Comparing Market structures

In perfect competition market a firm will operate at allocative efficiency, where MC =P.

Monopolistic competition – a firm will operate at a profit maximizing output, where MC=MR. Profits are normal with P1. With new players coming the demand will decline and profits decrease – P2 and eventually will come to P=AC – economic profit.

Oligopoly

With collusive oligopoly the chart will look like the one with monopolistic market, where MC=MR (profit maximizing output)

With non-collusive oligopoly – kinked demand curve. With very stabilized priced increase in MC is absorbed by a manufacturer. With P2=AC the manufacturer will operate with economic profit only.

A monopolist will operate at a profit maximizing price and output, where MC=MR.

Defining Oligopoly and Game Theory

The main ideas of the game theory are:

·         They exist in oligopoly type of market

·         There is a mutual interdependence between firms

·         Each firm is analyzing the behavior of rivals

·         The firm can act in collusion and non-collusion

“Game theory was developed by economists John Neumann and Oskar Morgenstern in the 1940s to analyze strategic behavior” (Principles of Microeconomics, John E. Sayre, Alan J. Morris). The theory, I assume, was the result of observation on a human nature.

There are numerous evidences of game theory in the current economy. One of the examples was presented in a textbook – OPEC. As a cartel organization, OPEC raised the oil prices acting collusively.

The payoff matrix shows possible scenarios of market/profit share for collusive agreements. The main idea of the matrix is to show the options based on firms’ sticking/non-sticking to the agreement.

The main principle of collusive/cartel idea is to come to an agreement on prices, market share or production quotas. In this way, all participants will gain the maximum profit share. The main condition for gaining this maximum profit share is no cheating among the participants. This main condition can be maintained only during relatively short period of time. History shows that all firms tend to cheat trying to gain extra profit or market share.

Defining Monopolistic Competition

Monopolistic Competition will form a market where all small companies will make a zero economic profits in a long-run. It happens because of easy entry of new players. Many sellers are on the market, and they strive to produce differentiated products. Differentiation is achieved by physical differences, perceived differences or support services.

References:

http://www.cobsbread.com/home/

http://www.carecentre.ca/website/DesktopDefault.aspx?tabindex=0&tabid=195

http://www.chevron.ca/operations/refining/refineryworks.asp

Competing as Starbucks

Starbucks can be considered as a part of a perfect competition market because it fits all four major conditions (by textbook “Microeconomics”, John E. Sayre, Alan J. Morris)):

·         The industry is represented by many small buyers and sellers all of whom are price-takers

·         No preferences shown

·         Easy entry and exit by both buyers and sellers

·         The same market information available to all

The main reason for re-aligning Starbucks business practices was the fact that many stores became unprofitable. They became unprofitable because Starbucks was “blended in” with many small and cheap coffee stores. The idea of “special, homemade” coffee was lost and it “has led to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops” to take their niche (http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html).

Starbucks was trying to gain back the special customers’ attitude by moving their business into another, more expensive area. Going back to the conditions perfect competition, Starbucks was trying to get “out of the box” of perfect competition.

I assume the strategy was:

·         Let the customers show their preferences for their product

·         Use their unique expertize for little coffee shop atmosphere

Therefore, they closed the number of stores. It was impossible to get to upper standards of operating the business with existing fast-food practices, which came into play with greater quantity of stores.

“In total, the company forecast up to $348 million US in charges related to the closures, with $200 million to be booked in the fiscal third quarter ended June 30” (http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html).

Those charged are short-run. I think company will gain in a long-run by raising prices for coffee and providing unique service to the customers.

“Starbucks Corp. recently announced that it would be expanding its coffee offerings as well as offering a new line of pies and tarts. Additionally, the coffee giant will also begin selling a single serve coffee maker this year.

Moving forward, mounting commodity costs and greater competition will likely be headwinds for specialty eateries for the remainder of the year. However, successful new product lines and ad campaigns in combination with the recovering economy could lead to gains in both the short- and long-term” (http://www.marketwatch.com/story/analytical-reports-on-starbucks-corp-and-panera-bread-company-eateries-respond-to-greater-competition-2012-03-14?reflink=MW_news_stmp).

I personally think the prices in Starbucks are too high but many customers don’t think so. What Starbucks sales most likely are emotions and special experience with coffee.

On the top of it Starbucks provides the highest quality coffee to its customers.

“Years of focus and expertise have led to the Starbucks Roast Spectrum. Each coffee bean requires a unique balance of temperature and time to reach its individual peak of aroma, acidity, body and flavor. Our coffees are classified by three roast profiles – Starbucks® Blonde Roast, Medium Roast and Dark Roast – so you can easily find the flavor and intensity that’s perfect for you”( http://www.starbucks.com/coffee/learn/roast).

If Starbucks lower the prices they would experience immediate demand increase for their product as they would attract customers from their competitors. At the same time, they wouldn’t be able to provide the same level of service and their profits will get back to the same level (or lower) as there would be no differentiation between Starbuck and their competitors.

References:

http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

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

http://www.marketwatch.com/story/analytical-reports-on-starbucks-corp-and-panera-bread-company-eateries-respond-to-greater-competition-2012-03-14?reflink=MW_news_stmp

http://www.starbucks.com/coffee/learn/roast

http://seattletimes.nwsource.com/html/businesstechnology/2008028854_starbucks02.html

Long Run Costs and Economies of Scale

I would create a Spa Salon. It would be the best to start with a small business and as it grows turn it into a medium business by suggesting more services.

