Comparing Market Structures

Now let's take a look at the graphs for the four market structures.

Perfect Competition Graph

Perfect competition graphs shows how demand is constant at a set price. Producers in this industry are price takers which means they must sell their products at the price the market sets. The market price is determined by thousands, or even millions of individuals. This type of market allows producers to achieve maximum allocative and productive efficiency. We can see this by looking at the graph and noting that the average and marginal costs are in line with the price and quantity.

Monopolistic Competition Graph

The graphs below show a monopolistically competitive market in both the short and and long run. In the short run, we can see that an economic profit (or normal profit) is earned but in the long run, only normal profits are earned. The graphs also show that the demand (represented by AR in these graphs) is somewhat flexible to price and producers do have some control over what price they choose to sell their products at. From looking at these graphs, we can determine the profit maximising quantity and price which is where Marginal Revenue (MR) meets Marginal Costs (MC). The break even points on these graphs is where Average Costs (AC) meets Average Revenue (AR).

Oligopoly Graph

The graph below shows what is called a kinked demand curve and can be seen in an oligopoly. This market is generally made up of a few large firms with similar products. Producers in this type of market are price setters which means they have moderate to substantial control over their market price. The kinked demand curve shows both elastic and inelastic sections as well as the best price and quantity to produce for maximum profits.

Monopoly Graph

This graph is very similar to the monopolistically competitive graph. One of the main differences between a monopolistically competitive firm and a monopoly is that a monopoly can earn economic profits in the long run. Once again, we can determine the profit maximising quantity and price which is where Marginal Revenue (MR) meets Marginal Costs (MC).

Game Theory

The Game Theory is defined as “a method of analyzing firm behaviour that highlights mutual independence among firms (Morris & Sayre).” The main idea behind the game theory is strategy; each player will evaluate a situation and make the decision that is best for them regardless of how that choice may affect other players (Dixit, Avinash & Nalebuff, Barry).

The game theory was first introduced in 1944 by John Von Neumann and Oskar Morgenstern (SiliconFarEast.com). It was developed and adjusted by many difference scholars over the years. Albert Tucker expanded on the Game Theory and invented the Prisoner’s Dilemma in 1950 (SiliconFarEast.com). Tucker talked about the different strategies that players are able to choose which can be represented in the form of a payoff matrix (see image on right for an example). John Nash later introduced a concept which is now called the Nash equilibrium. This is when no one player can change their strategy to better their position so they both choose a position that negatively impacts them (SiliconFarEast.com).

There are many examples of the Game Theory in today’s economy. One such example can be seen by looking at the movie industry. All Calgary theaters charge similar tickets prices and do not want to upset the balance by changing their prices. Theaters are well aware of the fact that they provide very similar products and each theater has to think about how the others will react before they make a price change. If one theater did decide to drop their price, they would likely attract more customers initially but if other theaters follow suit, they would lose those same customers and now the industry as a whole would be earning less profit. Businesses must continually evaluate how their competitors are acting and adjust their own strategies accordingly.

I mentioned a payoff matrix earlier in my blog. You may be wondering exactly how a payoff matrix works. Let me explain it for you. Say I had the option to either stay in my current job or apply for a better position at another company. Now let’s imagine that I have a co-worker that I know would like to apply for the same position. We could both choose to apply and hope the best person is hired leaving us with equal opportunities at the job. My second option would be to tell management about my co-workers intention to apply for the new job and consequently sway management to fire her, which could mar her employment record and lessen her chances of getting the new job. Likewise my co-worker could do the same to me. The third option that we both have is to stay in our current jobs so neither one of us would be hired at the other company. These choices could be visually shown by using a payoff matrix.

Let's look at the principles behind collusive and cartel actions. Collusion is defined as "an agreement among suppliers to set the price of a product or the quantities that each will produce (Morris & Sayre).” Cartel is described as "an association of sellers acting in unison (Morris & Sayre).” Both actions involve businesses agreeing to act together for the common good of each individual business. The goal is for businesses to generate greater individual profits by working together. Even though they are similar, one of the main differences between collusive and cartel actions is that collusion is illegal whereas cartel is not.

