You will probably have come across the concept of consumer sovereignty. In the mythical world of perfect markets, producers are at the beck and call of consumers. Firms that are not responsive to consumer demand go out of business. In other words, in order to survive they have to respond to any shifts in consumer demand. These in turn can be the result of changes in tastes, changes in income, changes in the prices of other goods, and so on.
Of course, the real world is not perfect, but it is still often assumed that consumers are powerful in influencing what firms sell and at what prices. Well, firms would much rather be in a position of manipulating consumer tastes and hence the huge amounts spent on advertising and marketing.
And it doesn’t end there. Firms use many pricing practices which, to put it mildly, try to confuse consumers or lure them into buying things by making them think they are getting something much cheaper than they really are. Take the case of airline tickets. Some budget airlines offer tickets at extremely low prices, such as 99p. But if you select such a flight, by the time you get to the final screen where taxes, charges, supplements, luggage, etc. are added, the price could exceed £100! And ask yourself this, when you buy something with 20% off, or when you buy ‘three for the price of two’ how rational was your decision? Did you really want the product? Was the offer really ‘genuine’?
The Office of Fair Trading has recently completed two investigations into pricing. As it stated 14 months ago when the investigations were launched:
The first, into online targeting of advertising and prices will cover behavioural advertising and customised pricing, where prices are individually tailored using information collected about a consumer’s internet use. It is expected that this study will be completed by spring 2010.
The second, into advertising of prices, will consider various pricing practices which may potentially mislead consumers. The study will look in particular, but not exclusively, at how these practices are used online.
The following articles look at some of the practices that firms use to drive sales – practices that deliberately attempt to manipulate the consumer. The assumption of ‘perfect knowledge’ by consumers may be a long way from the truth.
Articles
Shoppers lose out on ‘billions’ because of ‘deceitful’ marketing The Telegraph, Harry Wallop (2/12/10)
OFT warns retailers about ‘misleading’ price offers BBC News (2/12/10)
OFT cracks down on price gimmicks Guardian, Rebecca Smithers (2/12/10)
We’re all gulled by special offers BBC News blogs: Peston’s Picks, Robert Peston (2/12/10)
OFT publications
OFT warning on misleading pricing practices, OFT Press Release 124/10 (2/12/10)
OFT launches market studies into advertising and pricing practices, OFT Press Release 126/09 (15/10/09)
Advertising of Prices, Office of Fair Trading, OFT1291 (December 2010)
Advertising of Prices, Office of Fair Trading, project page
Advertising of Prices Study Overview, Office of Fair Trading, video
Questions
- Explain each of the different types of pricing practice investigated by the OFT.
- Which of the pricing practices are the most misleading for customers?
- What is meant by ‘invisible price increases’? How can they be used to mislead the consumer?
- Why do certain pricing practices make it hard for the Office for National Statistics to work out the rate of inflation?
- Explain the new framework the OFT is adopting for ‘prioritising enforcement action’.
- If we end up buying something that we didn’t really intend to buy, does this mean that we were being irrational?
- Is advertising generally in or against the interest of consumers? Explain your answer
In 2003, the Office of Fair Trading launched an investigation into possible collusion between tobacco manufacturers and retailers to fix prices. The investigation sought to establish whether the firms had breached the Chapter I prohibition of the Competition Act 1998. Chapter I is concerned with Restrictive Practices.
The allegation was that two tobacco manufacturers, Imperial Tobacco and Gallaher, had colluded with 11 retailers to fix the retail prices and thereby reduce competition. The details of the allegations are given in a 2008 press release.
As a result of its investigations, the OFT has decided to impose fines of £225m. “The OFT has concluded that each manufacturer had a series of individual arrangements with each retailer whereby the retail price of a tobacco brand was linked to that of a competing manufacturer’s brand. These arrangements restricted the ability of these retailers to determine their selling prices independently and breached the Competition Act 1998.” As the Times Online article states:
The OFT said that the companies were guilty of “price-linking” or “price matching”. It said that Imps and Gallaher had come to an arrangement with each retailer that if one or other manufacturer increased or decreased prices the retailer would alter the price of the competitor brand in line, up or down accordingly – a practice known in competition law circles as “vertical price collusion”.
Articles
‘Unlawful’ tobacco pricing leads to £225m fine by OFT BBC News (16/4/10)
OFT levies £225m fine for cigarette price fixing Guardian, Richard Wray (17/4/10)
Tobacco giants face £225m fine for price-fixing Independent, Alistair Dawber
(17/4/10)
OFT case will send smoke signals Financial Times, Michael Peel, Elizabeth Rigby and Pan Kwan Yuk (16/4/10)
Imperial and Morrison set to appeal OFT fine Financial Times, Michael Peel, Pan Kwan Yuk and Elizabeth Rigby (16/4/10)
OFT faces challenge to £225m price-fixing ruling Times Online, Robert Lea (17/4/10)
OFT gets tough on tobacco as price-fixing net is cast wider Independent, Nick Clark (26/4/08)
OFT Press Release
OFT imposes £225m fine against certain tobacco manufacturers and retailers over retail pricing practices OFT Press Release (16/4/10)
Questions
- What are the allegations against the tobacco manufacturers and retailers?
