Free Operations Decision Essay Sample
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In a competitive market structure the firms face an elastic demand curve. The monopolist on the other hand faces a demand curve that is somewhat inelastic in nature. So we can see that the elasticity of the demand curve faced by a firm can indicate the type of market the firm operates in. The way the demand for the product is affected by the price of the close substitute also gives us an idea whether the firm has any close competitor or not. The demand function and the elasticities that we have obtained from the regression analysis can provide us with the information about the market form in which the firm operates.
The elasticity of the demand faced by the firm is -0.0079. The low elasticity suggests that the firm enjoys some amount of monopoly power. Added to that, the cross price elasticity which is 0.0045, is also very low indicating that the firm has no close competitor. The elasticity for advertisement expenditure which is 0.07 also points to the fact that the role of advertisement on the demand is quite insignificant. We know that in a monopoly kind of market advertisement has no significance. All these findings point to the fact that the firm operates in a monopoly form of market and enjoys significant amount of market power. This market power can be the outcome of the innovation of a product that makes the firm move in a market segment uncatered to by the other firms. For example in the world market for frozen food we find that Nestle is a company that mainly caters to the children. It not only produces frozen food but also semi processed and instant food that target the little ones. It promotes its products as nutritious and full of growth vitamins ideal for children. The tastes also are innovated in a manner that appeals to the young ones. On the other hand the ConAgra foods mainly target the middle and the old ages. It has ready to eat frozen meals that are convenient for busy couples. So we see that though these two companies form a part of the broader market for frozen foods they are in reality a monopoly in their own market segment. In a similar fashion, the microwaveable frozen food producing company that we are discussing here is a monopolist in its own domain though it has close substitutes but the substitute producing companies are not close competitors as they operate in different domains. So one reason for market power here is that the targeted class of consumers is different and another reason is of course innovations that produce goods that are ideal for that target group which is not produced by any other company. Looking at the market for frozen foods as a whole we can see that the demand faced a downswing during the recession of 2008. But recently with a change in the peoples’ perception towards frozen foods the demand has shot up to an impressive extent. The demand for frozen foods is highly positively related to the income of the individual as out regression analysis has clearly shown. The income elasticity of demand for frozen foods is more than unity. This explains the recent rise in demand for frozen foods. Another important reason is the shift in the peoples’ preference towards the frozen foods. Previously it was believed that the frozen foods are inferior in quality compared to the fresh ones. But the joint propaganda launched by the frozen food companies have changed this wrong notion among the consumers. People now know that the frozen foods retain their nutritional quality for a longer time compared to the fresh ones. Moreover they are easy to prepare and can be stored for a longer time.
In the previous analysis we have considered an upward rising supply curve as in case of a competitive industry, for the sake of simplicity. Now that we have inferred that the firm actually operates in a monopolistic market we should now calculate the equilibrium price and quantity for the firm based on its cost functions as well as the demand function obtained from the previous analysis. In a competitive market the industry equilibrium is obtained at the point where the supply curve intersects the demand curve. The firms in the industry follow this industry determined price. The monopolist sets the price at the level where the firm’s profit is maximum. From microeconomic theory of the firm we know that the profit maximizing output is obtained at the point where the marginal revenue equals the marginal cost. That is:
TC = 160,000,000 + 100Q + 0.0063212Q2
VC = 100Q + 0.0063212Q2
MC = 100 + 0.0126424Q
AC = TC/Q = 160,000,000/Q + 100 + 0.0063212Q
AVC = VC/Q = 100 + 0.0063212Q
Let us analyse the cost curves of the firm graphically. Figure 1 shows the AC curve. We can see that the average cost is initially quite high. As the output rises the AC falls steeply upto a certain level of production. A further increase in output makes the AC curve flat. The AC remains more or less same for higher levels of output. Figure 2 shows the AVC curve. We find that the AVC is constantly rising with the level of output. The firm should invest in the development of advanced technique of production so that the running costs can be reduced and the benefits of increasing returns can be used to reduce the average variable cost of production. Let us now calculate the total revenue (TR) and marginal revenue (MR) of the firm. The demand function as obtained from our previous analysis is given below:
QD = 26770 – 42P
We write the demand curve in the inverse form as:
The total Revenue may be obtained as:
Let us now plot the TR and the TC curve in the same graph. This is shown in figure 3. We observe that the TC curve lies above the TR curve for the viable range of output. The TR is positive for a certain range of output after which the TR becomes negative which renders the output level infeasible. This implies that along with innovative technique of production the firm has to adopt innovative ways of marketing its product as well. With innovation of production technique the cost curve can move downwards. With effective marketing technique and product innovation the TR curve will move upwards. If the TC moves downwards and the TR move upwards the firm can expect to earn profits in the long-run. But in the short-run the firm is earning losses which is clear from the figure 3 below. The theory of markets suggests that a firm incurring losses in the short-run should continue with its operations so long as it can cover its running costs. In the long-run the firm can expect to earn profits by investing in new capital and cost saving techniques. But if it cannot cover its running costs it is not advisable for the firm to continue with its operations. It should rather shut down in that case.
In our present case we can see that the firm is presently incurring losses. Whether the firm should continue with its operations depends on whether it can cover its variable costs. Let us now find out the profit maximizing output of the firm. In this case it will be the loss minimizing output which is obtained by equating MR with MC.
We can find out the price from the demand curve:
So, QD=12240.22 and
The output and price in the previous case was:
P = $286.38
QD = 14742
The price was lower and output was higher before. As we consider the monopoly equilibrium output is reduced and price is increased. The profit under the monopoly condition is:
TC = 160,000,000 + 100Q + 0.0063212Q2
or TC = 162171083.10
Profit = TR-TC= $-157935198.7
Or Loss = $157935198.7
The average variable cost at this level of output is:
AVC = $177.37
P = $346.06
Since the price is higher than the AVC, we conclude that the firm is covering its variable costs. So the firm should continue with its operation in the short-run as long as it is able to break even. It can expect to earn profit in the long-run by technology and product innovation. To compare the profit with the previous case we calculate the profit that the firm earned in the competitive scenario:
TC = 162847964.7
TR = 4223883.737
Profit = TR – TC = $ -158624080.9
Or Loss = $158624080.9
Loss was higher in the competitive scenario. The movement from a competitive situation to a monopoly market condition has reduced the firm’s losses. We can see that a firm can earn higher profit when it can restrict competition in the market and increase its market power.
The comparison of the current analysis and the previous analysis teaches us important lessons on how the change in the market structure produces changes in the firm’s optimal price and output and in turn its profit –loss situation. A firm in an imperfect market situation constantly endeavors to increase its market power through effective marketing strategies, technological change and product innovations to earn higher returns and survive successfully in a situation of strategic interdependence.
Gasparro, A. (2014). Frozen Foods Grow Cold as Tastes Shift to Fresher Fare. The Wall Street Journal.
Henderson, J. M., & Quandt, R. E. (1980). Microeconomic Theory: A Mathematical Approach. McGraw Hill.
Koutsoyiannis, A. (2003). Microeconomics. Pulgrave Macmillan.
Pindyck, R., & Rubinfield, D. (2009). Microeconomics (7th ed.). Prentice Hall.
Varian, H. R. (2010). Intermediate Microeconomics A Modern Approach (8th ed.). New York: W. W. Norton & Company.
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