Dixit, Avinash & Nalebuff, Barry, Game Theory,

http://www.econlib.org/library/Enc/GameTheory.html,

site accessed on November 4, 2012

Morris, Alan; Sayre, John, Principles of Economics, p. 387 - 390

SiliconFarEast.com, Game Theory,

http://www.siliconfareast.com/game-theory.htm,

site accessed on November 4, 2012

Defining Monopolistic Competition

Monopolistic competition is a market which has many different sellers that are all selling similar products. The bossiness selling in a monopolistically competitive market have some control over the price the choose to sell their product at, but not a lot. If a business in a monopolistically competitive market were to price their product to high, the consumers would move on to one of the many other similar products available at a lower price.

The products sold in a monopolistically competitive market are considered to be differentiated products. This means that although the businesses are selling something similar, they each search for something in their product that distinguishes it from the rest of the products in the market. Product differentiation is extremely important for businesses because it helps consumers see their product as different, or better than the others on the market and ensures more sales for them.

Size:	Small Company	Medium Company	Large Company
Features:	Local Business (Atcom Systems)	Canadian Retail Business (Danier)	Major Sports Business (TaylorMade)
Differentiated Products	Service, Mobility (they come to you), Convenience	Location, Service, Luxury Products	Brand Names, Logos, Distinctive Packaging, Celebrity Endorsements
Control Over Price	Some	Some	Some
Mass Advertising	Word of Mouth, Internet, Fliers	Word of Mouth, Internet, Newspaper & Magazine Ads, Radio	Internet, Newspaper & Magazine Ads, Television, Billboards, Celebrity Endorsements
Brand Name Goods	Few	Some	Many

Competing as Starbucks

Starbucks meets some of the conditions which are necessary to be considered part of a perfectly competitive market. Those conditions are as follows (Morris & Sayre):

1. Many small buyers and sellers all of whom are price takers
2. No preferences shown
3. Easy entry and exit by both buyers and sellers
4. The same market information available to all

Starbucks cannot be considered to be in the type of market that is considered perfect competition by economists because they don't meet all 4 conditions. One of the conditions that is not met is number two, that no preferences are shown. Starbucks charges more than most coffee shops and one of the main reasons they continue to sell their coffee is because certain customers prefer Starbucks as opposed to other shops.

The competition is strong in the coffee industry and in order for Starbucks to continue to succeed, they must come up with new and innovative ideas to meet demand and carve their place in the market. Unfortunately some of the new ideas did not mesh with one of Starbucks main goals, which is to show that they provide more than a cup of coffee; they provide an experience. The video below shows a few customers who feel they got more than coffee from Starbucks (http://www.starbucks.ca/about-us).

In 2007 Starbucks chairman Howard Shultz wrote a memo regarding Starbucks changes. They were losing their individuality and becoming like every other coffee chain (Shultz, Howard). He felt that it was necessary for Starbucks to realign their business practices to bring back the Starbucks experience.

Starbucks struggled to find the balance between trying to give customers an experience when they enter the store and keeping up with the demand. In addition, the economy became very turbulent which eventually led to Starbucks announcement in 2008 that it would be closing 600 stores (Allison). Because of Starbucks rapid growth, change in consumer demand and the state of the economy, they experienced diseconomies of scale.

The store closures had a large impact on costs and profits for the coffee chain. In an article by Melissa Allison, she wrote “Starbucks said the store closures will lead to pretax charges of about $328 million to $348 million, including $8 million in severance costs and $120 million to $140 million in lease-termination costs and future lease obligations (Allison).” The short-run costs are extremely high but they made the best decision when considering the long-run costs. By choosing to close the underperforming stores, they increase profits in the long-run.

