Puzzled by pricing in commodities market

competitive response mining pricing
New answer on Apr 06, 2020
3 Answers
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Clem asked on Apr 05, 2020
Preferably candidate-led, non-Preplounge, complex cases other than profitability and investment

Hi,

quick question about something that puzzles me on Commodities pricing.

Let's say the demand is 650, then it decreases to 600 (see sketch attached).

I know that price then decreases to the marginal cost of the player with the higher cost structure (player C, so price becomes P1) within the boundaries of demand, which pushes players with a higher cost structure (D) to exit the market.

However, I don't really understand why price doesn't stabilize being above the cost structure of the least efficient competitor within the boudaries of demand (that would be C), while remaining below the cost structure of the next player (D): meaning a price like P2. All remaining players would be better off, and I don't see what any of them has to win by decreasing the price.

Can you help me understand?

My only hypothesis: quantities are never as clean as on my sketch, and if demand is actually 580, then competitor C decreases the price until they cannot anymore to try and regain market share, which brings the price down to its marginal cost.

Thanks to anyone who has a better idea or can explain the dynamics better!

graph pricing in commodities market

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Francesco
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replied on Apr 06, 2020
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Hi Clem,

assuming that:

  • A and B cannot increase supply, and there are no other possible entrants
  • There is no risk of anticompetitive claim for a higher price

the only reason I see not to put a price as P2 instead of P1 for C is that there would not be demand for Player C at that price level (for example because a buyer has perfect information on the marginal cost of C and buyer power), thus C has to decrease the price at a lower level with a minimum possible price equal to P1.

Best,

Francesco

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Anonymous replied on Apr 06, 2020

Hey there,

The price is not only determined by the supply curve, but also the demand curve. It is at the intersection of demand and supply curves. When demand drops to 600, you cannot assume buyers would be willing to pay P2 just because sellers could in theory collude to set price at P2 (btw this is not allowed by anti-competition law also).

Best,

Emily

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Clara
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replied on Apr 06, 2020
McKinsey | Awarded professor at Master in Management @ IE | MBA at MIT |+180 students coached | Integrated FIT Guide aut

Hello!

I don´t fully understand the problem, since we are missing to analyze a key part here: demand. Your are only providing data about the offer, but both are key. Can you enrich it?

Hope it helps!

Cheers,

Clara

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Francesco gave the best answer

Francesco

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