity will not be sold. Demand curve is not only downward sloping, it is very much elastic. It indicates that degree of responsiveness of quantity to price change will be very high. This property provides opportunity to firm to influence the demand curve to a great extent. It is possible by introducing various innovative activities like - 1. Introduction of new styles of the product 2. Change in design to make the product more attractive and cost effective 3. Introduction of variety of sizes to suit the customer's requirements 4. Addition of some new features or qualities in the existing product etc. Factors for introducing variations: In order to introduce such features following factors should be kept in mind- 1. Customer's need: Entrepreneur should give maximum emphasis on customer's needs. Only those features which consumer will value should be introduced. Consumer will value it if they feel that this feature will provide them more satisfaction than they are paying for. 2. Cost: Another key factor is the cost associated in the introduction of new feature. If the feature has increased the cost significantly then result will be negative. Customer will think that extra money they are paying for the added feature is more than the extra satisfaction they will get from it. 3. Time: Also important is the time. Sometimes an effort to introduce the feature may take a very long time. In the mean time rival firm has introduced some added features of different nature to capture the customer attention. Thus entire effort and cost will be wasted. 4. Advertisement: Also important will be the advertisement expenses. Sometimes added features are not so prominent. Thus it requires lot of advertisement to make customer aware of this feature. This advertisement cost may raise the price and may make the added feature ineffective. 5. Imitation: Also firm has to consider how quickly other rivals can imitate the features. If the feature can be imitated very quickly, then the advantages gained from the introduction will be quickly lost. Many more factors may be considered depending upon the nature of the product. (b) It is observed that there are only a few varieties of toothpick. But different types of napkins are found. It is depending upon how customers are valuing their varieties. If customers consider that addition of varieties in the product is adding significant value then they will be ready to accept the varieties. They will be ready to pay for the cost of introduction of variation. They will think that whatever extra they are paying is less than the extra satisfaction they are getting from such varieties. In case of toothpick, customers believe that introduction of varieties is useless and will not provide any significant extra satisfaction. So they are not ready to pay for such variation. But napkin is valued differently. Customer is ready to accept different varieties of napkins. Some napkins may be specially designed to suit the purpose where they are used. They will be ready to pay more for this. Therefore it can be concluded that since customers has put value on the variation of napkins, more varieties of napkins are available in the market. But for toothpick they consider variation is useless. So only a few variations are available for toothpick in the market.