Strategies For Reducing Alcohol Consumption And Market Dynamics In Monopolistically Competitive And Oligopolistic Markets, Essay.

1.Assume the government wishes to reduce alcohol consumption by considering a higher excise tax on alcohol products. Collect information on estimates for the price elasticity of demand for alcohol products. Based on these elasticity estimates illustrate using a demand/supply diagram(s) who bears the burden of the higher excise tax, consumers or producers.

As an alternative for reducing alcohol consumption assume the government is also considering the imposition of a minimum price on alcohol products. Using a demand/supply diagram illustrate the consequences of imposing a minimum price on alcohol for the consumption of alcohol products.

Provide comment on the relative merits of increasing excise taxes compared to imposing a minimum price on alcohol products for reducing alcohol consumption.

2.a) Assume that in long-run equilibrium the minimum point of the LRAC curve for a table manufacturer’s tables in $200 per table. Under conditions of monopolistic competition, will the long-run price of a table be above $200, equal to $200 or less than $200. Explain your answer.

b) What are of the characteristics of an oligopolistic market? Give three examples of industries with oligopolistic firms in Australia. Justify your examples by relating them to the characteristics of oligopolistic firms.

c) What are the characteristics of a monopolistically competitive market? Give three examples of industries with monopolistically competitive firms in Australia. Justify your examples by relating them to the characteristics of monopolistically competitive firms.

d) Assume that two firms make up a natural duopoly. What are the conditions which may make this occur? Sketch the market demand curve and cost curves that describe the situation in this market and that prevent other firms from entering.

Enhancing the excise duty

1.The alcohol menace needs proactive action on government’s part which may be necessitated through the following two measures that have their own individual merits.

The pivotal aspect of any strategy to tackle the problem of alcohol abuse or addiction is the increase in the price as higher price tends to act as the deterrent.  This is also true for this particular strategy which also relies on price increase as it tends to raise the indirect tax associated with alcohol which is to paid by the manufacturers of alcoholic products.  As the tax levied on them increase, there is a cost increase which if not passed on to the end consumers would result in drastic reduction in profits (Arnold, 2008).

However, a critical aspect in this regard is to take prudent decision on the level of tax burden that would be borne by the firm and the remainder would be borne by the consumer. The key concept to enable the above reasoning is price elasticity of demand of the underlying product. This is imperative since it enables in understanding the reaction of customers to likely increases in price (Nicholson and Snyder, 2011). For instance in relation to products with high elasticity, small changes in price can bring about he changes in quantity and thus if the price of the end product in increase even by small amount, the impact on sales could be significant.  In such a market scenario, the tax burden to a large extent is absorbed by the suppliers thereby lowering their margins of profit.  However, this is not the case when underlying markets are inelastic. In such a market, the customers are highly tolerant to price with minimal changes in quantity. Thus the suppliers in such market are confident while hiking the price for the end consumer (Pindyck and Rubinfeld, 2001).

For alcohol, the price elasticity would tend to vary across segments but there is no denying the in general demand is inelastic. The extent of inelastic demand tends to vary across different consumers.  Based on this, it would be fair to consider a price elasticity for a given alcohol product to be -0.3. In line with the discussion above, the taxation burden would be disproportional on customers, which is apparent from the relevant graph indicated below.

As represented in the above diagram, customers bear a lion share of the higher tax burden and still the decrease in quantity is minimal only. However, the behavior of this price rise would be different in various segments depending on their nderlying elasticities (Krugman & Wells, 2008).

The given method offers a very big advantage which is in the form of incremental revenues for the government through higher taxation. These incremental funds could be used to wage a war on the alcohol related menace from various fronts. On one hand there is an increase in the price and on the other the government could focus on generating higher awareness regarding this issue and providing requisite facilities for rehabilitation to the alcohol addicts.  Another potential positive aspect of utilizing this strategy is that the profit margins in the business tend to decline and hence this could stop the proliferation of suppliers (Mankiw, 2014).

Usage of minimum price pegged at more than market price

b.Usage of minimum price pegged at more than market price

Another strategy which aims to tackle alcohol problem by increasing the prices is the usage of higher minimum prices in the industry. This order tends to lead to a demand supply mismatch which is estimated below (Besanko & Braeutigam, 2010).

Clearly, like in the excise strategy, the minimum price levying would tend to lead to lesser quantity demanded atleast across the more elastic markets. However, for the addictive people, this strategy would make little difference except for further impoverishing them on the name of the state (Mankiw & Taylor , 2011).

This particular method tends to have its relative merits and demerits. The merits include better reflection of higher costs and lower alcohol consumption in some segments. The demerits of this strategy include high profitability of alcohol manufacturers which would result in the proliferation of the overall supply since businesses may be lured by the increase profitability in the business. Additionally, the indirect impact of this strategy is limited as it does not aim any of the public bodies with providing of public funds (Pindyck and Rubinfeld, 2001).

Conclusion

The above discussion hints that both the underlying strategies rely on higher prices in order ot control consumption. But, for a problem as deep-rooted as alcohol abuse, a multi-pronged strategy is required. In this regards, the government is ought to play a bigger role which is feasible only for the option where excise duty is increased as in the second alternative the government support is minimal.

2.The factors of production tend to variable in the long run as against the short run and this aspect would be helpful in understanding the long term equilibrium dynamics associated with the monopolistic competitive market.  It is quite possible in this market that the firms in the short run may exhibit a profit or a loss. Based on whether they achieve a profit or loss, in the long run the supply would either increase or decrease respectively.  This tends to alter the market dynamics and in the long run equilibrium is attained as indicated in the graph below (Mankiw, 2014).

