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Why do firms in perfectly contestable markets lower their prices? watch

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    If they lower prices to the point where they break even, isn't it better to just continue earning super normal profit until new firms enter? In both instances they would end up earning normal profit right? Or do losses start occurring when many new firms enter as firms look to undercut?
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    This may or may not be unrelated to what you are asking. But what is better? Making a nice fat profit off a customer once because you are in a position to not lower your prices, or dropping your price to entice customers, making less profit but generating some recurring customers, which can be used to make a profit on other products later on?
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    (Original post by Acsel)
    This may or may not be unrelated to what you are asking. But what is better? Making a nice fat profit off a customer once because you are in a position to not lower your prices, or dropping your price to entice customers, making less profit but generating some recurring customers, which can be used to make a profit on other products later on?
    If you lower prices to only make normal profit, their wouldn't be any chance of innovation I think.
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    Lowering the price could increase volume which means you can run your factory more efficiently assuming you are in manufacturing. You can also take customers from your competitors and lower their volumes and increase their costs as they have to run their factories less efficiently.

    Once you have the customer, you can sell them additional products and services like spare parts, consultation services and service contracts which may be more profitable.
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    (Original post by dont know it)
    If you lower prices to only make normal profit, their wouldn't be any chance of innovation I think.
    That depends on what your goals are and how you are lowering prices. It's generally not a linear process, where lowering prices for customers simply means you make less profit. Odds are you get something else out of it to offset the drop in profits.

    Innovation isn't purely a response to high profit. But this is an overly generic conversation, do you have specific examples to describe what you are talking about?
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    (Original post by Maker)
    Lowering the price could increase volume which means you can run your factory more efficiently assuming you are in manufacturing. You can also take customers from your competitors and lower their volumes and increase their costs as they have to run their factories less efficiently.

    Once you have the customer, you can sell them additional products and services like spare parts, consultation services and service contracts which may be more profitable.
    Thanks. Can that be summarised as saying lowering prices would help maintain market share?
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    (Original post by Acsel)
    That depends on what your goals are and how you are lowering prices. It's generally not a linear process, where lowering prices for customers simply means you make less profit. Odds are you get something else out of it to offset the drop in profits.

    Innovation isn't purely a response to high profit. But this is an overly generic conversation, do you have specific examples to describe what you are talking about?
    Thanks, not really got any examples no, which is unfortunate. That does make sense however it's not quite what I need to know.

    I think the answer is related to market share of each firm when comparing highly competitive and not so competitive markets.
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    (Original post by dont know it)
    Thanks. Can that be summarised as saying lowering prices would help maintain market share?
    I would say one of the main motivations to lower prices is to increase market share and increase volume. By lowering the price and increasing the volume, the company will hope to offset lower per unit profit for a larger volume of units sold.
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    (Original post by Maker)
    I would say one of the main motivations to lower prices is to increase market share and increase volume.
    Oh right! Thank you.
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    Contestable markets exist when there are no barriers to entry or exits, such as sunk costs related to a market. If a firm exists in such a market, the threat of potential competition (i.e. through hit-and-run competition) is constant, meaning they are incentivised to behave in a productively efficient manner in order to maintain their market share.
 
 
 
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