 Hello and welcome to the session in which we'll discuss market structure and pricing strategies. What is market structure? We refer to the organizational characteristic of a market. What is that? It includes the number of firms operating in the market, the degree of competition among them and the exit and entry barrier. What does that all means? Let's take a look at this market. So this is the market here. In this market, basically we have one, two, three sellers. So the number of operating firm in this market three. Now, how tough or how stiff is the competition between those? Well, it all depends on the product that they're selling. Is it unique product, not unique product? On other factors such as the uniqueness of the product that they're selling? Are they selling something that is considered a commodity where you can find everywhere or are they selling something unique? Also, how competitive are they in terms of pricing their product? It all depends how many people can enter this market if let's assume this is operating in a small town. If the municipality of the small town allows three other firms to operate and everyone is selling the same product, then guess what's going to happen? The prices, the pricing strategy will change. So different market structure will have different implication for pricing strategies. Now, why as accountant, as CPAs, we have to learn about market structures? Because at some point you might be auditing a company or preparing financial statement of a company. You have to understand in what type of market structure this company operates. So you can understand their pricing strategy. You can understand the revenue structure. And that's very important. Revenue is the first item on the financial statement and how the company price their product will drive their revenue. There are four common market structures that we need to be familiar with. Perfect competition, monopoly. Those are the two extremes. So we have monopoly and the perfect competition on either extreme. Then we have monopolistic competition and we have a monopoly. What we're going to do, we're going to discuss each one of these market structures separately, including the various pricing strategies that companies would undertake, assuming they are operating in this market structure. Let's go ahead and get started. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today. Starting with perfect competition. What is a perfect competition? Well, let's take a look at this picture. Before I discuss perfect competition, this picture is a perfect competition. Those are two stores, store one and store two. Here we go. Those are two stores. They're basically selling the same thing. They're close to each other. Let's assume I believe these are corns. This lady is selling corns and this individual is selling corns as well. She's selling tomatoes and he's selling tomatoes. Guess what? In this type of market, they're selling the same product. They are going to compete on the price. Why? Because this customer here, this lady here, she's going to look at both product and we're going to assume they're bringing the tomatoes from the same suppliers or the tomatoes are fairly the same and the corn is fairly the same. So they're going to basically, since they are also close to each other, they are going to price the product almost the same. So they are dealing in a perfect competition. In a perfect competition, there's a large number of small firms producing homogeneous product, producing or selling homogeneous product, the same product with no single firm have control over the market. What does that mean? It means this individual cannot control. It means this individual, for example, they cannot have too many tomatoes or too many corns to control the market. So everybody is basically don't have extra power. So the key feature of a perfect competition is many buyers and seller, as I mentioned, no individual buyer or seller can influence the market price. So who sets the price then? The market sets the price, supply and demand will set the price. Homogeneous product, the products are identical. So the consumer, this lady here, she has no preference for one seller over the other, other than the price and the price cannot be easily raised. So again, if one of these sellers raised the price, the customer will go to the other seller. There's a perfect information. Buyers and sellers have access to all relevant market information. It means there's nothing hitting about the corn, nothing hitting about the tomatoes that both parties are selling. And there is easy market entry and easy exit entry. What does that mean? It means we have those two stores here. We can easily bring another store, open a third store and a fourth store. So in a perfect competition, well, you could easily enter the market and simply put in a perfect competition, your profit is close to zero. Why? Because you are competing on price. So prices are determined by the factors of supply and demand. So individual firms are price takers, not price setters. Price takers means what? It means whatever the market determined the price, they have to go with that price. What does that mean? Let me give you an example about this. Let's assume this seller here, this gentleman, bought the corn last week and the Bush law of the corn was let's assume $6. Okay? Now in order to sell it, he got to sell it for more than $6. This lady here, she bought her supplies today and the market happens to be $5. So she bought the, she bought it $1 less than him. So she can sell it for $4.50 and still make a profit. He's going to be forced to either take a loss or not be able to sell his corn. Why? Because now the price dropped. So in a perfect competition, the firms are price takers. It's set by the market. It's set by the market. An example of perfect competition will be agricultural product, wheat, corn, often exhibit characteristic of perfect competition. Basically the price of the wheat is known, there's plenty of supply, plenty of demand, unless there's a shortage, same thing with corn. So what is the pricing competition? The pricing strategies in a perfect competition, again, firms are price takers. The focus is on maximizing efficiency. How do you make money and when you operate in a perfect competition, you want to reduce your cost. It means operating at a maximum efficiency. You are going to, you're going to accept the market, as I mentioned this, and adjust your output level accordingly. You might have to cut, you might have to increase depending on the market forces. Sometime in a perfect competition, firms operate on a cost-based pricing. What's cost-based pricing? It means I'm going to try to sell my product, the minimum, just to try to cover my cost. Set their prices based on production costs, aim to cover their expenses and achieve small or