Comapring Market Structures

Economists group industries into four different market structures: perfect competition, monopoly, monopolistic competition, and oligopoly. The following table will briefly represent the characters of each market structure.

Also the following four general graphs demonstrates brief and general ideas regarding demand, costs, revenues, output (quantity), and profits for each of the four market structures.

1. Perfect Competition: The P = MC output allows the competitive producer to maximize profits or minimize losses. At Q₁, the average cost is AC1, and the average profit is equal to the distance P1 and AC1. The total profit is the blue shaded area, which is the average profit times the quantity produced

2. Monopoly: A monopoly maximizes profits by producing the MR = MC output; break-even occurs where AR = AC. Every output between two points is profitable. The total profit is the purple shaded area.

3. Monopolistic Competition: In monopolistically competitive market, demand curve is elastic; AC and MC are the normal U-shaped cost curve. The green shaded area is economic profits; P1abC1 = P1aQ10 - C1bQ10. A monopolistic competitive firm maximizes total profits where MR=MC.

4. Oligopoly: The discontinuity in the marginal revenue curve is the result of the kink in the demand curve. Prices above the kinked are not matched by rival firms, and ones below are matched by rival firms.

Game Theory

Oligopoly exits "when the number of firms in an industry is so small that each firm must consider the reactions of rivals in formulating its price policy" (McConnell at al., Microeconomics, 5th ed., Toronto, McGraw-Hill, 1990. at 254). In an oligopoly, for a firm to maximize its profit, it need to choose the best choice depending its rivals action and reaction. Game theory, introduced by John Neumann and Oskar Morgenstern in the 1940's, is concerned with the choice of the best strategy in conflict situations and analysis of oligopolistic behavior. The main idea of game theory is that payers in oligopolistic market is seeking the best payoff with it strategy; people are motivated by their interest. The payoff is the outcomes of each combination of strategies by the two players.

The following table is one of the most famous example of payoff matrix. Two suspects are arrested for armed robbery;

In the example above, if both suspects don't confess, both will receive a sentence of one year imprisonment for possessing stolen goods. If both confess, the sentence will be reduced to 5 years each. However, if the district attorney promises each suspect that by confessing, he will go free while the other suspect (who does not confess) will receive the full 10 year sentence. Oligopolistic firms often face this kind of dilemma problem in deciding their business strategy.

Not like the example above, in the real world, each player may have chance to communicate with his rival, and thus reach to an agreement for the purpose of setting prices or dividing market - collusion/cartel. One example is the Organization of Petroleum Exporting Countries (OPEC).

Monopolistic Competition Market

Monopolistic Competition Market is one in which many firms sell a differentiated product, into which entry is relatively easy, in which the firm has some control over the price at which the product it produces is sold, and in which there is considerable non-price competition.

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=monopolistic+competition

Competing as Starbucks - Perfectly Competitive Market

If (1) there are a great number of sellers and buyers of the product, so that the actions of an individual cannot affect the price of the product; (2) the products of all firms in the market are identical, or undifferentiated; (3) New firms are free to enter and existing firms are free to leave – no significant obstacles; legal, technical, financial, or other; and (4) consumers, resource owners, and firms in the market have same market information available to all, then the market is said to be perfectly competitive. In a perfectly competitive market, since the price of a product is decided only by the intersection of the demand curve and supply curve, therefore a firm is a price taker. Even if perfectly competitive market is theoretical, it is primarily used as a benchmark against which other market structures are compared. Considering four conditions above, Starbucks would be considered a part of a perfect competition Market; in the market, as a price taker, Starbucks does not have enough market power to affect the price and the quantity.

According to articles (see links blow), Starbucks let as many as 12,000 workers out when the company began closing 600 stores in U.S. in 2008 because these closed down 600 stores could not make a profit and were not expected to do so in the future. Starbucks has struggled with, externally, the faltering U.S. economy and, internally, its own rapid expansion; especially, its rapid expansion caused the loss of total profit.

For the better status of Starbucks' long-run costs and its profit, it needs to maximize its profit or minimize its losses by adjusting its output (sale).  Therefore, as Starbucks closed 600 stores, it minimized its loss by reducing its profitless sale. Reducing a price is another option to maximize its total revenue, attracting more customers. However, when we consider reducing a price of a product, in a perfect competition market, we have to accept a lower profit. Furthermore, we have to also consider how much the price of a product will be reduced. For this, Starbucks, as a competitive firm, shall consider break-even price and shutdown price as shown at the following graph.

 

   At P_BE, If the price is above this level, Starbucks is able to cover its average costs (AC), and thus make a profit; but below this, it will make a loss. However, if the price is to fall to P_SD, Starbuck would not cover all costs and thus operate its business at a loss. If the price is above the minimum of average variable costs (AVC), it will still produce; but below this, it will shut down.

http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html, http://seattletimes.nwsource.com/html/businesstechnology/2008028854_starbucks02.html,

http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html

Long Run Costs and Economies of Scale

“Personalized Organic Healthy Food” business is one of the areas I want to indulge myself in near future; individualizing each customer regarding their health condition and purpose such as weight control etc. All products would be customized to match each individual customer’s needs and requests. 

