Case Study: Imperfect competition and alternative theories of the firm

Sangeetha had started her career working as a dinner lady at a local primary
school. After a few years doing this she was keen to set up her own business with
the help of a few friends. She noticed that many schools were now outsourcing the
provision of their food, and Sangeetha decided that she and the others should bid
one of these contracts. After a few failed bids they finally own the right to supply a
small local school and from then on never looked back.
Since then Sangeetha has built up her business over the years and now is one of
the biggest suppliers in the country. There are two other main competitors, and
Sangeetha is increasingly going head to head with them when bidding for contracts.
To win the deals she is having to guess what they are going to bid and try to
undercut them; this process is eating into all their profits. At a recent meeting of the
Indian catering Society the bosses of Sangeethas biggest rivals asked for a chat.
They suggested to Sangeetha that life could be a lot better for all of them if they
took it turns to bid for contracts. That they would avoid competing against each
other. Sangeetha liked the sound of this but asked for a few days to think about it.
Questions
1. Discuss the possible consequences of these firms competing against
each other?

In a perfectly competitive market,

(i) There are buyers and sellers, so each buyer or seller is a price taker,
(ii)All sellers supply the similar product.
Hence, the firm cannot affect the market price. This simply says that firm
has no power to raise its price. If it does so, the firm might not be able to sell
output because consumers will buy goods from others.
So, each competing may even choose to bid at lesser value (Marginal cost),
so they can maintain market share or achieve other objectives. These firms
need to reduce the cost to bid lower than current marginal cost.
By Group 6
Eashwar.T.K (1403006); Praveen.R (1403019); Jiby Issac M (1403008);
Mervyn Samuel (1403016); Jebadoss Rajesh J (1403007)

Sample Oligopoly Pricing Strategy

2. Should Samantha accept the proposal to take it in turns to bid for

contracts?
This is illustration of the Cartel situation. The factors that make collusion
more likely are
a. Relatively few business which can monitor each others actions easily
b. Significant barriers to entry, providing existing firm strong control over
the market
c. Similar costs, will gain similar rewards and disputes are less likely
d. Stable market conditions
Cartel Price Model

By Group 6
Eashwar.T.K (1403006); Praveen.R (1403019); Jiby Issac M (1403008);
Mervyn Samuel (1403016); Jebadoss Rajesh J (1403007)

Given the product sold at price P1, Marginal revenue = P1. Profit
maximization by producing at q2 where marginal revenue = Marginal
cost.

This would increase its profit, hence more output in the industry as a
whole and move the industry away from the profit maximization
position

Firm gains at others expense, if all the firms deviate from this
agreement the overall production price of the industry would go down
whereby reducing the overall profit generated by the industry.

Though there are few advantages to bid in turn for contracts, as per Game
theory, agreements are inherently unstable as the behavior of members of a
cartel is an example of a prisoners dilemma. Each member of a cartel would
be able to make more profit by breaking the agreement, producing a greater
quantity or selling at a lower price than that agreed, than members abiding
by the agreement. However, if all members break the agreement all will be
worse off.
Also since Cartel is illegal, the company is under constant risk of legal action,
which might in turn affect its reputation as a whole.
Pricing risk - Competitor may reduce price for a contract which may affect the
overall economics of the industry.
This is a case of Prison dilemma which is depicted below.

By Group 6
Eashwar.T.K (1403006); Praveen.R (1403019); Jiby Issac M (1403008);
Mervyn Samuel (1403016); Jebadoss Rajesh J (1403007)

3. Should the government allow firms to make agreements on which

contracts to bid for?
No! The government should not allow due to following reasons.
Higher prices
Colluding members can all raise prices together, which reduces the elasticity
of demand for any single member.
Goods & Services Quality
A significant disadvantage of such agreements is that the quality of goods
and services will likely go down or not improve.
Efficient Firms have disadvantage
New players are not allowed to enter into market as the rates are pre
determined by the groups.
4. If the government decided not to allow such agreements, what
would be an appropriate penalty for businesses that continued to
make them?
i.

Cancellation of license

ii.

Levy of fines

iii.

Suspension of business dealings

iv.

Suspending applicable incentives & subsidies.

5. Do you think that competition is a good thing?

By Group 6
Eashwar.T.K (1403006); Praveen.R (1403019); Jiby Issac M (1403008);
Mervyn Samuel (1403016); Jebadoss Rajesh J (1403007)

Yes! In our opinion competition is good.

The following are the advantages.
i.

Lower prices for consumers

ii.

A greater discipline on producers/suppliers to keep their costs down

iii.

Improvements in technology with positive effects on production

methods and costs

iv.

A greater variety of products (giving more choice)

v.

A faster pace of invention and innovation

vi.

Improvements to the quality of products/service for consumers

vii.

Better information for to customers which allows them to make proper

choices.
----x----

By Group 6
Eashwar.T.K (1403006); Praveen.R (1403019); Jiby Issac M (1403008);
Mervyn Samuel (1403016); Jebadoss Rajesh J (1403007)