- Why has the OFT judged that such behaviour is in breach of the 1988 Competition Act, and hence against the public interest?
- What are the arguments put by the tobacco companies and retailers in their defence?
- Is giving companies an amnesty if they alert the OFT an example of a prisoners’ dilemma game? What credible threats or promises may the companies have in such a situation?
Increasing traffic on the roads is observable by everyone and government policy is focused on reducing the demand for road space, rather than increasing its supply. One method has been to improve public transport and make it a viable substitute for car travel. Private costs of motoring have increased, but if there is no viable alternative, people will continue to demand car travel. Investment in buses and trains has improved their quality: they are more frequent, more reliable, arguably more comfortable and supposed to be part of an integrated transport policy. Local bus services provide a crucial link for local communities, but it is these services that are now facing problems.
In your economics lectures, you may have looked at local bus services, when you considered monopolies, oligopolies and possibly contestable markets. Oligopolies, whilst closer to the monopoly end of the market spectrum can be very competitive, but are also open to collusion and anti-competitive practices. The local bus sector has been referred to the Competition Commission by the Office of Fair Trading through complaints of ‘predatory tactics’ by companies. It is argued that local bus services, by limiting competition, are causing prices to rise and the quality of service to fall. One key issue is that those companies established in the market are alleged to be acting aggressively towards smaller bus companies and thus reducing competition in the industry. A low number of bids for supported service contracts in many areas, local bus routes dominated by a few large companies and predatory actions by incumbent firms are all complaints that this industry is facing.
This investigation is especially important, given the amount of public money that goes into the bus industry: £1.2bn. Investigations found that in areas of limited competition, prices were 9p higher. A number of take-overs have contributed to this situation. Two-thirds of bus services are controlled by only five operators. This limits competition in the market and hence is argued to be against public interest. Yet, industry representatives still argue that the market is competitive. Read the following articles and answer the questions about this issue. Was the OFT right to to initiate this investigation?
Local buses to be re-regulated BBC News (27/9/09)
OFT refers UK bus market to Competition Commission Dow Jones Newswires, Kaveri Nihthyananthan (7/1/10)
Office of Fair Trading prompts probe into bus services Guardian (7/1/10)
Trasport groups fear OFT competition probe over buses Telegraph, Alistair Osborne (4/1/10)
Bus industry competition queried BBC News (20/8/09)
OFT refers bus industry on poor service and prices Times Online, Francesca Steele (7/1/10)
Inquiry into local bus market ‘may delay investment’ Scotsman, Hamish Rutherford (5/1/10)
Questions
- Why are local bus services argued to be (a) a monopoly; (b) an oligopoly?
- What are the main aspects of UK competition policy?
- What is a concentration ratio and how does this apply to the bus industry?
- What predatory tactics are being used in the local bus industry and how do they affect competition, prices and quality?
- Why may limited competition be against the public interest?
- Traffic congestion is a major problem. Explain the economic theory behind government intervention in this area. Think about the effects of taxes; building more roads; investment in substitutes. Which is likely to be the most effective method?
A number of UK supermarkets, including Sainsbury’s, Asda and Safeway, have been fined £116m by the Office of Fair Trading (OFT) for price fixing. The OFT is still investigating other supermarkets, including Tesco which denies that it was involved in the price collusion. The collusion is estimated to have cost consumers around £270m in higher prices.
Supermarkets fined £116m for price fixing Guardian (8/12/07)
OFT hands out £116m in fines for milk price fixing Guardian (7/12/07)
Supermarkets admit milk price fix BBC News Online (7/12/07)
Videos
Farmers reaction to price fixing claims BBC News Online
Questions
| 1. |
Explain how Sainsbury’s and the other supermarkets colluded to fix milk prices. |
| 2. |
Assess the market conditions most likely to lead to price collusion in a market. |
| 3. |
Examine the role of the OFT in reducing uncompetitive and restrictive practices in markets. |
British Airways has been fined £270m for their part in a price-fixing cartel. Fines were levied by both the US Department of Justice and the UK Office of Fair Trading following an agreement between British Airways and Virgin to fix the level of surcharges charged to passengers as a result of rising fuel prices.
Where’s Branson’s apology? BBC News Online (Robert Peston blog) (7/8/07)
BA’s price-fix fine reaches £270m BBC News Online (1/8/07)
OFT defends ‘snitch’ policy Guardian (5/8/07)
BA boss speaks out over price fixing Guardian (3/8/07)
How arch rivals colluded to hike up cost of air travel Guardian (2/8/07)
Questions
| 1. |
Define what is meant by the term ‘price-fixing cartel’. |
| 2. |
Explain the characteristics of a market that are most likely to result in a cartel. |
| 3. |
Discuss policies that the government could put in place to prevent this kind of price-fixing arising in the future.. |