Price and Competition

Price and Competition • Basic economics • Pricing decisions • Consumer price response • Competition in food markets

Supply Curve of supply across prices offered Generally upward sloping Non-linear cost structures may change shape Quantity supplied Quantity supplied at any given price Demand Curve of demand across prices offered Generally downward sloping (but high price may “signal” quality Quantity demanded Quantity demanded at any given price Equilibrium: Intersection of supply and demand curves Some Basic Economic Concepts

Elasticity • Price elasticity = % change in quantity demanded ----------------------------------------------- % change in price • If • Elasticity > 1, demand is elastic • Elasticity < 1, demand is inelastic

Elasticity Issues • Elasticities for • Farmer’s commodities—can only sell at or below clearing price • Product category (e.g., flour) • Brand elasticity (< product category elasticity) • Cross price elasticity = % change in quantity demanded ----------------------------------------------------- % change in price of competing product

Determinants of Supply • Long term investments made based on market price expectations and expected costs • Current market situation • Current crop size • Variable costs of production (fixed costs are “sunk”)

Costs • Fixed • Short run: Existing investments and contracts already in place • Long run: Planned investments and contracts • Variable • Supplies (inputs such as feed, energy, and fertilizer) • Labor • Other processing

Some Causes in Changes in Supply and Demand • Change in number of customers • Overall • Within segments • Changes in income or wealth • Change in tastes or preferences • Change in prices of competing products (cross-price elasticity) • Future expectations of prices

Short Term Decisions • May be optimal to sell at a loss so long as variable costs are covered • Contracts may require production at predetermined price even if not profitable

Clearing Price • Allocates current supply to those who value it most • Encourages substitution where appropriate • Encourages investment in markets with profitably served unfilled demand • Encourages market exit under insufficient demand

Macroeconomic Ways of Changing Price Levels • Subsidies/taxes • Price controls • Import controls • Rationing • Government purchase of excess crops

Ways to Change Prices • Sticker price • Quantity (e.g., smaller candy bars for same price and/or fewer products per package) • Quality (charge separately for services or “dilute” product) • Terms (e.g., charge for delivery)

Price Discrimination • Explicit: Lower rates for some customers • Discounts to select customers • Quantity discounts (if customers compete against each other, the seller must prove that the discount is justified by reduced costs in serving the larger account) • Implicit: e.g., coupons (typically legal in U.S.; sometimes illegal in other countries) Ten percent discount for senior citizens!

Some Forms of Implicit Price Discrimination • Coupons • Periodic sales • Predictable (periodic) • Random • Rebates

Consumer Price Awareness • A survey revealed of consumers who had just selected a product suggested:: • Avg. time spent before departing from product area: 12 seconds • Avg. no. of products inspected: 1.2; only 21.6% claimed to check price of non-chosen brand • 55.6% could state price of just chosen product within 5%

Yet... • Scanner data shows large effects of price on sales (own price elasticity is typically around -2.0) • Price cuts combined with other factors may greatly influence sales • shelf space • signs SAVE 125%

The Promotion Signal • A segment of consumers will respond to negligible discounts--e.g., “SALE! $3.95 (Was $4.02). • However, merely placing a sign “EVERYDAY LOW PRICE” randomly also increased sales of affected products. SALE! Hurry!

Price as An Attraction Strategy • Positioning • Value--perception vs. reality • Price ---> quality • Loss leaders • “Bait-and-Switch”--frequently illegal

Discounting of Discounts • Promotional claims (e.g., “Save 25%) are often not taken at face value • Even implausible claims appear to impact perceived savings

Odd/Even Pricing--Does It Have an Impact? • Theory: $3.00 is rounded to $3.00 while $2.99 is rounded to “$2.00 plus change” • Reality: Studies in U.S. have found some impact; no impact found in Germany • Note that odd pricing may signal receiving a bargain, which may nor may not be compatible with the desired product image • Odd pricing has typically been used by tradition (initially implemented to force cashiers to ring up purchases).

Price Changes You’re note gettin’ away with this! You mean tell me that you are chargin’ me $1.29 for a $0.99 hamburger? • Consumers tend to resist prices being raised above expectations--latitude of acceptance varies between products and consumers • Certain thresholds are difficult to pass; e.g. • Cereal above $2.00 per box in 1970s • Coke above 5 cents per bottle

Estimating Consumer Price Response • Ineffective methods • Direct questioning (difference between predicted behavior and actual choice) • Focus groups (small sample size; non-independent response) • Very difficult--since precision matters a great deal • Some possible methods: • Empirical • Test marketing • “Split” catalog • Conjoint analysiswith price as one attribute --> determine weight

At the farm level Commodities are usually sold under perfect competition (market clearing price for a commodity of a specified grade) Manufactured Products Oligopoly for very highly branded products—e.g., Cola drinks Breakfast cereal Monopolistic competition where more competitors exist Brands with strong equity (consumer preference) influence prices Competition in Food Markets

Realities of Competition in the U.S. Market • Types of competition • Price (everyday price, periodic discounts, coupons) • Non-price (product quality, brand building) • Collusion (discussing how to set prices) among competitors is illegal • Competitors do “signal” to each other • Cooperative measures (taking turns promoting each brand)

Price and Competition