i. List the items that Peter would consider to compute his explicit costs.
ii. List the items that Peter would consider to compute his implicit costs.
iii. Compute Peter's monthly total economic cost.
iv. Should Peter continue his business? Support your answer with calculations.
The purpose of this assignment is to enable students to enhance their knowledge and understanding on the market structure and different pricing approach in the economy.
a. What are the reasons for the existence of monopoly in a particular industry? Provide example for each.
b. Discuss and provide example of different price discrimination that exist in the Malaysian market.
c. In your opinion, which price discrimination is acceptable in the market? Justify your answer.
Stages of production and different factors affecting output
The demand function for Multipurpose Double-Sided Magic pan is given as
QM: Quantity of Magic Pan demanded
PM: Price per unit of Magic Pan
PT: Price per unit of another brand of pan
Y: Income level per household
A: Advertising expenditure
In the demand equation, coefficient of income has a positive sign. The microeconomic theory of demand suggests that for a normal good, an increase in income leads to an increases in demand. The income coefficient thus has the expected sign. Firms promote their product through advertising. The adverting thus likely to have a positive impact on demand. The coefficient of advertising here found to have a positive sign. For substitute goods, demand of a product changes in response to change in price of the substitute good. Price of one good has a positive effect on demand of the substitute. Coefficient of price of another band of pan has a positive sign. Sign of the estimated coefficient thus goes in line with economic theory. Lastly, own price of the magic pan has a negative sign. This is again supported by economic theory of law of demand which depicts an inverse relation between demand and own price.
The value of R square is given as 0.87. The R square value is high and close to 1. This means that own price, price of another brand of pan, income level and advertising together explain 87% variation in the demand of quantity demanded of Magic Pan. The R square is a measure of goodness of fit. Based on the high value of R square, the estimated equation can be expected.
In order to test statistical significance of the coefficient, the t ratio of each of the coefficient needs to be estimated. If the absolute value of computed t is greater than 2 which is the critical t value at 95 percent level of significance then the variable is said to be statistically significant.
|
t ratios
|
|
Variable
|
Coefficient
|
Standard error
|
t -value
|
|
PM
|
-10
|
4
|
-2.5
|
|
PT
|
5
|
4
|
1.25
|
|
Y
|
30
|
7
|
4.29
|
|
A
|
10
|
3.5
|
2.86
|
From the above table, it has been observed that among the four explanatory only the variable representing price of another brand of pan has computed t value less than 2. Therefore, all the independent variables except PT are statistically significant.
Given PM = 250, PT = 250, Y = 50 and A = 400, the current quantity demanded for Multipurpose Double Sided Magic pan can be estimated as
The cross price elasticity is positive. This implies a change in the price of another brand of pan has a positive influence on demand of Multipurpose Double Sided Magic pan. With 1% increases price of other brand, the demand for multipurpose double sided magic pan increases by 0.35%
Explicit and implicit costs in business
The income elasticity is less than 1. That is in response to a change in income, change in demand is proportionately less than the corresponding change in income. This is the case of necessity good.
The model of kinked demand curve in an oligopoly market developed by Paul M. Sweezy is based on the following assumption
- The model assumes presence of a few firms in the oligopolistic market
- The few firms in the market are selling a product that is close substitute to each other.
- The product quality remains same and the firms do not engage in advertising
- There is set of price for the product that has been already decided and prevails in the market.
- Each firm has a belief that if it lowers its price then rivals will immediately follow the same. However, the same does not happen when it increases price (Fine, 2016). If one firm increases price the others keep their prices same to make their product relatively cheaper. The asymmetry in the reaction pattern of firms make the demand curve kinked at the existing market price.
Because of the kinked demand curve, firms in the oligopoly market face a price rigidity. On the inked demand curve, slope of the demand curve differs under condition of price increase or price decrease. At price above the prevailing price the demand curve is highly elastic while below this price the demand is inelastic.
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Figure 1: Kinked demand curve and oligopoly market
(Source: as created by author)
In the above figure suppose prevailing price in the market is P*. Any attempt to change price a price different from P* can expected to have three different reactions from rival firms. First, it the firm increases price, then demand curve of the firm shifts to DD’ from dd’. As the new demand curve is more elastic buyers switches to the similar products of the rival firms reducing sales volume of the firm. If the firm on the other hand reduces its price, then other will reduce price as well resulting in a smaller sales of the concerned organization (Svoboda & Kopecka, 2017). Second, the rivals do no react on pricing strategies. Third, rivals only follow the strategy of lowering price but not the strategy of price hike.
In the presences of kinked demand curve, the marginal revenue curve is discontinuous as shown in the figure above. The profit maximizing point is E, where marginal revenue curve meets with marginal cost curve. Now, in response to an increase in cost shown by the upward shift of the MC curve the firm cannot raise its price in fear that other will lower their price to gain a higher market share (Baumol & Blinder, 2015). The new equilibrium is at E1. As there is no difference in profit between E and E1, firms lack motivation for changing price. Price and output therefor remain stable.
Total product of a factor input is the amount produced with a given input holding other inputs constant. Average product is the output obtained per unit of the employed input. Marginal product is the change in total produce due to unit increase or decrease in factor inputs. The relation between total product, average product and marginal product can be explored by using different stages of production (Ilut, Valchev and Vincent, 2016). The figure below describes three main stages of production with one variable factor. The variable factor is measured in horizontal axis while total, average and marginal product is measured in vertical axis.