normal profit margin. So how do companies in a perfect competition make a lot of money? For example, Walmart. Walmart is in a perfect competition because if you don't like Walmart, you can go to Target. If you don't like Walmart or Target, you can go to Amazon. That's a perfect competition. So if you're making a small profit, how do these companies operate? They make small profit, but they sell a lot. They'll try to gain a market share. So their concern is to maintain their market share and increase their market share. So since prices are standardized, firms differentiate themselves through factors such as product quality, customer service, or branding. Now, how can this individual differentiate themselves from the other seller? The gentleman can differentiate themselves from the lady or the lady can differentiate themselves from the gentleman. For example, the lady could say, look, you buy it, go ahead, finish your shopping. I will deliver the product to your home. So basically, I'll provide you some extra customer service, or this gentleman can present their product as a better product, somehow convince this lady that what he's selling is better corn than the other store. So marketing here plays a big role in branding. Otherwise, you have no extra competitive advantage and a perfect competition. Another market is called a monopoly. A monopoly is the other extreme of perfect competition. Here you have one single firm is the sole provider of a particular product or service in the market. Now monopolies, generally speaking, are illegal. For example, the US government does not allow companies to have a monopoly. For example, Microsoft at some point, it had a monopoly, and the Department of Justice made sure they don't. I'll talk about this in a moment. So you have a single seller that dominate the whole market. There is no close substitute. There are no viable alternative. You either buy our product or you have no other option. For example, utility companies, and utility companies in some area, one utility company, they cover a wide geographical area. Because of that, if you want electricity, if you want gas for your home, you only have one supplier. Well, that's a monopoly. You don't have an alternative. You don't have an alternative. And there's a high barriers to entry. High barriers mean, well, you cannot just start a utility company in that area because you need a large capital expenditure, billions and billions of dollars. You need government approval. You need so many different licenses. So there's a high barrier to entry when you have a monopoly. So new firms, it prevents them from entering. And in a monopoly, you have a pricing power. You don't care about market share because you have the whole market. So what you do now, you can set the prices that you want, but you don't want to set your prices too high where you upset the citizens as well as the government. So you have a substantial control over prices versus the perfect competition. You have no control whatsoever. Here you are a price setter, not a price taker. You set the price. So in a monopoly, the firm has the power to set prices based on its market dominance. Now, unregulated monopolies, as I told you in the US, we don't have this, can potentially exploit their market and charge as high as they can. In some world countries, you have unregulated monopolies. In the US, we'll try to keep them. We'll try to keep them under control. Examples, utilities with exclusive service territories. For example, Apple computers, their first iPhone, the first six months, the first six months in the life of the first iPhone, Apple had a monopoly. If you wanted a smartphone, that was the only viable option. They were monopoly by default. They did not try to win monopoly. They simply did not have a competition. Then Samsung came along and they started to present other alternative. But this is what a monopoly is. So firm in a monopoly aimed to optimize their profit while considering their market power. So they cannot go out of control. Differentiation and competitive pressure within the respective market structure. So they will try to make profit, but at the same time, keep the pressure off. So they don't want you to enter the market as well, give you any incentive. The pricing strategy in a monopoly, it includes profit maximization. As I just said, you set your own prices, but you take into account cost structure and demand elasticity. When I say you have a price, pricing power, well, if you charge too much, no one happened to your sales. Nobody wants to buy your product. So you have to kind of charge, but keep it reasonable. Price discrimination. The monopolist charges different prices to different customer segment based on their willingness to pay. Also, they can charge different people, different prices based on the, you know, if they can provide them extra service, they can charge this barrier pricing. They want to price their product to keep competition out to deter potential entrant and protect its market dominance. So they don't want to make too much profit, too much profit. And it's worth it for a competitor to come in and invest billions of dollars. For example, going back to the utility companies, if they're making a lot, a lot, a lot of profit, then investors will kind of join together and start the utility company because there's a lot of profit to make. So you don't want it to make it look it's, there's a lot of profit unlimited profit, then people will enter the market. So somehow you price your product to keep, to keep new, new competition out. You could also bundle your product, the monopolist offer product or services together at a combined price to increase sales and capture more, more value. A case in point is Microsoft. In 1995, Microsoft had Windows 95, Windows 95. That was the first kind of graphic user interface operating window based system, Windows 95. And from 1995 till 2001, 2003, Windows dominated the market PC. At that point, in 1996, 1997, we started to have the internet. Okay. So what happened is what would Microsoft do every time they sell you their Windows, they will bundle with it Netscape Navigator. I'm not sure you guys don't know what Netscape Navigator is. Think of Chrome. Think of the first version of something like Chrome. Chrome is the web browser. But Chrome is for Google. You have Chrome, you have Firefox, you have different web browser. Back then, what Microsoft did, every time they sold you Windows 95, they bundle with it Netscape Navigator. So what happened with all these web browser developer? Well, they could not compete because no one's going to buy their product. If everybody, if everyone is buying Windows 95 comes with it, comes with it Netscape Navigator. Why would someone invest in a web browser? Until obviously the market break them. It's important to know that these