At the beginning, I would lease a small place for an office and displaying some products; my business will be mainly an online promotional. Depending on the sales volume, I would eventually move move into a medium size place suitable for staffs, equipment, and inventories.

As term defined – the short run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can varied –, at the beginning, leased small office, some inventories, and basic equipment such as computer and printer will be the short-run costs.

If, in the future, the demand for my products, organic health food, has greatly increased, I will consider more inventories to be a variable input. I will need extra labor, but we can likely increase our labor supply by running an extra shift and getting existing workers to work overtime, so this is also a variable input. The equipment such as refrigerators on the other hand, may not be a variable input. It may be time consuming to implement the use of additional equipment. It depends how long it would take me to buy and install the equipment. Adding an extra store is certainly not something I could do in a short period of time, so this would be the fixed input.

One of the similar businesses would be The Community Natural Food established in 1977. They provide their products through both on and off-line; they provide unrefined and organic foods and natural nutritional supplements.

Law of Diminishing Returns

Law of diminishing returns means that if one variable factor of production is increased while the others remain constant, the overall returns will relatively decrease after a certain point. For example, if more and more labour are added to harvest a wheat field, at some point each additional labour will add relatively less output than his predecessor did, simply because he has less and less of the fixed amount of land to work with.

Read more: http://www.answers.com/topic/law-of-diminishing-returns#ixzz1XmAwH1fo

“The Diminishing Returns to Tobacco Legislation” written by Pierre Lemieux, http://www.pierrelemieux.org/artdiminish.html, is about the law of diminishing returns regarding the tobacco legislation. According to Pierre, the current efforts to reducing in tobacco consumption of government, such as forcing producers print shocking illustration of tobacco related diseases and panic warnings on the cigarette pack and cigarette taxation, have already achieved most of the possible improvement. For his argument for diminishing returns to government intervention, he pointed out that shocking therapy such as color pictures illustrating the presumed effects of tobacco related diseases has no more effects; the impact of shocks and the information decays with time. He also pointed out that the phenomenon is also illustrated by cigarette taxation; inputting sin tax on cigarette, at the beginning, reduced the demand, but the effectiveness of this plan is also decreasing; cigarettes have an inelastic demand due to the fact that there are no close substitutes and addictive product.

The possible solutions that decreases the cigarette consumption would be larger tax increases. Another option is restricting the places where people can smoke or  is sold in separate store or limited places. Imposing higher tax on cigarettes cause the price to increase; when the price of a product changes, it affect, in common sense, the quantity traded will be changed. If we think only demand and supply and government intervention is successful, the demand for cigarette will decrease. Unless the manufacturer reduces the production costs and thus the price decrease, then price increased by tax will work as a price floor. The supply will be surplus. However, when we consider elasticity of the cigarettes and find out it is inelastic product; the resulting increase is greater than the decrease in the quantities demanded, we can conclude that the main reason government put sin taxes on cigarette is because they can increase their tax revenues.  

Income and Cross Elasticity

Even without reviewing an article, “How to Raise a Global Kid: Taking Tiger Mom tactics to radical new heights, these parents are packing up the family for a total Far East Immersion” written by Lisa Miller at Newsweek on July 25, 2011,¹ we easily conclude that international education is and will be one of the great businesses. A report released on October 28, 2009 estimates that “total expenditures by international students while they study here resulted in a $6.5 billion infusion to the Canadian economy in 2008.”² Expenditures of international education students have now surpassed exports of coniferous lumber ($5.1 billion) and coal ($6.1 billion). The report also finds that these international students generated about $291 million in government revenue in 2008 and created economic activity that sustained employment for 83 000 Canadians.³

1.http://proquest.umi.com.libresources2.sait.ab.ca/pqdweb?did=2402602851&sid=4&Fmt=3&clientId=5337&RQT=309&VName=PQD

2.http://www.international.gc.ca/media_commerce/comm/newscommuniques/2009/319.aspx?lang=eng&view=d

3.http://www.international.gc.ca/education/impact.aspx?view=d

According to the report, the number of international students in Canada has more than doubled since 1998 to 178,000, and I believe this trend will be same because China and India, who are main consumers for this, maintain their economic health, and thus their incomes tend to increase.

For example, in earlier 1990, when the economy of China started to grow faster but their people were still in poor, studying in foreign countries including Canada was luxury product. However, in these days, due to their enough income to cover the cost, much more student come out to foreign countries; depending on the level of the consumer’s income, studying in Canada may be a luxury at low levels of income, a necessity at intermediate levels, and an inferior good at high levels. Therefore, we can conclude the study in foreign countries including Canada is normal product for Chinese; a product of which more is purchased as income increase is normal or superior product and when the coefficient of income elasticity is negative, the good is inferior. If income elasticity is positive, the good is normal; a normal good is usually luxury if income elasticity is greater than 1, otherwise it is a necessity.