Market demand curve equation and elasticity of demand
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Figure 2: Different stages of production
(Source: as created by Author)
The TP curve shows the total product. Initially, total product increases with increases in variable factors. TP rises at an increasing rate till point C. Up to this point TP curve is concave in shape. When TP increases at an increasing rate, then marginal product (MP) is also rising. The increasing trend in marginal product also pulls up average product (AP). The marginal product in rising till the point D which is exactly vertically down to C. After point C, total product still rises but at a decreasing rate (Leontief, 2016). From C onwards, the TP curve is concave in shape. As TP starts increasing at a diminishing rate, marginal product starts falling. Marginal product though falls but remains positive. The average product however continues to increase. The first stage ends at point F, which denotes the maximum point of average product.
In stage two, TP still increases at a diminishing rate and then reaches its maximum point at F. This is the point where stage II ends. At stage II, AP and MP both are falling and MP falling at a much faster rate but none of them is negative. This stage is called the stage of diminishing return. The fall in average product implies a decline in efficiency of variable factors while that of the fixed factor continues to increase (Merhav, 2017). Corresponding to the highest point of TP, MP is zero. Second stage is the most crucial as production operation takes place at this stage. After this stage TP starts falling making MP negative. AP is also falling at a faster rate. This stage is known as stags of negative return.
The items that would consider for explicit cost are operating cost of fuel, maintenance cost and depreciation.
The items included in implicit costs are rent of the similar office like that peter has and salary he could have earned by working in a competing construction company.
Revenue that can be earned from the business per month is RM 35,000. As the economic cost exceeds the earned revenue, Peter should not continue the business.
Market demand curve equation
At price = 30,
Demand for Ceria Orphanage (C)
Demand for Jaya Orphanage (J)
Quantity demanded for the market as a whole
Slope of the demand curve
The price elasticity of demand is obtained as -1.56. Measure of elasticity greater than 1 implies that proportionate change in demand is greater than the corresponding change in price. This in turn means the T shirt demand is elastic in nature.
Monopoly and its reasons for existence in an industry
The first order condition for revenue maximization requires
She should charge a price of 52 for each unit in order to maximize revenue.
The first order condition for profit maximization requires
Therefore, profit maximizing output is 3.33 ~ 3
She should charge $176 to maximize profit.
Monopoly is a market where a single seller has control over the entire market. Following are some of the basic reasons for existence of monopoly in an industry
Ownership over a strategic resource
When one single firm or individual enjoys an exclusive control over a strategic resource that is needed to make a particular product then the market become a monopoly (Ahamat, Rahman & Mohamed, 2015). For example, if one company has exclusive right over an ingredient that is used to make a life-saving drug, then the company become the monopolist in that particular industry.
Government Franchise
Monopoly market often arises from government support that allows only a single firm (private or public) to serve the entire market. The railway transportation service is a common example of national monopoly. Here the government grants permission to a single firm to control operation of the passengers’ train in a nation.
Intellectual Property Protection
Another way through which monopoly arises in the industry is the extension of intellectual property protection by granting patent or copyright. Patent provides firm an exclusive right to supply a product in the market.
Natural monopoly
This is a special form of monopoly where a single firm exists simply because it is cost effective for one firm to serve the market instead to two or more (Carlton & Perloff, 2015). The existence of huge fixed cost makes it difficult for other firms to enter the market. Water supply, electricity and public utilities are examples of natural monopoly.
Tenaga Nasioanl Berhad (TNB), Keretapi Tanah Melayu (KTM), Syarikat Bekalan Air Selangor Sdn. Bhd, Telekom Malaysia are some existing monopoly companies in Malaysia. TNB devices a monopoly right over electricity distribution and communication in the Peninsular of Malaysia. In the consumer market, TNB uses the strategy of price discrimination. The price discrimination used by TNB is similar to second degree price discrimination. TNB charges a certain price up to a certain amount of usage (Ahamat, Rahman & Mohamed, 2015). After the particular amount, the company charges a different price for next units of usages. For example, the price for first 200 kwh of usage is 21.8 sen/kwh. This raises to 33.4 sen/kwh for usage lies between 201-300 kwh.
Another form of price discrimination in Malaysia is in form of quantity discount. In Malaysian market Nestle charges a price of RM 7.99 for per bottle of fat free yogurt but the discounted price for 2 bottle is RM 14. That means purchases for two bottles cost RM 7 each (thestar.com.my, 2018).
Second degree price discrimination is the most acceptable form of price discrimination. In this form of price discrimination, firms are not able to completely differentiate between different consumer types. As firms do not know exact consumption pattern of the individual they cannot grab all the consumer surplus (Fine, 2016). Consumers have freedom to choose how much quantity is to consume at the determined price. This in turn allows buyers to differentiate themselves as per their preferences. This type of price discrimination commonly found in supermarkets, airline industry and others.
Reference list
Ahamat, H., Rahman, N. A., & Mohamed, A. M. H. (2015). Competition Law and Affirmative Action in Malaysia: Complementarity or Conflict?. Pertanika Journal of Social Sciences & Humanities, 23.
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.
Carlton, D. W., & Perloff, J. M. (2015). Modern industrial organization. Pearson Higher Ed.
Fine, B. (2016). Microeconomics. University of Chicago Press Economics Books.
Ilut, C.L., Valchev, R. and Vincent, N., 2016. Paralyzed by fear: Rigid and discrete pricing under demand uncertainty (No. w22490). National Bureau of Economic Research.
Leontief, W. W. (2016). Essays in Economics: v. 2: Theories, Facts and Policies. Routledge.
Merhav, M. (2017). Technological dependence, monopoly, and growth. Elsevier.
Nestle Malaysia to strive to maintain product prices - Business News | The Star Online. (2018). Retrieved from https://www.thestar.com.my/business/business-news/2015/10/26/nestle-to-strive-to-maintain-product-prices.
Svoboda, R., & Kopecka, L. (2017). The Sweezy model of price competition among private labels of chain stores. Agricultural Economics (Zem?d?lská Ekonomika), 63(7), 299-307.
