Appl Ex 4j

Application Exercise 4j: Spooksy’s supermarket

  1. Like most business owners, the Spooks’ will be motivated by the possibility of making a profit.
  1. The supermarket industry was most likely an effective duopoly, with two major firms (Cales and Walewiths) controlling the bulk of the market.
  1. This is because the major supermarkets have major buying power given their size, and in some cases exercise what is known as monopsony power. As the major buyer of some supplies from other businesses, it can squeeze these suppliers by refusing to continue purchasing their products unless they reduce prices to very low levels.  These suppliers are therefore forced into a position where they must recoup some of their ‘lost profits’ by charging higher prices to other customers, such as Cales and Walewiths.
  1. They may have reduced the prices of milk and bread to $1 in order to attract consumers who might ordinarily purchase these staples from other smaller retailers (e.g. milk bars, convenience stores, small supermarkets etc.). By having these consumers into the big supermarkets they are then more likely to purchase other products on their way through. It is also possible that the major supermarkets reduced the prices of bread and milk to such low levels in order to ultimately destroy competition (which is an example of predatory pricing) in the short to medium term after which they are able to raise prices to much higher levels.
  1. The Spooks’ eventually closed the business because they were making losses as a result of selling bread and milk at below cost.
  1. The major supermarkets were able to raise their prices once more because competition was eliminated. Consumers had no choice but to purchase these staple items, being necessities for households, from the major supermarkets.
  1. If Cales is successful in its takeover of Walewiths then the market structure in the supermarket industry effectively becomes a monopoly, with one sole supplier of supermarket items.
  1. A monopoly is generally considered to be bad for an economy because it is more likely to charge exorbitant prices and less likely to be efficient given that it has total control of the market. In this respect, there is a role for the government to regulate the monopoly and ensure that it does not abuse its position of market dominance.  Alternatively, the government could attempt to make it exceedingly difficult for companies to form a monopoly (which is indeed the case in Australia by the Australian Competition and Consumer Act.
  1. The Spooks’ were motivated by what they considered to be relatively high prices being charged for a massage. They considered that it was relatively easy to establish a business in this particular industry (very low set up costs) and reasonable profits could be made.
  1. The massage industry is unlikely to be oligopolistic essentially because of the ease of entry into and exit from the market. If very high profits are being made in the industry it would be very easy for new operators to offer their services.  This acts as a constraint on the ability of any one or two operators being able to exert any degree of market power and increase prices to excessive levels in the medium to long term.
  1. The massage industry is much more likely to have a market structure referred to as ‘monopolistic competition’. There are likely to be lots of buyers and sellers, as well as freedom of entry and exit to and from the industry. However, massages in themselves are unlikely to be homogenous. In other words, a massage provided by one masseuse is likely to be different to massage provided by another masseuse.  In this respect, the product provided in the industry is differentiated and the market is therefore considered to be monopolistically competitive.
  1. This is because of the highly competitive nature of the industry (monopolistic competition) where excessive or very high profits will attract new entrants into the market which raises supply, exerts downward pressure on price and reduces the profitability of each operator in the market