Since this market offers very little resistance to firms either willing to enter or exit, thus based upon the short term profit/loss there would be alternation in the number of firms present which eventually would given rise to the above. For instance, if in short term profits are realized by the firm, then the new players would tend to enter the market and this would result in greater supply which might find hard to be absorbed considering the static demand.  This leads to reduction in price in the long run to a level in the long run where the economic profits are zero. Similar trend is also noticed when in the short term losses are made and certain firms exit the industry so as to help the industry manage supply in a manner that economic profits should be zero (Krugman & Wells, 2008). Thus, the above discussion suggests that LRAC and price in this case would be equal at $ 200.

a.Features of Oligopoly (Mankiw, 2014)

• While there are a larger buyers of goods but the providers or sellers are only handful in number.
• The entry barriers tend to be potent usually in the form of upfront capital, skill , brand and limited availability of some scarce resource. The exit option is also difficult as it typically would mean high loss.
• There is quality and attributes based price differentiation using mechanisms such as promotion and advertising.
• Even though the decisions in regards to price and output is essentially in the hands of the underlying firm, but this is exhibited after considering the ongoing prices and moves by the rival firms.

b.Examples of oligopoly (Australia)

• Retail Industry –  This industry across various segments has only limited sellers which tend to have a high concentration index with top 4-5 firms occupying a majority of maret share.  There are issues in making an entry into this industry as huge capital costs are required for just starting the business coupled with other issues. Exit also is difficult due to the high capital already invested which may be wiped in case a distress sale. The competition in this industry is not essentially price based but also quality based.
  
  
• Mining Industry - This industry across various segments has only limited sellers which tend to have a high concentration index with top 4-5 firms occupying a majority of maret share.  There are issues in making an entry into this industry as huge capital costs are required for just starting the business coupled with obtaining regulatory approvals and mines. Exit also is difficult due to the high capital already invested which may be wiped in case a distress sale. The competition in this industry is not essentially price based but also ore - quality based
  
  
• Banking industry  – This industry across various segments has only limited sellers which tend to have a high concentration index with top 4-5 firms occupying a majority of maret share.  There are issues in making an entry into this industry as huge capital costs are required for just starting the business coupled with regulatory approvals. Exit also is difficult due to the high capital already invested which may be wiped in case a distress sale. The competition in this industry is not essentially price based but also service quality based.

c.Features of monopolistic competitive market (Arnold, 2008)

• Both the sellers of products/services coupled with buyers of these are present in ample quantity just like perfectly competitive market.
• However unlike perfectly competitive market, the information available with the buyers is far from perfect.
• The exit and entry barriers are only marginally higher than the corresponding level in perfectly competitive market.
• Heterogeneity in product and services offered is noticed and this requires use of advertisement to maximize customers.

Example of monopolistically competitive industries (Australia)

Fast food –  In this industry, the customers would have many options available in terms of providers and would not have perfect knowledge of which one would be best as the differentiation in product/service is significant in this segment. Further, in attracting the customers, the individual players need to invest in some form of promotion. Also, the low capital requirements and scope to differentiate implies low barriers for both entry and exit.

Grooming industry – In this industry, the customers would have many options available in terms of providers and would not have perfect knowledge of which one would be best as the differentiation in product/service is significant in this segment. Further, in attracting the customers, the individual players need to invest in some form of promotion. Also, the low capital requirements and scope to differentiate implies low barriers for both entry and exit..

Coffee café industry – In this industry, the customers would have many options available in terms of providers and would not have perfect knowledge of which one would be best as the differentiation in product/service is significant in this segment. Further, in attracting the customers, the individual players need to invest in some form of promotion. Also, the low capital requirements and scope to differentiate implies low barriers for both entry and exit.

(d)  For the prevalence of natural duopoly, it is imperative that the cost dynamics should be such that presence of a third player makes the industry unstable which is the case here as entry of an additional firm would lead to losses for all the sellers. As a result, one player has to exit the market in order to bring back a stable equilibrium state (Nicholson and Snyder, 2011).

The relevant curves indicated equilibrium position in a duopoly is indicated below.

In reference to the above graph, it becomes evident that entry of any incremental player tends to create an unstable situation which is on account of decrease of equilibrium price caused by a supply surge which the demand is not able to accommodate.  The resultant MR tends to come down to a lower point which results in all the firms making losses. Further, no firm can raise the final price as a bid to break even may result is significant market share loss.  Hence, the only manner to restore equilibrium is for one of the firms to exit the market so that previous duopoly could exist again (Krugman & Wells, 2008). 

References

Arnold, A.R. (2008). Microeconomics (9^thed.), Sydney: Cengage Learning.

Besanko, D. & Braeutigam, R. (2010).Microeconomics (4^thed.), New York: John Wiley & Sons.

Krugman, P. & Wells, R. (2008) Microeconomics (2^nded.), London: Worth Publishers.

Mankiw, G.(2014) Microeconomics(6^thed.), London: Worth Publishers.Mankiw, G.N. & Taylor, P. (2011) Microeconomics(5^thed.), Sydney: Cengage Learning.Nicholson, W. & Snyder, C. (2011).

Fundamentals of Microeconomics (11^thed.), New York: Cengage Learning.Pindyck, R. & Rubinfeld, D. (2001) Microeconomics (5th ed.), London: Prentice-Hall Publications