Question

In \(2005,\) a major U.S. automaker announced a new discount plan for its cars for the month of June. It offered consumers the same price that its employees paid for new cars. When the automaker announced in early July that it was extending the plan for another month, the other two major U.S. automakers announced similar plans. What market structure is exhibited in this story and what specific characteristics of that market structure does it demonstrate?

Short answer

The market structure is an oligopoly, shown by strategic interaction and similar pricing plans among major competitors.

Step-by-step solution

Understanding Market Structures

Market structures describe how different industries are organized in terms of competition and pricing. The main types are perfect competition, monopoly, oligopoly, and monopolistic competition. Each has distinct characteristics that affect how firms make decisions.

Identifying the Relevant Market Structure

In the exercise, the automaker extending their discount plan in response to a competitor's move suggests a market where firms' decisions are interdependent. This feature is most characteristic of an oligopoly, where a few firms dominate the market and are sensitive to each other's pricing strategies.

Analyzing the Characteristics Demonstrated

Oligopolies tend to have a few dominant firms that offer similar products, and firms are price setters rather than price takers. The automakers' decision to imitate each other's pricing plans reveals key oligopolistic behavior: non-price competition and strategic interaction, where each firm's actions can influence the market outcome.

Summarizing the Market Behavior

The automakers are behaving in a way that indicates they are aware of and respond to each other's business strategies. This is typical in an oligopoly, where firms might engage in price matching or other strategic moves to maintain market share without engaging in price wars.

Key concepts

Market Structures

Market structures refer to the organizational and competitive characteristics of a market that influence the behavior and strategies of firms operating within it. Whether you're dealing with breakfast cereals or large automakers, understanding these structures can help clarify how markets function. There are several types of market structures:

• Perfect Competition: Many firms, identical products, and no single firm can influence the market price.
• Monopoly: One firm dominates the market, setting prices due to lack of competition.
• Oligopoly: A few firms dominate, as with the automakers example, creating a shared market influence.
• Monopolistic Competition: Many firms with similar but not identical products, each having some pricing power.

In the automakers' case, we see an oligopoly. Here, a few large firms influence the bulk of the market, each aware of their competitor's actions and capable of strategic pricing decisions. Understanding this structure helps explain the firms' behavior—such as matching discount plans—which we'll explore further in the next sections.

Strategic Interaction

Strategic interaction is a crucial component of oligopolies, where firms must consider the potential reactions of competitors when making business decisions. Unlike in perfect competition, where firms operate independently, oligopolistic firms are entwined in a web of strategic dependence. Every move by one firm—a price cut, a new feature, or an extended discount—can potentially prompt a response from competitors. For our automakers, the decision to extend employee pricing to customers wasn't made in isolation. It was a calculated move, likely anticipating that competitors would react similarly. This behavior highlights a characteristic of strategic interaction:

• Interdependence: Decisions are not made in a vacuum but are influenced by competitor actions.
• Predictive Reactions: Companies often anticipate moves and countermoves, like a chess game.

This strategic dance can lead to stability in pricing or periods where firms choose non-price strategies to lure customers, maintaining a form of tacit understanding and minimizing direct conflict.

Price Competition

In the context of oligopolies, price competition is a delicate balance. Firms possess the power to influence market prices but must tread carefully, as aggressive pricing strategies can lead to destructive price wars. Instead, it's common to see tactics like price matching, as seen with the automakers' various discount plans. Here are key points about price competition in oligopolies:

• Price Leadership: Often, one firm—usually the largest or most profitable—sets the price that others follow.
• Price Matching: A defensive tactic to protect market share without engaging in a costly war.
• Non-price Competition: Due to the risks of price wars, firms often focus on marketing, product differentiation, or features instead.

By extending similar pricing plans, the automakers exhibited price matching, showing their awareness of competitors' moves. These actions reflect a careful balancing act, where each firm's goal is to maintain or enhance market share without triggering price reductions that could hurt all players' profits.