The following services could be offered from the very beginning:

·         Hair styling

·         Massages

·         Manicure and pedicure

·         Facials and skin treatment

·         Body treatments

·         Make up application

Two or three specialist will be required to offer the above range of services. Some spa salons operate with only couple employees but I think that specialization will increase professionalism and customer satisfaction.

When business becomes profitable it will be possible to offer more services like day spas, and operated with hotels several days spa programs. We can also suggest such services as weight loss and health supplements. The perfect size of business for this industry is medium – 10-12 employees (may be it is considered small). Smaller business is able to maintain closer relationships with its customers and provide more emotional satisfaction, which is critical for this type of business.

Spa salons usually target the local market. Demographically: young men between 17 and 28; and women between 15 and 55. Ideally Spa salon should be located in downtown to offer services to busy professionals.

Some costs the business will face are:

Long run costs: equipment and instruments, technology.

Short-run costs: working materials like creams, lotions, make up.

Fixed costs: rent, salaries, certificates, taxes.

The following article gives some idea to possible strengths and weaknesses of the business.

http://startingaspabusiness.com/

Strengths:

·         relatively small cost of starting the business

·         entry to industry is easy

·         high demand for services

·         industry is developing rapidly with new technology and new products

Weaknesses:

This business is highly dependent on quality of services provided. The article uses the term “happiness factor” which means complete and full customer satisfaction. The “word of mouth” sometimes means more than well done advertising program. People employed in the business will be the main factor of success. The best way to solve this problem is to create and maintain close relationships with highly trained professionals in the industry and offer them competitive salaries and working conditions in your business.

Law of Diminishing Returns – Tobacco Legislation

Few points in the debate have merit. First, obviously the fact that “the phenomenon of diminishing returns to government intervention” is in place. Secondly, the figures show that the highest output was between 1985 and 1995 and then it started to decline. One of the reasons of the decline is that the smokers “who were the most easily persuaded have already quit.”

I agree with the author statement that too much information may kill information. If the information is redundant it can be easily ignored. It can be demonstrated by the fact that the new legislation that forced manufactures to print pictures demonstrating effects of smoking didn’t get the expected output.

Some points lessen the debate. The author refers to studies of American economist Kip Viscusi. He states that smokers “overestimate the risks of smoking as evaluated by the public health literature.” I strongly disagree and I think that smoking risks cannot be overestimated as smoking is addictive as well. Most likely they are underestimated; otherwise a lot more people would quit smoking.

The point of diminishing returned for government was approximately in 1995. The number of people quit smoking was the highest by that moment. After this point the return began to decline regardless higher prices.

There should be new solutions or actions taken to lessen the diminishing effect. I think the government to target the younger people first. For those who smoked couple of years or may be few months would be much easier to quit. One of the ways – to raise the minimum age of those allowed smoking. In Canada the legal smoking age is 18-19 years old depending on the province.  If government makes it 21 years old there will be less youngsters starting to smoke.

The article confirms the fact that tobacco is a very inelastic product. Regardless the higher prices the demand remains stable. Moreover, the consumers try to circumvent taxes and regulation by turning to a smuggled consumption.

As higher taxation can be applied to tobacco as a sin product the article debates on feasibility of higher taxation for cigarettes to lessen the Diminishing effect. Higher taxes bring more criminal into play if it concerns addictive products.

Tourism Industry in Canada

http://en-corporate.canada.travel/research/statistics-figures/international-visitor-arrivals#international

The state of Tourism Industry in Canada is improving. As we see from the graph above the number of travellers into Canada significantly dropped in 2009. It was the year of recession and this drop is quite explainable. But in 2010-2011 we can see a steep rise in number of international trips. The degree of elasticity of demand is high. The demand is Price elastic and Income elastic.

Canada is relying on service businesses heavily and tourism is one of them. This area is not fully developed and has a lot of potential growth. One of the initiatives taken by Canadian government to increase growth of tourism was to attract tourists from China.

Harper launched the new tourism campaign — which highlights Canada's West, including the Calgary Stampede — at the official opening of the Canadian Tourism Commission's newly outfitted marketing centre in the heart of Beijing.¹

¹http://www.vancouversun.com/travel/Harper+urges+Chinese+tourists+come+Canada/6116976/story.html

Elasticity and Revenue

http://www.foodnavigator-usa.com/Business/Orange-supply-price-squeeze-set-for-relief

The first graph shows the Demand Curve. In the left section of the graph the curve is very steep and demand is inelastic. It is 0.08 at the price change range $1.3 - $1.5. The right part of the curve shows that demand is elastic. At the price range $1-$1.3 the demand elasticity is 1.8. This trend can be explained by the time factor: after price increase demand dropped and then went up again over the time. It can be explained by the fact that we are dealing with orange juice and it is a normal good which cannot be totally substituted.

The revenue curve: when demand is inelastic the revenue falls with price fall. It is represented by the left side of the curve. As the demand becomes elastic the revenue rises with the price fall.

Changes in Demand

In a mixed economy there are numerous forces which change demand. They can be grouped as follows:

·         A change in preferences towards the product

·         A change in income

·         A change in price for a substitute product

·         A change in price for a complementary product

·         The expectation that future prices or income will change

·         An increase/decrease in population or a change in its income or age distribution

Example: In a small town a new bigger project was launched. A lot of local skilled workers got new job offers. They expect their income to increase. So they are going to spend more money for groceries. In my example below they will buy more strawberries.

Change in Demand for Strawberries
Price	Demand D1	Demand D2
$       2.50	110	120
$       3.00	105	115
$       3.50	100	110
$       4.00	95	105
$       4.50	90	100
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