Monopolistic Competition

Monopolistic competition is a market where many firms sell similar products but not identical ones. The products sold may have the same functions but could physically look different or just simply have different packaging. This makes the products sold as substitute products. Firms in monopolistic competition have some control of the price of products they sell.  Almost all retail businesses are in monopolistic competition as well as services aimed at homeowners.  There are 4 characteristics of a monopolistically competitive industry:

·         There are many small firms

·         There is freedom of entry

·         Firms have some control over price

·         Differentiated products

Below is a table that shows some features and examples of monopolistic competition.

Monopolistic Competitive Companies

Size:	Small Company	Medium Company	Large Company
Features:	Local Coffee Shop: Insomnia Coffee	Canadian Chain: Timothy’s	International Chain: Starbucks
Differentiated products	Packaging, Food	Packaging, Food, Accessories	Packaging, Food, Accessories, CDs
Control over price	Some	Some	Some
Mass advertising	Local Publications, Online	Print, Online	Television, Online, Print
Brand name goods	Few	Few	Few
Freedom of Entry	Yes	Yes	Yes

Compteting as Starbucks

In order for a perfectly competitive market to exist there must be four conditions that are met:

·         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

Looking at Starbucks it looks like all of these conditions are met. The only thing missing on Starbucks’ part would be no preferences shown. There are a lot of different coffee stores to choose from whether they are chain stores like such as Starbucks or local independent businesses and preferences are shown by consumers.

In the US, Starbucks closed 600 of its stores over the summer of 2008 (Allison, 2008). According to the company’s Chief Financial Officer Pete Bocian, the stores closed because they were not profitable and were not expected to generate profits in the future (Press, 2008). The closed stores “were being cannibalized by nearby Starbucks locations” (Allison, 2008).  It looks like the company was improving its efficiency with these closures.

In a 2007 memo, Starbucks CEO Howard Schultz stated that as the company has become more efficient over the years, the company has paid a price by “watering down the Starbucks experience” (Rebel, 2007).

Starbucks are known to sell expensive drinks. I believe that their prices are high because they are a brand that is recognized worldwide and that there is an “experience” when visiting the stores. There is a laid back atmosphere when entering a Starbucks store. It is also a very fashionable brand. Many celebrities are pictured with the famous Starbucks cups. Motiv Strategies’ Joy Thomas points out that “Starbucks coffee is widely perceived to be a small luxury, and people understand they are paying a premium for it” (Thomas, 2012).

If Starbucks lowered their prices, then demand would increase. Starbucks’ main competitors such as McDonalds or Tim Horton’s have lower priced coffee so right now Starbucks profits for coffee is higher. If Starbucks lowered their prices they could potentially steal customers from the competition. Once the demand increases, then the supply will increase. If we look back at the Elasticity article from earlier on in this blog, the same effect would happen to Starbucks. The demand is elastic based on price.  If the price of a Starbucks drink is reduced below $5, then demand would be inelastic and profits will begin to drop.

Since Starbucks have closed their selected locations, this means there are sunk costs related to building and operating costs. Closed locations mean laid off employees so in the short term at least, there are reduced employee wage costs until the company decides to hire more people.

Allison, M. (2008, 07 02). Business & Technology - Starbucks closing 5 percent of U.S. stores. Retrieved from The Seattle Times: http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

Press, C. (2008, 07 02). Starbucks Boosts Planned Store Closure to 600. Retrieved from CBC: http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html

Rebel, B. S. (2007, 02 23). Starbucks Gossip: Starbucks chairman warns of "the commoditization of the Starbucks experience". Retrieved from Starbucks Gossip: http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

Thomas, J. (2012, 01 09). Starbucks is Raising its Prices, But People Probably Won’t Occupy Starbucks. Retrieved from Motiv Stragegies: http://motivstrategies.com/motiv_blog/2012/01/starbucks-is-raising-its-prices-but-people-probably-wont-occupy-starbucks/

Long Run Costs and Economies of Scale

If I had the chance to run a business it would be a liquor store. It seems that alcohol is always in demand and would probably be a safe bet if the business was run correctly.

I would start with one small location in a well populated neighbourhood or a busy urban area such as a downtown street with lots of pedestrian traffic. Depending how that location does, there would be interest in expanding the business and opening new locations. How far beyond the city the business would expand again, depends on the success of the business. I would offer a delivery service to homes and parties.

The market is aimed at people who are at the legal drinking age in the province. In the province of Alberta that would be 18.

Opening a new business certainly has its costs. Some examples of fixed costs would be licenses, permits, costs related to the buildings such as utility bills and rent, and salaries.  Long run costs would be the products sold in store. Obviously we would need to look at the size of the store and see how much liquor would be right for the space.

A great example of a successful local liquor store would be Crowfoot Liquor. Their original location is in the Crowfoot area and has now seven stores in the city of Calgary and has locations outside of the city. This is a great strength and the company is working in their economies of scale. They have weekly promotions, so this can help the store decide which products are worth keeping and if there is a preference in price or brand. A weakness of theirs is that they do not offer a delivery service.

http://www.crowfootliquor.com/

Law of Diminishing Returns

Pierre Lemieux’s 2001 article “The Diminishing Returns to Tobacco Legislation” has some interesting points about government intervention in the tobacco industry.

The article mainly points out taxes the government and imposed regulations on packaging over the years. The most notable being that between 1985 and 1995 taxes were increased significantly enough to raise the price of cigarette packs by 52%. There was a drop in consumption by 48% during this time.  There was a further increase in price by 48% between 1995 and 1999 but only a drop in consumption of 11%.