Over the years, Starbucks has been criticized for the prices they charge. The question is, if Starbucks is too expensive, why do customers keep returning? How can Starbucks manage to charge such prices without losing customers to other, less expensive coffee chains? The answer is that among other things, they have been successful in creating a Starbucks experience and customers continue returning for the experience. Rachel Hennessey wrote an article about why Starbucks exceeds despite market shortcomings and she agrees that part of the success lies in the fact that customers like the ambience. She wrote “When you enter a Starbucks store, you will notice a rich warm color scheme, alternative music, organic-looking art, and baristas in green aprons (Hennessey).”

If Starbucks were to lower their prices, the quantity demanded would increase. This would drive the quantity supplied to increase as well. Eventually the market would adjust and a new equilibrium would be reached.

Allison, Melissa, Starbucks closing 5 percent of U.S. stores, http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

site accessed on October 27, 2012

Hennessey, Rachel, 3 Reasons Why Starbucks Still Shines, Despite Market Shortcomings,
http://www.forbes.com/sites/rachelhennessey/2012/08/06/3-reasons-why-starbucks-still-shines-despite-market-shortcomings/

site accessed on October 28, 2012

Morris, Alan; Sayre, John, Principles of Economics, p. 261

Schultz, Howard, Starbucks chairman warns of "the commoditization of the Starbucks experience",
http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

site accessed on October 27, 2012

The Health Nut

If I had the resources to set up a business, I would open The Health Nut, a business that provides healthy food options for people on the go. There are currently quite a few fast food chains but they mainly serve calorie laden meals. There are a few healthy options such as Jugo Juice and Booster Juice but these chains do not provide a drive through service for busy customers. As a society we seem to be more aware of our choices and our health. We are also a very busy and appear to have trouble balancing our professional and personal lives. I feel many consumers would like a fast, affordable and healthy option for meals to grab on the go whether it’s a soccer mom on her way to practise with the kids, an office employee on their way to a meeting or a busy student rushing between classes.

My business would start out small with the hope to expand. If the first location were successful l, I would plan on opening more locations and keep expanding from there. The ultimate goal would be to create a franchise.

The market for a business like this is enormous. I checked McDonald’s website and saw that there are more than 1,400 McDonald's restaurants in Canada employing more than 80,000 Canadians (http://www.mcdonalds.ca/ca/en/contact_us/faq.html). These restaurants are placed all throughout Canada. McDonald’s also has many, many more restaurants located worldwide but I would want to keep my business within Canada. In the beginning, the market within my reach would be fairly small and mainly restrained to the area I chose for my business. People of all types and ages would patronise my restaurant but the majority of the business would likely come from health conscious consumers between the ages of 20 – 45 who lead a busy lifestyle. With success and new restaurant locations, the size of the market I could reach would increase.

Some of the fixed or short-run costs to consider would be salaries, rent, utilities, capital investments and business taxes. When starting up, the short-run costs need to be kept as low as possible until the business starts to earn a profit. Once a profit is being earned, new locations may be opened. With regards to future planning, all the short-run costs would become long-run costs.

As the business expands, the economies of scale for the business will change. With each new location opened, the output levels will need to be evaluated. Businesses must strive for the highest level of output for the lowest average cost per unit in order to succeed.

Jugo Juice is a great example of a similar business. Jugo Juice was founded in 1998 in Calgary, AB (http://www.jugojuice.com/about-jugo/history). They have grown from one small business in Calgary to having locations in 7 of Canada’s provinces (http://www.jugojuice.com/about-jugo/locations). Clearly this business has been very successful. They saw that society was starting to take notice of their health and were pioneers in providing healthy alternatives in the fast food industry. One of their major strengths is that they took initiative when they saw change happening and were able to start a business to supply products for the new demand. That being said, I feel my restaurant has potential to compete with Jugo Juice because I believe one of Jugo Juice’s biggest weaknesses is the fact that they don’t have locations that offer a drive through service.