Here, we need to also consider the concept of cross elasticity of demand, which measures how sensitive consumer purchases of one product are to a change in the price of some other product; Studying in Canada and USA are substitute goods or Staying and studying in China and going to Canada are also substitute; the number of Chinese student in Canada varies directly with a change in the cost of studying in USA or staying in China; we conclude the cross elasticity of demand here is positive, and this positive coefficient is large.

Elasticity and Revenue

Before a firm increases or decreases the price of its product, it needs to determine how a price change will affect its total sales revenue. If demand is elastic, a decrease in price will result in an increase in total revenue because even though a lesser price is being received per unit, enough additional units are being sold to more than make up for the lower price. However, if demand is inelastic,  a price decrease will cause total revenue to decrease. The modest increase in sales will be insufficient to offset the decline in revenue per unit, and the total revenue declines. Elasticity typically varies over the different price ranges of the same demand curve; demand tends to be more elastic in the upper-left portion than in the lower-right portion. At midpoint (unitary elasticity), where the percentage change in quantity is exactly equal to percentage change in price, total revenue does not change.

According to an article, “NB Liquor profits rise 1.3%; Retail Price increases offset lower sales volume as consumers spend less, beer purchases go flat” written by Chris Morris at Telegraph-Journal on Sep 29, 2011, NB Liquor agency reported higher profits despite an overall drop in sales for the fiscal year ending in March 31, 2011. “The Crown corporation raised a number of prices during the year, helping boost the value of total sales by 1.3 per cent over the previous year to $412.4 million”.

As seen above, when the price is below the midpoint; demand is inelastic, if the price rises, the total revenue will increase. This article shows that if demand is inelastic, a price increase will cause total revenue to increase.

http://proquest­.umi­.com­.libresources2­.sait­.ab­.ca/pqdweb­?did=2470993381­&sid=4­&Fmt=3­&clientId=5337­&RQT=309­&VName=PQD

Graphing Change to Demand

Demand is the quantity of a product that consumers are willing and able to purchase at each specific price in a series of possible prices during some specified period of time, all other things being equal (ceteris paribus).

However, when any of the ceteris paribus conditions (determinants) changes, the entire demand curve, which presents the inverse relationship between product price and quantity demanded on a simple graph, shifts. This shift is referred to as a change in demand as different to a change in the quantity demanded, which is movement along the same demand curve. This change in demand is caused by a change in determinants of demand: consumer preference, consumer income, prices of related goods, expectations of future prices, income, or availability, and population size including income and age distribution. A change in consumer's preference, possibly prompted by advertising or specific event, affect the entire demand curve; the more favorable change to a product, the more demand on that product. The impact of changes in income is vary, depending on whether a product is normal goods or inferior goods. Whether a change in the price of related good will increase or decrease the demand will depend on whether the related good is a substitute for, or a complement to, the product. For example, coffee and tea are substitute goods. If the price of coffee rises, consumer will purchase a smaller amount of coffee, causing the demand for tea to increase. Consumer future expectations about product prices, product availability, and future income can shift demand. For example, consumer expectations of higher future prices may prompt them to purchase more goods now, causing demand to shift to right. Conversely, expectation of falling price will tend to decrease the current demand for the goods. Clearly, an increase in the number of consumers in a market will constitute an increase in demand.

The following two graphs represent an example of a change in demand when the price of a related good is changed; when the price of coffee rises, the demand for tea increase. A change in one or more of the determinants of demand will cause a change in demand. An increase in demand shifts the demand curve to the right while a decrease in demand shifts the demand curve to the left.

 

Diner-City

The Diner-City provides us a chance to think about how to succeed in business. Considering the proper allocation of limited resource such as budget and time and making right decision on where and when the limited asset shall be used, the business must find and develop the product and set the price based on the demand on that product. Most successful companies such as Microsoft and Apples found out what consumers need and come up with it; attracting new customers and maintaining the customers satisfied are the key for the business to be successful. Another key for success is building up reserves from capitals accumulated from a healthy stream of profit because the reserves or accumulated assets shall be used for the further improvement of the business such as upgrade of new equipment or purchasing a new building. Improvement should be the topmost priority even when the business is doing well. In addition, reducing the cost creates higher revenues.

In this game, Upgrading is important because it increases the revenue per customer. Another strategy to achieve high revenues will provide fast customer service; faster service is more beneficial than simply adding seats. Security system and cleaning are also crucial factors to save unnecessary expense or lost. Purchasing a new building is a priority. In addition, it is beneficial to invest in delivery vehicles which will raise the revenues with no maintenance.