Another considerable change that the government made in the tobacco industry was the inclusion of health warnings on cigarette packets but this action doesn’t seem like it was enough to encourage smokers to quit. Lemieux believes that government involvement in this was “less effective… smokers who were the most easily persuaded have already quit.” I agree with Lemieux because health warnings alone are not enough to stop people that are heavily addicted to tobacco. “As advice, warnings, and threats from authority become more numerous and visible, they tend to be discounted or ignored.”

It seems that looking at the two periods in reduced consumption, the point of diminishing returns is no longer moving. The peak reduction rate was between 1985 and 1995 and it seems, again, like Lemieux points out that most people who were willing to quit already have.

A solution that can help the government’s production would be free assistance to smokers who are willing to try to quit. They can offer free nicotine patches, gum and other products, include coupons in cigarette packets; also free sessions for professional assistance in quitting. The government could also get more involved in production of these products in order to increase revenue.

With tobacco being demanded by addicts, demand in this case would be inelastic. If the price were to increase, then demand would stay the same. Governments take advantage of this by increasing revenue with taxes known as sin taxes. These taxes apply to tobacco products and most alcohol products


Lemieux, Pierre, http://www.pierrelemieux.org/artdiminish.html

Travel

Travel from the US has declined. This is most likely due to the increase of the Canadian dollar which discourages travel from the US but has seen an increase of Canadians travelling to the US. The increase in the Canadian dollar has made the exchange rate higher In the US and has increased the cost for US travelers to visit Canada. So if it is true that the exchange rate is a cause of decline in US travel to Canada then the demand would be elastic.

With international travel on the other hand, the exchange rate my work in favour of travelers from other countries. Another factor may be that the economy of other nations is currently stronger than that of the US. 

Other products in the travel industry that have an elastic demand would be air travel and hotels. The more visitors that arrive in Canada, the more hotels are demanded as well as flights.

Canadian Tourism Commission: http://en-corporate.canada.travel/sites/default/files/pdf/Research/Stats-figures/Tourism-performance/Quarterly%20International%20Travel%20Accounts/ITA_Q1_2010_EN.pdf

Elasticity

Arguably the leading company in technology right now is Apple. Everything they sell is extremely popular. There are lineups outside shop doors whenever there is a new product of theirs that hits stores. It is rumored that Apple will launch their newest product on October 17^th; the iPad mini.

The new iPad is highly anticipated with orders reportedly at 10 million units. Experts say that the major factor that determines the success of the new iPad is the price. If the price is below $300, then great success is anticipated.

Price elasticity of demand is the responsiveness of quantity demanded to a change in price. If demand for the new iPad is as high as predicted, then the demand will be inelastic, meaning that the quantity demanded is not very responsive to a change in price. The maximum price in this case is very important because if the price exceeds $300 then the demand will be elastic or is quite responsive to a change in price and demand will be at its lowest point. It is also worth noting that unitary elasticity is the point the percentage change in quantity is exactly equal to percentage change in price, so then, total revenue does not change.

Here is a graphed example of elastic and inelastic demand of the new iPad:

To calculate elasticity we simply take the percentage change in quantity and divide it by the percentage change in price. If the elasticity is over 1, then we have elastic demand. Elasticity demand of 1 is unitary and elasticity below 1 is inelastic.

The bottom graph shows how elasticity effects total revenue. At the midpoint, revenue is at a maximum while demand is unitary.  When price elasticity of demand is greater than 1, the total revenue rises. Also when price elasticity of demand is less than 1, the total revenue falls.

Durham, Jessica, Apple iPad Mini to Sell Millions, Strong Demand, Details on Release Date, Rumors, Why Price is Essential to Dominate Nexus 7, Kindle Fire 2,HD
http://www.booksnreview.com/articles/1316/20121008/apple-ipad-mini-sell-millions-strong-demand-details-release-date-rumors-why-price-essential-dominate-nexus-7-kindle-fire-2-hd.htm

Determinants of Demand

Determinants of demand are normal products, inferior products, substitute products and complementary products. The demand of normal products increase as income increases and demand decreases when income decreases. An example would be the latest video games. As our income increases, so does demand for video games. The demand decreases while our income does.

Inferior products on the other hand are products that experience an increase in demand as our income decreases and a decrease in demand as our income increases. No name brand products would be an example of inferior products. As income decreases, the demand for no name products rises.  As income increases, the demand for no name products decreases and there is an increase in demand for brand name products.

Switching from brand name products to no name products is an example of substitute products. If the price of a product increases, then there will be more of a demand for a similar product.

The demand for complementary products is related because they are purchased together. If you recall the video game example, let’s say that there is a new games console released and there is a high demand for it. Then there would also be an increased demand for accessories such as games, cables, extra controllers, etc.  

 Another example of substitute products effecting demand would be in the case of the Chicago Tylenol scare in the 80s.

There were a number of bottles of Tylenol that had been tampered with. Seven people died as a result of taking extra strength Tylenol with traces of cyanide in the capsules. Johnson & Johnson recalled all their bottles of Tylenol. Demand for Tylenol dropped significantly until the late 80s when Tylenol was re-launched.  While the demand fell for Tylenol, demand increased for substitute products.

http://iml.jou.ufl.edu/projects/fall02/susi/tylenol.htm

http://mediaguru-mayopr.blogspot.ca/2007/05/remember-tylenol-scare.html