In the food and service industry, it is crucial to keep customers happy and today’s consumers are busier than ever. A healthy fast food drive through option may be just what consumers are looking for!

Law of Diminishing Returns

I recently read the article ‘The Diminishing Returns to Tobacco Legislation’. This article discusses the different strategies the government has taken regarding cigarettes and the effect they cause to diminishing returns.

 

One thing that struck me as odd is that when the government implemented cigarette taxation from 1985 to 1995, there was a 52% change to the real price of cigarettes yet when a similar change was made in later years, the effect was not strong. Another section of this article points out that while advertisements on cigarette packages warning of the health problems were initially successful they no longer seem to be working. This could be because consumer awareness for health concerns has reached maximum potential awareness. It could also be that consumers also choose to ignore or discredit the warning as the shock value is no longer there.

 

The point of diminishing returns for the government appears to be at a standstill. When taxes are raised and new advertisements are displayed, they don’t seem to have much of an effect on the amount of cigarettes being consumed. Most of the smokers that are left appear to be strongly addicted and will choose to continue feeding their addiction regardless of the efforts the government makes to reduce usage.

 

I believe that some of the money the government has put into raising awareness to the health problems caused by cigarettes has been equalized by reduced health costs. One possible avenue that the government could take is to encourage producers to make a nicotine and chemical free cigarette option. Some smokers may switch to the healthier option if they are addicted more so to the habit then the nicotine. Sales might increase due to non-smokers taking up the habit if the health risks were not as severe. This would in turn increase revenue and reduce health costs which would help offset the money that would be spent on the campaign to produce a new and healthier cigarette option.

 

If a new cigarette option were introduced, demand would likely increase which would in turn drive the supply up. The price of cigarettes may also be driven up if more consumers are now willing to buy the product.

 

Of course the government could always choose to make cigarettes illegal but this would be a very poor decision. Because cigarettes do involve an addiction, this product is considered to be inelastic. Consumers are willing to buy cigarettes regardless of the price and whether or not it is legal. As we know from Chapter 4 of the textbook, the government knows that this product has an inelastic demand and chose to impose a sin tax in order to make a profit. Making cigarettes illegal would be highly ineffective so imposing sin taxes instead was a smart choice for the government. Instead of spending millions or billions of taxpayer dollars on trying to control yet another illegal substance, the government chose to make a profit which they can in turn use to create a healthy economy.

 

Lemieux, Pierre, The Diminishing Returns to Tobacco Legislation,

http://www.pierrelemieux.org/artdiminish.html
site accessed on October 15, 2012

Tourism Industry in Canada

The tourism industry in Canada is strong with Canadian arrivals increasing by 8% and domestic travel increasing by 12%. The amount of international travellers from India, China and Brazil is expanding and Canadian citizens also appear to have positive travel expectations.  On the other hand, the number of U.S. travellers has declined over the last 10 years.

Travel is affected by many factors, one of them being exchange rates. The Canadian dollar has been gaining strength and this seems to fall in line with the decline of U.S. travellers. It appears that the Canadian dollar has an elastic demand as U.S. travel is fairly responsive to a change in price.

The exchange rates seem to have less of an effect on other international travel.

As for Canadians own travel expectations, long term travel within Canada is slightly down but is up for various other locations.
 

It is interesting to note that while long term travel expectations within Canada is down, short term actually shows an increase in travel in domestic travel.

One potential reason that short term domestic travel for Canadians may be up is because of the economy’s current instability. People are unwilling or unable to spend large amounts on international travel and instead choose budget friendly vacations within Canada.

The overall current state of the tourism industry in Canada is healthy and appears to be improving. 

This industry has an elastic demand as there are many other available substitutes. There are thousands upon thousands of travel destinations to suite every preference and budget. Consumers have the ability to choose from a wide variety of options when making their travel choices.

Deloitte, Ipsos & TIAC, Navigate,
http://tiac.travel/_Library/documents/navigate_winter2011-12.pdf
site accessed on October 6, 2012