Walmart Swings Low
The article by Greta Guest, “Holiday Shopping Price Wars: Wal-Mart Swings Low: Aggressive Cuts Take Fight to Big Rivals,” concerns Wal-Mart’s actions in this year’s Black Friday event, in which it engages in a massive price war by offering much lowered prices on holiday gift items between the hours of 5:00 a. m. and 11:00 a. m. on the day following Thanksgiving. According to a case analysis done on Wal-Mart in 2004, the company is the largest in the United States. Its annual sales grew by $26.
7 billion between 2002 and 2003 (Shah, Offstein & Phipps, 2005). As North America’s largest retail outlet and bargain-price centers, it is one of the primary players in the major price cuts that follow Thanksgiving. Although Wal-Mart engages “everyday low prices,” this season’s price cuts represent one of the major battles of the price wars, and it several economic principles are evident in its practice. These principles include opportunity cost, (shock) demand/supply, competition, and comparative advantage.
However, as the Wal-Mart scenario rests most heavily on the principle of demand and supply within what should be a perfectly competitive market, it will ultimately be considered to what extent the concept of perfect competition can actually be applied to the situation. The idea of opportunity cost underlies the concept of price wars as exhibited by Wal-Mart and its competitors during this holiday season. The financial resources available to consumers are scarce, and this fact reduces the number of items that can be bought with their limited amount of money.
When opting to buy one item at a particular store, consumers and suppliers alike know that consumers must forfeit the opportunity of buying something else—the next best alternative. Wal-Mart capitalizes on this by reducing prices in order to create in the consumers’ minds a feeling of having their opportunity cost reduced. Demand takes on a higher significance this holiday season, as the concept of shock demand can be seen in this scenario. Especially on Black Friday (the day after Thanksgiving in the United States), a sharp rise in demand (shock demand) for gift items is usually seen in the market.
This is usually preceded by a higher level (shock) supply (in the form stock piling) in anticipation of the event, and this brings in the idea of economies of scale. Especially for Wal-Mart (which according to the news article, saw 10 million consumers nationwide within the 6-hour period that constitutes the Black Friday event), this allows them the privilege of slashing prices to a larger degree than their competitors (Guest). For example, last year for a toy pony that went for approximately $300 at Toys R Us and $540 on Amazon was being sold at Wal-Mart for $268.
Yet, this is not the only time in which Wal-Mart has exhibited an ability to out-price its competition. Within a market, prices are usually determined (among other things) by the demand for and the supply of the good (Case & Fair, 2003). At the point where supply peaks and demand matches this, the number of suppliers within a market usually levels out to a point where the price for a particular uniform commodity is established within the market.
In such a scenario in which the all the goods available for supply can be sold at a particular price, it is logical and natural (in theory) for the price to become inelastic—that is, remain at that level for a reasonable amount of time (that is, at least in the short run). These prices come about as a result of the interplay of several factors, but once normal profit has been computed (and especially if the suppliers’ profit margins run into supernormal area) other suppliers enter the market and/or price wars generally result to cut these profits down to normal and create a perfectly competitive market.
Wal-Mart might be considered a supplier whose actions fly in the face of perfect competition. This entity supplies a wide variety of products that are also supplied by other similar stores. Many of these products are identical to those supplied by its competitors, and the breadth of the market in which this product is being supplied sets the stage for perfect competition. The problem is that Wal-Mart consistently offers prices that are lower than the price of the goods on the general market (as demonstrated by the prices offered by the Wal-Mart’s competitors).
The fact that Wal-Mart continues to stay in business testifies that the profit margins it accepts for this wide variety of goods is enough to keep it afloat, despites its low prices. This raises an issue concerning the validity of perfect competition as an economic model for real world market economies. It questions whether perfect competition can actually be realized in the real world or if it is just an ideal. Economies of scale appear to have a large amount of influence in the way that Wal-Mart fares in the market.
Though the company might not be a producer of a particular good, the fact that it obtains its stock in large numbers creates an effect that mirrors that seen in economies of scale. The more products it can acquire and offer to the consumer, the smaller the cost of each additional unit. Therefore, compared to its competition, marginal costs would appear lower. This facilitates Wal-Mart’s ability to offer lower prices to its consumers. Economies of scale offers to Wal-Mart, therefore, what might be considered a comparative advantage.
The opportunity cost of obtaining each good is lower for Wal-Mart, the opportunity cost of the next best alternative good (the supply of which is has to forfeit) is smaller than that of its competitors. Not only is Wal-Mart’s advantage apparent in its lower opportunity cost, but in the compensation provided to the company by its wide variety of goods. Wal-Mart can afford to cut its profit to very low levels because it offers this variety. It is necessary to note that this store does not offer these rock-bottom prices on all its items.
However, it offers low prices on enough items to attract customers to the store. These customers (out of convenience) buy the low-priced as well as regular priced items. Wal-Mart’s supply of a wide variety of goods attacks competitors and entices consumers in the area of convenience. By shopping at Wal-Mart, for example, a mother is able to do grocery shopping as well as pick up toys for her children’s Christmas presents. Toys-R-Us as Wal-Mart’s competition is unable to attract customers on this grounds, and therefore does not compete perfectly in that area.
To compound this effect is the fact that concept of economies of scale applies to most of the items Wal-Mart supplies, regardless of their profit margins. This means that the higher profits gained from some commodities can compensate for the lower profits earned from others. This area of economies of scale is one in which Wal-Mart does seem to defy the concept of perfect competition and its applicability in the real world. Though the store does offer some products that are identical to those offered by its competitors, other factors create a scenario that deviates from the ideal of perfect competition.
Disparities created by the concept of economies of scale places Wal-Mart (usually) on a different footing from other companies. It grants the company a smaller marginal cost and therefore creates a scenario in which the competition is not truly perfect. Wal-Mart’s operations in the market economies of North America offer practical insight into the concepts studied in economics. Such ideas as demand and supply, opportunity cost, economies of scale, price inelasticity, and perfect competition are areas in which Wal-Mart provides practical examples of the theories of microeconomics.
Though in many areas the ideas studied in this discipline are substantiated in the actions of this competitive firm, the concept of perfect competition is shown to be (at least in this example) more of an illusion or an ideal than an actuality. Because of biases such as location and economies of scale in Wal-Mart’s marketing and supply strategies, the concept of perfect competition shows itself difficult to realize in the real world.
Case, Karl & Ray C. Fair. Principles of Microeconomics. 7th Ed.Upper Saddle Creek: Pearson Prentice-Hall, 2003. Guest, Greta. “Holiday Shopping Price Wars: Wal-Mart Swings Low: Aggressive Cuts Take Fight to Big Rivals. ” Detroit Free Press, 2006. http://news. edgar- online. com/news/fis_story. asp? textpath=COMTEX%5Cko%5C2006%5C11%5C 20%5C85940689. html&clientid=168&provider=KNIGHT-RIDDER Shah, Amit, Evan Offtein & Tyra Phipps. “Wal-Mart Store, Inc. —2004. ” Strategic Management: Concepts and Cases. Fred R. David. Upper Saddle River: Pearson Prentice Hall, 2005.