Unit 3 - Business Economics and Economic Efficiency
Essay
Essay Unit 3 - Price Wars
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Unit 3 - Business Economics and Economic Efficiency
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PEARSON (PEARSON)
This essay critically examines the statement "A price war inevitably causes long term harm to consumers and the employees of firms within the industry," using chains of analysis and evaluation to determine a judgement.
Unit 3 - Business Economics and Economic Efficiency
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A price war inevitably causes long term harm to consumers and the
employees of firms within the industry.’ Critically examine this statement.
A price war arises when several firms in a market repeatedly lower their prices to outprice
other firms. The main objective of starting a price war is usually to gain or defend market
share. This type of competition tends to occur among oligopolies. For example, this is a
common occurrence in the airline industry as different airline companies try to capture
increased market share.
A price war between firms is likely to cause
more harm to consumers, as less
competition in the industry may result in
firms spiking up prices in the long term. In
the airline industry, as different firms
compete in price wars, this may drive certain
firms out of business, thus resulting in less
choice for consumers which then allows to
airline companies to charge higher prices for
tickets. This occurs because as a firm enters a
price war, this results in them continuously
trying to lower prices with the aim of
outperforming competitors since consumers
usually prefer lower prices. Competitors may not be able to constantly lower prices without
making a loss in the long run, therefore they may have to shut down and leave the market.
This leads to fewer firms in the market and as a result, allows firms to increase prices due to
less supply. In the diagram above, the initial equilibrium point is at P1Q1. Due to a fall in
supply, as firms leave the market, this shifts the supply curve upwards from S1 to S2. This
leads to a fall in quantity from Q1 to Q2 and an increase in price from P1 to P2. The new
equilibrium point is now at the point P2Q2. The more firms try to outprice one another, the
higher the increase in the fall in supply. This will then allow firms to charge increasingly
expensive prices to consumers in the long run, thus causing a fall in consumer surplus from
PCAP1 to PCBP2. However, in the short term, consumers are likely to benefit from lower
prices. As firms compete with each other and try to lower their prices this results in lower
prices for consumers to enjoy in the short run, but as a result of lower prices firms may look
to cut costs and lower the quality of goods and services. In the airline industry lower quality
products may translate to overcrowded flights or uncomfortable seating. This may leave
consumers unsatisfied and reduce consumer benefit as individuals may not perceive
cheaper flights as worth the lower quality flights, even in the short term.
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