Problems

Posted: August 12th, 2013

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Problems

Normal economic profits in perfect competition

The phenomenon of maintaining level profit margins in a perfect competition environment entails various aspects. However, in the long run, economic profit becomes inherently unsustainable. The entry of new organizations, or the growth of existing companies in the market, causes the horizontal demand curve of each firm to swing downward, given the returns to scale are kept constant. This action simultaneously brings down the average revenue, the price and marginal revenue curves. The result is that, in the long term, the company will realize only normal profits that can be categorized as zero profit. Normal profit denotes the opportunity cost for doing business and not making any extra profit over the operating costs.

Perfect competitions are characterized by many buyers and sellers. All of the companies within such an environment offer the same products or services. The sellers and buyers also have accurate and updated information on the activities within their market. Lastly, perfect competition is marked by little or no barriers such as transaction costs and entry or exit barriers. It is against this backdrop that the average firm operates, and this means that no single company can dominate the market. One pertinent assumption that underlies the hypothesis of perfect competition is that of a liberal entry and exit policy. If companies can earn short-term economic benefits, in the long run, extra firms will penetrate the market with the intention of reaping most of those profits. As more companies penetrate the market, the market supply curve will shift to the right. At the optimum market price, each company receives just about adequate profits to cater for the average production costs. Average cost of production is considered because, in the end, there is no distinction between variable and fixed costs.

Competitive markets are typically considered as having an adequate number of both sellers and buyers in levels that no single buyer or seller can exercise control over the market. In such situations, efficiency is assumed to exist because the competition amongst buyers compels them to accept their maximum price demanded and similarly, competition among sellers compels them to charge their minimum supply price for the particular quantity traded. If the state were to determine prices in the market, there would be more inefficiency as the government would not consider the particular market clearing prices. If the market prices are not balanced, there arises a disequilibrium that results in a loss of welfare and an over allocation of resources. This is especially if the prices of goods and services are set very low. Conversely, perfect market forces automatically change prices in the market towards equilibrium where everyone gets what they deserve.

Case for and against the consolidation of market power

Consolidation refers to the process of joining of one or more firms that are similar, be it smaller or larger into one corporate body. Consolidation occurs when more markets mature and the dominant players emerge by buying up the other smaller firms.    In the event of such a phenomenon occurring, the playing field is immediately changed. Whereas a firm had its own independent program, targets and scope, the acquisition of another company immediately changes the playing field. This state of affairs promotes further cooperation between the two players in different sectors.

Another major advantage of consolidation of market power is customer satisfaction and engagement. Consolidation means that the different market players can pool their resources and capital to come up with more comprehensive, complex and efficient goods and services at a lower cost as compared to doing the same individually. Customers always have expectations that are seldom met by any firm and this can be rectified by consolidating market power to match that of bigger companies. In a monopoly model, consolidation of market power would prove disastrous to the smaller firms in that they would have lesser or no influence over the activities of the market. The idea that a company has the sole freedom to sell particular good in a market evidently awards that firm superior market power than it would posses if it struggled against other businesses for customers.

Disadvantage of consolidation of market power

In the event of a market consolidation, the power will be centralized to the most aggressive and resourceful firms, and consequently, the options will be limited. There is a low level of consumer sovereignty in markets having monopolistic structures. Customers have little or no say in making decisions concerning their choices, tastes and preferences. The companies that have consolidated power have an upper hand in that they control the quality and amount of goods and services that the consumer can access. This low level of quality is brought about by monopoly that lacks the strong pressure on the producers (Baye, 11).

`           A monopoly market is disadvantageous in that it promotes consumer exploitation. There is little competition from other smaller companies and therefore, the consumer gets access to injustices in terms of pricing, quality and quantity. The firm uses minimal resources to produce substandard or imperfect goods with prior knowledge that at the end of the day, all the substandard items will be bought, as there is no competition in the available market. Because of this, customers are always disgruntled as they get a raw deal in terms of compromised quality. Therefore, it is very common to spot very discontented customers who often criticize the firm’s products. Monopolies also mean little or no price wars that could benefit the consumer by lowering the prices. Monopoly firms therefore charge higher prices on goods and services.