strategies are not exhaustive in terms within each market may structure, in each market structure may employ additional or hybrid pricing approaches based under specific circumstances and objective. The key point is to understand what a monopoly in general is. Monopoly is basically you have control, basically you have no competition. You are a price setter, but you have to be very careful not to be too greedy because you're going to either upset the citizen, your potential customers or the government. Then we have monopolistic competition. Monopolistic competition combines both the perfect competition and monopoly. We talked about the perfect competition and monopoly. So something in between. It involves a large number of firms producing differentiated product. What's differentiated product? Firm sells products that are similar but not identical, creating some sort of a product differentiation. When you think of monopolistic competition, think of the fast food industry, think of McDonald's, BK, Burger King, Wendy's. Wendy's. Those are all they operate in a monopolistic competition. They sell the same product but somehow they want burgers, basically food, soda, french fries. They try to differentiate themselves. So individual firms have limited control over their market price because there are many buyers and sellers. Now if McDonald's increased their prices a lot, they would lose. So basically as long as they keep their prices close to Burger King, Burger King keep their prices close to Wendy's, that's fine. They can live together. They rely on advertising and branding. Firms engage in non-pricing competition through advertising and marketing efforts. So they'll try to differentiate themselves and I'm pretty sure you see a lot of ads for them. There are easy entry and exit. So the barrier to entry is relatively low. They're not very high, relatively low, but to compete it's going to be tough. But it's not like a monopoly where it's prohibitive. So relatively low. Perfect competition, perfectly low. It's very low. Relatively low in a monopolistic competition. They can adjust their prices based on perceived product uniqueness and consumer preference. So what they do, they'll try to make you feel what you're buying is something better than the other competition. For example, Burger King, they would say, well, our product is better because, and they'll try to kind of give you a reason why, to convince you that they want to charge you a little bit more. So the fast food industries with various chains offering slightly different menus is an example of a monopolistic competition. Some monopolistic competition pricing features. Again, they set their prices based on the perceived uniqueness or added value to their product compared to their competition. Price discrimination firms charge different prices to different customer segment based on their willingness to pay. If they can find a segment where they can charge it more, then they will do that. Promotional pricing firms use sales discounts or special offers to attract customers and differentiate their offering. Well, I'm pretty sure in the US, if you live in the US, you would receive discounts from McDonald's discount from Burger King to do what? To help increase their sales, to attract you to their store. And firms invest in advertising and marketing and branding campaign to do one thing, create a distinct market position. They want you to think they are different. They want you to think they are different, but they are not really different, but they want you to think and based on that perceived uniqueness, they can charge you a little bit more. Then we have a leg up a leg. Then we have, then we get to the oligopoly. The first thing you think of when you think of oligopoly is OPAC. What is OPAC? The Organization of Petroleum Export Countries. And this is, I don't think this is a comprehensive list, but this is the list of these countries. Here, oligopoly exists when few large firms or in this situation countries dominate the market either due to high barrier entry or strategic behavior or the uniqueness of the product you need to have oil okay the key features few large firms a few large firms a small number of firms control the significant share of the market these countries control the large proportion of the oil market in the world they are interdependence firms are aware of each other's action and consider them when making pricing decision now opac what they do they these countries they meet and they decide what the price is they're aware of each other's action barriers to entry is high okay high entry barriers prevent new firms from easily entering the market so you cannot just produce oil it's not that easy you need to find it in the ground first if you don't have it you don't have it product differentiation sometimes it may be differentiated sometimes it's not for example oil it's not differentiated oil is the same whether you bought it from Saudi Arabia Nigeria Iran or Algeria it's all the same oil pricing strategies firm consider the action and reaction of their competitors so they cannot just you know increase and reduce prices they do that for example for opac but there are political consequences to that sometimes what you have is collusive pricing in illegal collusion firms agree to fix prices or output level to maximize collective profit so what happened in the news every once in a while you would say that opac they they met and they wanted to cut output by three billion three million barrels per day they can do that price leadership sometimes one dominant firm sets pricing trend and other firms will follow for example in opac you got Saudi Arabia is one of the largest and if Saudi Arabia cuts their output the rest would follow and if they increase the rest would follow it gives them basically the signal strategic prices firms strategically adjust prices based on their assessment of competitor responses market condition and their own cost structure for example during covid they cut down their production because they don't want to produce the oil and put it you know put it in storage and not sell it then they have to reduce their prices what do they do they invest in research they don't you know they invest in research and development marketing and innovation to differentiate their product for example for oil companies they really don't need any marketing because everybody needs oil in a nutshell those are the four common market structure that you need to be familiar with as far as the CPA exam what should you do now to learn more about these market structure go to far hat lectures and practice mcq's multiple choice questions that's gonna help you what do better on the CPA exam I can only help explain the concept you got to learn it you got to do well on the exam good luck study hard and of course stay safe