Advantages of product differentiation in monopolistically competitive markets

Product differentiation is a dominant feature of all monopolies. Within these types of companies, there exist four major types of differentiation: The physical product differentiation that deals with the design, size and color of the product, the marketing differentiation that affects the promotion and packaging, the human capital differentiation and the differentiation through distribution. The purpose of product differentiation is to discern the product of one manufacturer from that of the other producers in the business. In monopolistic competitions, firms trade products that have genuine or apparent non-price differences. Although in monopolistically competitive markets, the products sold by different companies are similar enough to be considered substitutes, they are not equal (Baye, 149).

Benefits and costs of increasing your ad/sales ratio in a competitive environment

Benefits

Advertising to sales ratio refers to the assessment of the success of an advertising promotion that is realized by dividing the sales revenue by total advertising expenses. The advertising-to-sales ratio is used to determine whether the resources spent by a firm on an advertising promotion contributed toward new sales. High advertising-to-sales ratio signifies that the large advertising budget yielded low sales income. This would mean that the advertisement program had failed. A low ratio indicates the advertising campaign created sales. The purpose of advertising is to increase the market share by manipulating awareness of a company and its products. Since an increase in advertising is expected to improve the number of prospective customers that are acquainted with a product, such changes are expected to generate additional sales. Another benefit of increasing the advertisement to sales ratio is that firm cans reach a bigger audience with the aggressive advertising campaign. Getting and retaining customers is a core objective of most firms and through advertising, they can achieve these objectives.

Costs

            Increasing the advertising/ sales ratio for a firm can also have tragic consequences. Poor implementation of advertising strategies would mean heavy losses for the firm. When most of the elements are executed poorly, the company will have invested in loss making initiative. Choosing irrelevant messaging, poor choice of the right media channel and timing are all faults that may lead to the failure of an advertising campaign. Conversely, the advertising budget may already be operating on the red line therefore meaning that both sales and profits were at their peak for the firm. In such cases, increasing the budgetary allocation for advertisements will not result in incremental profits. It is therefore unlikely that overspending will result in any tangible gains and managers should instead focus on controlling the advertisement expenditure to satisfactory levels (Baye, 19).

In a competitive environment, overspending financial resources on the advertisement campaign can lead to the ultimate demise of the firm engaging in too many advertisements. Most extravagant expenditures in advertising result in increased awareness that only benefits other firms having similar products or substitutes. Such firms realize the effect of one firm and maintain or even lower their budgets respectively. Unsuccessful advertising expenditures therefore stimulate primary demand that will benefit other firms selling similar products.

Part 4.

1. A. The level of output = 8

B. Price =$40

C. Total Cost= $88

D. Average Total Cost = $15

E. Fixed Costs = $28

F. Profit at this level of output= $48

G. Lowest profit= $12, loss is at price lower than $12

H. The entity should not continue with its operations, as its average total costs are higher than the marginal revenue.

2.

A. Output c= 40+8q+2q^2

-8q= c- 40 -2q^2

8q= c-2q^2-40

B. Price in short run = $82

C. Short-run profits= $(40*11)

= $440

D. Increased production will decrease costs associated with low production.

3.

A. Optimal output= 18.5

B. Optimal price = $220

C. Profits = $220*18.5= $4,070

D. Increasing the price of the product would provide an increase in revenues and a decrease in the costs of production.

4.

A. P=200-2Q and C (Q) =2,000+3Q^2,

200-P=2Q,

C= 2,000+ 3(100-1/2P) ^2

C= 2,000+3(10,000+0.25P

C = 2,000+30,000+0.75P

B. C= 32000+0.75P

C=0.75P

P= C-0.75

P= 32,000-0.75+0.75

P= $31,999.25